There’s Only One Form Of Sublease: The One That Fits The Deal

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For reasons that will go unexplained, Ruminations has been thinking, lately, about subleases. It hasn’t been the ins and outs, the details, the clever wording, that’s been on our mind. No, we’ve been taking a step backwards and Ruminating about some conceptual issues, like “what type of sublease?

[There’s a quiz at the end of today’s posting, unrelated to subleasing. Take a gander.]

You see, if you pull a subleasing form out of the “book,” what you get is a document that overlays the underlying lease. A popular local form freely admits to this when it uses such terms as “Overlease” (the tenant-landlord lease already in existence) and “Overlandlord” (the “tenant-sublandlord’s own landlord). Basically, these forms try to put the subtenant in the tenant-sublandlord’s shoes, making the subtenant do (almost) everything the tenant-sublandlord is required to do under the underlying lease between the tenant-sublandlord and its own landlord. These forms try to make the subtenant look, not to its own “landlord” (the tenant-sublandlord) for any work that needs to come from the (actual) landlord (think: property owner), but to the tenant-subtenant’s actual landlord (again, think: property owner), the third player this three actor play. Is that a little confusingly written? We think so. Here’s why.

Subleasing terminology can be somewhat confusing, there being overlandlords, master landlords, landlords, lessors, master lessors, superior landlords, superior lessors, tenants, lessees, sublessors, sublessees, subtenants, undertenants, indwellers, renters, and whatnots. Today, we’re going to restrict ourselves to only a few terms and we think they will be self-explanatory: there are two documents, the Master Lease, and the Sublease; and there are three parties, a Master Landlord, a Tenant-Sublandlord, and a Subtenant.

Until now, we’ve never really thought about the relationship between “why” someone has chosen to sublease and what kind of Sublease document approach would be called for. But, last week, when we listed a slew of reasons why a transaction might take the form of a ground lease instead of as an outright sale, we realized that for income-producing projects, the ground tenant would be generating multiple Subleases. Even for financing projects, the ground tenant, often a governmental lending authority, would be subleasing the leased land. That’s a whole lot different from when a tenant leaves its leased store space and sublets to another retailer.

What’s the core difference when it comes to creating an appropriate Sublease document for a given situation? Simply speaking it goes to “who has what responsibilities?” More fundamentally, as we’ve written before, the issue is a bifurcated one: “Who does the work? Who pays for the work?” The two answers, as to each “tenant” obligation, may be same, either one or the other party, or may be split between the Tenant-Sublandlord and its Subtenant. Remember, the Sublease will not change the Master Landlord’s rights or responsibilities. Only the Master Lease or a separate agreement with the Master Landlord in connection with the Sublease would do that.

At one end of the spectrum lies a shopping center development wherein the Tenant-Sublandlord has ground leased bare land and constructed a monstrous, multi-tenant building or set of buildings. [By the way, “monstrous” doesn’t simply mean “large.”] Its ground landlord has promised very little beyond having good title, not even that it will promptly cash the ground tenant’s rent checks. In such a case, each retailer will be a Subtenant of the Tenant-Sublandlord (the ground tenant). Other than to get some assurance that, if the ground lease evaporates, the ground landlord, as fee owner, will step in as its landlord and that, if a fee lender takes over the underlying land, nothing will disturb its tenancy, the Subtenant expects to be able to completely disregard the existence of the land-owning ground landlord. It expects to look directly, and only, to the Tenant-Sublandlord as if the Tenant-Sublandlord owned the underlying ground. In that respect, the Sublease would look just like a (prime) lease but for some mention that, in figurative small-size font, it is subject to the Master Lease. Certainly, it wouldn’t look anything at all like an assignment.

At the other end of the spectrum might be the situation where a Tenant-Sublandlord is vacating its space and effectively going out of business except that it will remain in existence solely to hold some assets. It needs to shed itself of all active duties and to shield itself, as best it can, from any obligations to the Master Landlord. Ideally, it would have liked to effectuate an assignment of the Master Lease and a release from all liabilities, past and future, but that just wasn’t going to happen. Here, the Sublease would aim to make the Subtenant responsible for all obligations that the Tenant-Sublandlord has under the Master Lease and to make the Subtenant look to the Master Landlord for everything that the Subtenant needs done at the property.

Like the “disappearing” Tenant-Sublandlord, but for an entirely different reason, a Sublease that effectively make the Subtenant “take over” as the Tenant-Sublandlord under the Master Lease commonly is found where the Subtenant is a big and responsible tenant at multiple locations, well versed in abiding by the terms of a lease and well able to make the Tenant-Sublandlord whole if it, the Subtenant, screws up. That would be a situation where, by example, a national retailer takes space over from another retailer.

[At this point, because a few readers might be asking why wouldn’t these Tenant-Sublandlords, seeking to turn over all duties to a Subtenant, want to assign the Master Lease and get off the hook going forward? Well, in a lot of cases they certainly would want to do so, but their Master Landlords might not be cooperative in agreeing to such an arrangement. Or, they might be able to freely sublease the space, but not assign the Master Lease. Or, they might want to take the subleased space back at some later date. Or, they might want to be able to recover the space and mitigate its exposure to future losses by recovering the asset (the Master Lease) if the Subtenant bails out, broke. It doesn’t really matter why. What matters for today’s Ruminations is that the transaction will be a Sublease.]

Now, that we’ve noodled about both ends of the spectrum, the Tenant-Sublandlord being all-in or all-out (to the extent that’s possible), what about a little-in/a little out? Why?

Suppose the Tenant-Sublandlord is initially leasing more space than it needs at first so as to have room for future, planned expansion? Suppose the Tenant-Sublandlord wants to “skinny down,” but still retain a serious presence at the property? In each case, it is still at the property and has a hands-on (eye-on?) presence. It needs to maintain the physical space; it needs to carry the insurance; in fact, it needs, anyway, to keep doing whatever the Master Lease requires it to do. So, why not protect itself and keep on truckin’ [in the key of E, from the 1970 Grateful Dead album, “American Beauty”]?

The “a little in/a little out” approach invokes something we wrote way above about two questions: “Who does the work? Who pays for the work?” As we see it, when it comes to deciding what kind of Sublease approach should be taken, the trick is to figure out, in each case, how much risk the Tenant-Sublandlord is willing to take when giving up control of the space. After all, if the Subtenant fails to perform, the Tenant-Sublandlord is on the hook. So, if the Tenant-Sublandlord can perform the really important tenant obligations under the Master Lease (e.g., maintain the insurance), and charge its Subtenant for the cost of performing those obligations, the Tenant-Sublandlord can reduce its exposure to unexpected losses. If the Tenant-Sublandlord just wants to, or just needs to, step way, way out of the picture, it will have little choice but to accept the higher risk of having only tenuous control over how its Subtenant observes the Master Lease’s requirements.

One might posit that a Tenant-Sublandlord would always like to be absolved of any liability for the Master Landlord’s failure to abide by the Master Lease and would like to make the Subtenant deal directly with the Master Landlord for “all of those things.” Nice work if you can get it (a musical by a different Ira)! In a sublease situation, there is no privity of contract between the Master Landlord and the Subtenant. So, one way or another, the Subtenant will need to be appointed as the Tenant-Sublandlord’s agent so that it can deal directly with the Master Landlord in enforcing the Tenant-Sublandlord’s rights pursuant to the Master Lease. That’s not a risk-free proposition for the Tenant-Sublandlord.

“There’s no limit to how complicated things can get, on account of one thing always leading to another.” – E.B. White. But, we’re all real estate professionals of one variety or another, so we’re up to the task! And that task begins with figuring out what the deal is supposed to be and to fit the Sublease to the deal, not the deal to the Sublease. Beware, though: “The world is full of people who will help you manufacture tornadoes in order to blow out a match.” [Shaun Hick].

Here’s a quiz (perhaps a puzzle) for Ruminations readers.

[Source: The New York Times of Friday, April 18, 2014]

A Gathering of the Tribes, an art gallery in the East Village of New York City since 1991, is closing. Presumably, its lease’s term was at its end. That, and some bad blood between the landlord and the tenant (and disagreement about rent going forward, we would guess), led to the gallery’s demise.

At one time the gallery owner owned the building, but sold it to the current owner in 2004. Nine years earlier, a well-regarded artist, David Hammons (with works owned by the Museum of Modern Art and the Whitney Museum, and called, in a 2006 article in The New York Times: “one of the three or four most interesting and influential American artists of the last 30 years”), did a painting on a non-structural portion of drywall inside the gallery. It was one element of a larger art installation, other parts of which were sold several years ago to a collector.

The gallery has “boxed up paintings and books,” and has removed sections of the Hammons “wall work,” replacing those sections with unadorned drywall.

Here are the quiz’s questions. Is the painted wall a real property fixture or a personal property? What if it were just covered with expensive, antique wallpaper? The gallery owner says: “Personal property.” Its landlord says: “Real property fixture.” Ruminations says: “Click HERE and HERE” for (thin) guidance.”

What do you say? Anyone wanting share her or his thoughts is invited to add a Comment in the panel below.

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