How Can We Get Out Of Here In One Piece? (Part 1)

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Vacation time and the living is easy. Ruminations has a big backlist of material and sometimes we cheat by reaching into it and putting an edited, usually lightly edited, version of “stuff from the vault” in the form of a blog posting. That’s what’s happening this week and at least next week. Just like a resale store, “it’s new to you.” [That is, new to at least nearly all, but not all, of our readers.] Today, tour approach adds up to the first part of a primer, from the Ruminations perspective, on assignment and subletting.

Under common law, absent a lease restriction, tenants were free to assign their leasehold interest to others or to sublet all or part of their leased space. That rule of law is of little consequence today because virtually all leases restrict assignment and subletting rights, often in excruciating detail. In addition, a small number of jurisdictions have reversed the rule by statute and there are certain kinds of leases, generally tied into personal services that are not, as a default matter, freely assignable.

Given that, absent a release, the named tenant on a lease is just as liable for the lease’s obligations after an assignment of its interest or after a subletting of the leased space as before. Therefore, one can wonder if the almost universal imposition of restrictions on such transfers, at least in the first instance, really ought to be the norm. Even though this publication deals with what can happen when those restrictions are poorly crafted or entirely absent, and the problems that arise as a consequence thereof, it lets our wonderment dangle over whatever follows below.

A tenant’s point of view can be succinctly stated: let there be no restrictions whatsoever, but if there are to be any, then there should be as few as possible. What tenants want is to be able to have an “exit strategy.” A time may come when they can’t afford the space and, being obligated to continue paying for the space, need to find someone else to cover those costs. Perhaps the leased space became too large or too small. Perhaps the neighborhood has changed, and the tenant’s products or services no longer fit the location, but someone else’s business could thrive. To tenants, their leasehold interests are an asset, just like a piece of equipment. So they ask: “why can’t we freely sell or rent this asset?”

Landlords are less black and white about the subject. As any leasing attorney will tell you, however, there are landlords at each extreme. Basically, landlords have a fear of the unknown. They know that although they have given up possession of the leased space to a tenant, the landlord still owns the premises. Consequently, landlords want to retain as much control over the space and over the balance of the property as possible. To varying degrees, landlords want to control “who” will actually be using the space and “what” the space will be used for. It isn’t enough to have made a deal with an acceptable tenant in the first place and allow that tenant, with the confines of the balance of its lease, to use the space as and how it sees fit. Lest anyone misunderstand the limits of the preceding sentence, outside of the bankruptcy context, it is a given that regardless of who ever actually occupies the leased space, the lease’s limitations on use and the obligations imposed on the tenant remain fully in force.

At the end of the day, the parties, wanting to acquire their respective benefits from the leasing arrangement, will reach an agreement as to the breadth and scope of the lease’s assignment and subletting limitations. Then, they will wait until a prospective transfer of the tenant’s interests arises, if at all. What follows below is an exposition on the kind of things that can happen if the leasing parties lack the foresight or energy to address them, up front, in a well-crafted lease.

Here is a serious, and obvious, caution: the law differs jurisdiction by jurisdiction. For the sake of brevity, this treatment often ignores those differences, and deliberately so. This treatment is about issues that arise in the leasehold assignment and subletting context. If, in a given jurisdiction, a particular “situation” is “no problem,” more the better. But don’t take comfort the next time because the jurisdiction “across the river” may not be so forgiving. Further, why rely on a given jurisdiction’s law to be a “gap filler,” when the lease itself, in all but the rarest of cases, can spell out the rules for assignments and subletting?

One more caveat. This isn’t a treatise on crafting a lease. Its purpose is to identify situations that give rise to common and uncommon problems that can pop up and bite a landlord or a tenant in the assignment and subletting context. The simplest way to get there from here is to lay out what happens if a lease does not cover a given situation. So, that’s what follows. But, before we start, let’s all get on the same page. By way of background, we’ll begin with a few basics

ASSIGNMENT AND SUBLETTING DISTINGUISHED

Assignments

An assignment is not a subletting, and vice versa. The underlying considerations are not the same. By assignment, the new occupant (the assignee) becomes the tenant itself. Its right to possession of the premises is grounded in real property law – the law of conveyances. At the same time, only if the assignee assumes the lease will it be accepting a direct, contractual relationship with the landlord. If it does not assume the lease, the landlord and the assignee have possessory obligations to each other, i.e., those obligations that run with the land, but not contractual obligations. However, absent an express agreement by the landlord to the contrary or the occurrence of some subsequent “releasing” event, the original named (assigning) tenant isn’t let off the hook. To effectuate a novation, i.e., a full substitution of the assignee for the assignor, the landlord must accept that result. After an assignment, unless the lease or any other document says otherwise, the landlord doesn’t have to deal with its original tenant even though its original tenant remains on the hook. Of course, if the original tenant is granted bankruptcy protection, the lease will remain in effect and the assignee will remain in possession; but, the original tenant may no longer have the secondary liability it once had as a former tenant under the lease. The consequences to the assignee upon its assignor’s (or upon a predecessor assignor’s) bankruptcy might be built-in to the lease itself.

Letting the law run its course may not lead to favorable or even expected results. For example, absent an agreement to the contrary, an assigning tenant, though still liable to its old landlord, is no longer primarily on the hook for a tenant’s lease obligations. Upon assignment, it becomes a surety for the obligations; its assignee becomes primarily liable for those obligations. If the assignee has not assumed the lease, but has only taken possession, it may not even be liable for some moneys owed under the lease, such as obligations to repay a loan. It won’t be financially liable for prior default by its assignor even though it might lose the lease by reason of such a default. It won’t be liable for the obligations of a subsequent assignee, just for what happens while it, itself, is in possession of the leased premises.

So, think of the common and uncommon situations that can arise if a lease does not cover these gaps. If the lease (or a separate document, such as the consent to assignment document) doesn’t make the named tenant primarily liable for the obligations of subsequent tenants by assignment, a landlord may find itself with the equivalent of a guaranty of collection, not a guaranty of payment. That would delay the landlord in collecting what it is owed, and “to delay is to deny.” The antidote is for the lease to state that the named tenant, following an assignment of its leasehold interest, remains primarily liable for all the tenant’s obligations under the lease including those of all subsequent assignees. A more potent provision would make the tenant and all assignees jointly and severally liable for all tenant obligations under the lease no matter when incurred.

If a landlord wants an assignee to be contractually bound to the terms of the lease as if the assignee were the original, named tenant, the parties need make that happen by way of a specific provision in the lease or by requiring an express assumption of the lease from each assignee as a condition of a valid assignment.

Sublettings

A subletting does not change the original landlord-tenant relationship. The subtenant is not in privity of contract with the landlord. It isn’t even in privity of estate with the landlord. It may have possession of the premises through its own (sub)landlord, the original tenant, but it isn’t liable for the debts and obligations of the named tenant. Notwithstanding the subletting, its landlord, the named tenant, remains in possession of the leased premises by reason of the lease. What the tenant has done, vis-à-vis the subletting, is to encumber its right of possession by conveying a portion (in time, space or both) to its selected subtenant. By that conveyance, the tenant is in privity of estate with its subtenant.

In 1928, a Maine court described the difference between an assignment and a subletting when it comes to leasehold estates by writing: “… an assignment creates no new estate, but transfers an existing estate into new hands, while a sublease creates an entire new estate.”

It shouldn’t go unnoted that parties may self-characterize their transaction as a subletting or as an assignment, but the details of the actual possessory grant will trump any labels. The essential distinction between an assignment and a subletting is that in a subletting, the transferring tenant reserves some reversionary right, with the possible twists inherent in an “assignment pro tanto.” To be a subletting, the quantum of rights granted to a subtenant cannot be the entirety of what the purported sublandlord possesses. Plainly speaking, a subletting for the entire lease term and for the entire leased space will be characterized as an assignment. Whether a withholding of some element of a contractual right, as distinguished from a possessory right, alone, will cause a purported sublease of the entire leased premises for the entire lease term to be treated as a subletting is a question of state law, with the answer, if findable at all, to be found in that state’s case law.

For more (including what this “pro tanto” thing might be), tune in next week. Same Bat-time, same Bat-channel. See you then!

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Comments

  1. This is a critically important issue for both sides of the table. I eagerly await the follow-up Ruminations.

  2. Jeremy J. Deeken says:

    From the post: “A more potent provision would make the tenant and all assignees jointly and severally liable for all tenant obligations under the lease no matter when incurred”.

    Has any court held that an assignee (who has not assumed the lease) is bound in privity of contract with the landlord by the inclusion of the above referenced provision? I see this language often but have not seen its application in practice. Essentially, the lease imposes contractual obligations on prospective parties who are not signatories to the contract, thereby (1) blurring the privity of estate/privity of contract distinction and (2) vitiating the effect of the act of assumption.

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