Monday, February 26, 2018

Commercial Landlord’s “Reasonable” Discretion to Grant or Deny Tenant’s Assignment of Lease


 
Virtually every commercial lease provides a mechanism for the tenant to assign the lease (or sublease the premises) to a third party, and in most cases the lease provides that the tenant cannot do so
without the landlord’s consent. As with many “standard” commercial lease provisions, there are countless variations as to the manner in which such consent must be sought and the scope of the landlord’s discretion to say “yes” or “no” to the request for consent. Almost invariably, the assignment clause provides that the landlord’s consent “will not be unreasonably withheld.” While simple in language, and seemingly simple in concept, the “reasonableness” of the landlord’s discretion is fraught with potential confusion and, consequently, often the subject of substantive negotiation.

Well-represented landlords will be sensitive to the potential mischief that can result from being subject to a broad and otherwise undefined standard of “reasonableness.” If, for instance, a national retail tenant (say, Starbucks to choose an example at random) came to the landlord and asked for consent to assign the lease to start-up mom-and-pop coffee shop with no sales history and negligible assets. Would the landlord be acting “reasonably” if it denied consent to the proposed assignee, who operates the same “use”, but has a totally different economic profile? What if Starbucks agreed to remain principally liable for the lease obligations? Conversely, what if Starbucks proposed instead to assign the lease to a different user who has roughly equivalent (or better) financial strength, but whose propose use of the premises is “adult entertainment”? Or even a less extreme (but still relatively noxious in comparison to the original coffee shop) use like a nightclub, or a medical marijuana dispensary? If the landlord denies consent to an assignment, it is at risk of a challenge by the prime tenant that the denial was “unreasonable,” and having a third party (a judge, or an arbitrator, or a jury) make the determination as to whether the denial was reasonable or not.


Well-represented landlords will be sensitive to the potential mischief that can result from being subject to a broad and otherwise undefined standard of “reasonableness.”

Owing to these vagaries, landlords are interested in negotiating (and should negotiate) to insert standards into the lease to more specifically define “reasonableness.” By doing so, landlords can, practically and legally, reserve to themselves a more concrete and defined level of discretion such that, if challenged by the prime tenant, a “reasonable” denial of an assignment request will be more defensible. These standards are often drafted into the lease by the landlord’s counsel in the form of a stipulation providing, in substance, that the landlord’s denial of an assignment request “will not be deemed unreasonable” if the proposed assignee or its proposed use fall under any enumerated proscribed categories. As reflected by the hypotheticals outlined above, these proscribed categories most often relate to the proposed assignee’s use and to its economic viability.

The range of issues regarding the proposed assignee’s “use” is somewhat dependent on the type of property involved. If the property is an office building and the prime tenant’s use is limited to “office use only” the opportunities for dispute are relatively small. If the tenant proposes to assign to a non-office user (which would not only violate the lease, but would conflict with the overall nature of the building and use of the other tenants), the landlord’s denial would likely be upheld if challenged. And conversely, if the proposed assignee intended to continue normal office use, the landlord’s denial of consent on the basis of the proposed assignee’s use would likely not be upheld if challenged. Retail centers, on the other hand, present many more opportunities for conflict. Retail uses within a given center are varied and the tenants often negotiate exclusivity provisions to ensure that no other tenant having the same or similar use can set up shop and compete with them within the center (for instance, Starbucks will want to ensure that no other tenant in the center can sell coffee). Accordingly, retail landlord should negotiate, at minimum, for a stipulation that denial of an assignment will not be deemed “unreasonable” if the proposed assignee will conduct a use that is (or could be) in violation of exclusivity rights of other existing tenants in the center.

Even aside from legal exclusivity rights of existing tenants, it is important to the success of a given center that the uses be, to the extent reasonably controllable, complementary to each other. Starbuck’s landlord would, for instance, love to lease other space in the same center to a bookstore to complement Starbucks’ business and generally create a more cohesive tenant mix. Thus, it would be undesirable and disruptive to the tenant mix in the center if Starbucks assigned its lease to a disco bar whose business would be conducted primarily at night when the bookstore would be closed. Accordingly, landlords are interested in having the discretion to deny consent to an assignment to a new tenant whose use would be incompatible with the nature or character of the center (or building) and the current tenant mix therein. In order to ensure that this discretion is real (and to avoid the same types of “reasonableness” vagaries previously outlined), landlords will want the determination of “compatibility” to be made by the landlord unilaterally in its “sole discretion.” Tenants may (and often do) object that leaving this determination to the landlord’s “sole discretion” tilts the balance too far in the landlord’s favor and creates opportunities for the landlord to abuse that discretion. Both are valid points and the outcome of the issue is often determined in accordance with the relative negotiating positions of the parties.

The range of issues regarding the proposed assignee’s economic strength is usually a function of that economic strength in relation to that of the original tenant. At the time of original lease negotiation, the economic strength of the tenant will have driven many of the key economic terms of the lease. If the tenant is a Fortune 500 company, the landlord will have the benefit of that tenant’s high credit and substantially lower default risk, as well as (in the case of a national retail tenant) the tenant’s national identity and recognition, which will add value to the reputation and desirability of the center. In exchange for those advantages, the landlord may be inclined to offer more favorable economic terms to the tenant, and also may also agree to forego a security deposit, letter of credit or other security for the payment and performance of the tenant’s lease obligations. The economic strength of the tenant may also drive many non-economic terms of the lease, such as parking rights, more accommodating tenant alteration rights, favorable default terms and cure rights, enhanced or priority signage rights (in a retail lease), SNDA and estoppels, and even more favorable assignment and subletting terms. Indeed, large national tenants are likely to have considerable negotiating leverage, so many of the negotiable terms of the lease that are often determined by the relative bargaining strength of the parties will tend to be resolved in favor of the tenant. Accordingly, after having made so many tenant-favorable lease concessions on the basis of the economic strength of the tenant, the landlord understandably will be unwilling to allow such tenant to turn around and assign the lease to a small, thinly capitalized tech start up whose ability to make future rent payments will be dependent upon the next round of venture capital funding (i.e. a tenant to whom the landlord may not have even agreed to lease the premises, let alone on the favorable terms it gave to the original national retail tenant).

For those and other reasons, landlords will often (and should) negotiate for a stipulation that its denial of consent to an assignment will not be deemed unreasonable if the proposed assignee does not have at least the same net worth (or other equivalent measures of economic strength/viability) as the original tenant. This financial “equivalence” determination should made by reference to the original tenant’s financial standing at two distinct moments in time. First, as of the date of the execution of the lease, since the landlord would have negotiated the terms of the Lease (and may have agreed to significant lease concessions) based on the original tenant’s economic strength at that time. If the landlord is later forced to accept a replacement tenant with weaker financial strength, the landlord will be deprived of the benefit of the bargain it reached with the economically stronger original tenant. Second, the financial equivalence determination should be made by reference to the economic strength of the original tenant at the time of the proposed assignment. If the original tenant’s financial strength has increased, landlords will benefit from that increased strength (for many of the same reasons outlined above), and so will arguably suffer a loss if the tenant assigns the lease to a new tenant with lower financial strength (even if it were nonetheless equivalent to the original tenant’s economic strength at the time of the original lease execution).

In summary, like many other provisions of a commercial lease that seem simple in language and straightforward in concept, assignment provisions governing the landlord’s consent to a proposed assignment of the lease contain many levels of considerations and resulting complexities. Accordingly, it is always in the best interest of both landlords and tenants to be represented by knowledgeable and experienced commercial leasing attorneys who understand these hidden issues and can effectively negotiate the complexities in a manner to advance (or at least protect) the interests of their clients.

Originally posted February 26, 2018 on tlawmtm.com:

Tom is a principal of Moriarty Troyer & Malloy LLC and chair of its Commercial Real Estate Department and a former REBA president. Tom has over 20 years of experience in representing Fortune 500 companies, national and local banks, retailers, shopping center owners, and investors in all facets of acquisition, development, operation and leasing of commercial real estate throughout the country.

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