By: Thomas Bhisitkul
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
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.
