The Hidden Dangers in Assignment and Subletting Clauses

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Real estate and legal professionals each play a role in a commercial lease transaction.  While Real estate agents create the framework for the transaction, lawyers are responsible for filling in the details. The assignment and subletting clauses of the standard commercial lease may contain terms that can unwind a transaction if not specified in the letter of intent or discussed upfront.             

Assignment terms to be aware of:   

Conditions the landlord can place on their consent.

It is not uncommon for a lease to provide that the landlord’s consent to an assignment may not be unreasonably withheld. Both landlord and tenant should clarify the reasons consent may be withheld.  

Cost of the assignment.

In addition to a flat fee for the landlord to review a request for an assignment, there may also be a charge for attorney fees and costs associated with the preparation and/or review of a lease assignment and a transfer fee. These fees can add up to several thousands of dollars.  A lease may also contain a provision that allows the landlord to adjust the rent upon assignment of the lease. Depending on the market conditions then in effect, this can cause a rent increase that renders the assignment untenable to the assignee.

Recapture

Landlords may seek to recapture the premises instead of consenting to an assignment.  The impact of this term on an unsuspecting tenant who seeks to sell his business can be devastating. If the landlord insists on the ability to recapture, provide for the right to withdraw the request for assignment or alternative consideration for approval of the assignment.

Other consideration; hidden costs

Does the tenant have to pay any other amounts to landlord for transfer of the lease or sale of the business and if so, how much?  While uncommon in Arizona, I have seen leases that require the tenant to share with the landlord a percentage of the sale proceeds from sale of a tenant’s business.   A small business owner selling his or her business for $500,000 would be surprised to find out that in order to sell his or her business, he or she would have to pay the landlord $50,000 or more.  That additional cost would likely prevent the sale transaction from closing and will result in an unhappy client for both agent and lawyer.

Continuing obligation of Tenant for Rent

Most leases provide that the initial tenant, and any guarantors, will remain liable on the lease after an assignment. While it is rare for a lease to contain a novation (substitute of one obligor for another) many small business owners do not understand that there is a distinction and that their liability under the lease will continue. Ensure the tenant understands this is a common provision and if they are seeking a novation upon assignment, create incentives for the landlord by either having substitute guarantors or alternative security posted.  

The assignment and subletting provision of a lease can be complex.  The terms of an assignment provision should not be viewed as boiler plate or standard non-negotiated terms.  Discussions between the landlord and tenant while negotiating the letter of intent will avoid a battle over the language of the provision later.