Be Sure to Address COVID Deferred Rent in a Lease Transfer Transaction

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Tenants who are now involved in a sublease of space or an assignment of a lease that includes a COVID deferred rent payment obligation need to consider and clarify their responsibility for that future stream of payments.  Many tenants and landlords agreed to some form of rent relief during the COVID crisis, including future payments of deferred rent.  A basic form agreement for a sublease or an assignment of a lease probably does not already include a provision that specifically addresses liability for those COVID deferred rent payments.

Sublease

In a sublease transaction, the rent to be paid by the subtenant to the tenant is usually specified in the sublease and the tenant remains liable to the landlord for whatever rent and other obligations the main lease provides for, including any payments of deferred rent due under the main lease.  It would be quite unusual for either party to expect the sublease agreement to provide that the subtenant is liable to pay any portion of the deferred rent payments on top of the negotiated sub-rent, since the tenant got all of the benefit of that rent deferral.

However, the parties to a sublease need to be careful about using general wording that is intended to pass through to the subtenant the obligation to pay for other additional rent, common area charges, fees, expenses, etc. due under the main lease and associated with such space (or the subtenant’s proportionate share thereof if it is subleasing less than all of the space).  Such wording might be broad enough to inadvertently put at issue the question of whether or not the deferred rent payments are included in that list of other obligations being passed through to the subtenant.

Also, a subtenant might be a bit leery of the financial ability of the tenant to keep up with the payments of the deferred rent, so the subtenant might require a specific right to cure that failure and a right to offset any cure payment against future sublease rent payments. 

Assignment

In a lease assignment transaction, the assignee becomes primarily liable for all the obligations under the lease, with the assigning tenant remaining secondarily liable as sort of a guarantor (or perhaps even being released from liability if the landlord agrees).  Since the assignee is assuming the lease obligations and the tenant is stepping out of further direct lease liability, the tenant and the assignee need to allocate responsibility for COVID deferred rent payments between them in the lease assignment agreement. 

First, be sure that any disclosure of the rent economics of the lease being assigned clearly differentiates between the normal base rent and the additional payments of deferred rent.  Incorrect data could easily be picked up off of some old spread sheet or lease abstract as representing the normal monthly base rent.  Also, the payments of the deferred rent may not have kicked in yet, so any statement about the “current monthly rent” might be misleading, even if technically correct.

Second, be sure the lease assignment agreement clearly states how the future payments of deferred rent are to be allocated and paid as between the tenant and the assignee.  The tenant might naturally consider that the deferred rent payments “run with the lease” that the assignee is taking over and are simply part of the deal being assumed by the assignee.  The assignee might naturally consider the future payments of deferred rent as being owed by the tenant as unpaid back rent for the period that the tenant leased the property that just happens to be due in future months, since only the tenant benefitted from the agreement with the landlord to defer the rent due by the tenant in the first place.  If that negotiation results in an allocation to the tenant of any of those future payments, then the payment provision needs to be negotiated, considering the magnitude of the deferred rent owed, the financial condition of the parties and the tolerance for risk, and bearing in mind that: 

  1. the tenant might not want to pay the assignee at closing for the full amount of the future deferred rent payments (or provide a credit against other sums that might be due to the tenant from the assignee, such as for furniture, fixtures and equipment or for an assignment fee) in case the assignee fails to make those future payments to the landlord or otherwise defaults and the tenant has remained liable to the landlord under the lease and would thus face paying a second time for the deferred rent; 
  2. the tenant might not want to pre-pay the full amount of the future deferred rent payments to the landlord at closing (and thus eliminate that obligation), since the tenant would be losing the benefit of stringing out those payments that it negotiated with the landlord when the deferral was agreed to; 
  3. the landlord might not want to have to process separate monthly payments from the old tenant and the assignee; 
  4. the assignee may become in default if the tenant fails to pay the landlord the deferred rent payments even though the assignee is not otherwise in default in its obligations to the landlord; 
  5. the landlord is not likely to agree to go after just the tenant to collect the deferred rent if the tenant defaults in making those payments to the landlord; 
  6. the assignee might be willing to pay the deferred rent amount over to the landlord but only if and when the tenant has made each payment to the assignee; and 
  7. the assignee might want an escrow from the assigning tenant to secure the assigning tenant’s agreement to continue to pay the deferred rent payments or as the actual source for such future payments.  

Third, consider whether any pre-payment made by the tenant to the landlord or any payment made or credit given by the tenant to the assignee ought to be reduced to its present value to equalize it to the value of a current payment of a future stream of monthly COVID deferred rent payments.

Fourth, be sure that any estoppel certificate from the assigning tenant or the landlord clearly states the normal base rent amount and separately addresses the amount, timing and duration of the deferred rent repayments.

The main point is that the parties to a sublease or lease assignment need to ask early about any COVID deferred rent before it becomes an issue that is first raised during the due diligence period, or just as the transaction closing statement is being prepared, or when the post-transfer rent payments become due and need to include those COVID deferred rent payments.  

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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