In the current commercial real estate landscape, employers, as commercial tenants, must balance the need to secure adequate facilities to accommodate their business, with the employees’ expectations that remote work options be readily available. On the flip side, commercial landlords must take extra care, despite a willingness to be flexible, to ensure they have a financially sound and quality tenant, reliable for the duration of the applicable term of the commercial lease. As a consequence, attorneys should ensure that sufficient time is dedicated to negotiating one specific provision present in almost every commercial lease – the assignment provision.
Generally, the assignment provision governs the conditions in which a tenant may (or may not) assign, sublet or otherwise transfer any portion of its interest in the lease to another individual or entity. As one can imagine, a landlord will want to have the strictest set of conditions, and reserve as much discretion as possible in determining whether to consent to a proposed transfer (e.g., tangible net worth requirements, permitted use limitations). Why? Landlords want to maintain control regarding the financial capability and quality of its tenants. Alternatively, tenants want to have broad assignment rights, preventing a landlord from arbitrarily withholding consent to a proposed transfer. Why? If a tenant is no longer able to meet their obligations under their lease, or needs to relocate to a smaller (or larger) facility to meet its business or market requirements, and there are no blanket termination rights in the lease, they may need to find a third party to take over the remainder of all, or a portion, of their lease.
Of utmost importance when reviewing an assignment provision on behalf of a commercial tenant is discussing the issue of continuing liability. Most commercial leases, especially those drafted by a landlord, will have language obligating the tenant to remain jointly and severally liable for all obligations (e.g., payment of rent) for the entire term of the lease, even after assignment. What this language means is that a commercial tenant, even after assigning the lease to an unrelated third-party transferee, will be liable for all liabilities and obligations of that unrelated third-party transferee. While this language is certainly common in commercial leases, it often does not get the attention it is due during lease representation and negotiations. At a minimum, commercial tenants should be advised of the implications of this language.
By way of example, assume that Tenant X is a tenant under a commercial lease with Landlord Y (“Original Lease”) who is operating for general office use. The Original Lease is for a term of ten years. Three years into the Original Lease, Tenant X has grown exponentially, and the current space no longer accommodates the growing business. As such, Tenant X must assign its interest in the Original Lease to an unrelated third-party and look for a larger space.
The first issue is whether Tenant X may assign its interest in the Original Lease to a third-party transferee. If the Original Lease is more favorable to Landlord Y, then there will be one or more conditions that the proposed transferee must satisfy. Further, the Original Lease will have language describing the level of discretion regarding Landlord Y’s right to withhold consent. At a minimum, at the negotiation stage, Tenant X should ensure that the Original Lease includes a provision that states Landlord Y shall not “unreasonably withhold, condition or delay its consent to a proposed assignment” to prevent Landlord Y from arbitrarily withholding consent. What this means is that Tenant X will need to demonstrate that the proposed assignee is a quality tenant. At the end of the day, Landlord Y negotiated the Original Lease to be with Tenant X, and so it is important to provide reasonable information to reassure Landlord Y.
The second issue concerns the continuing liability piece. Tenant X should be aware of the potential consequences related to the applicable language. Assume Landlord Y consented to Tenant X’s proposed transfer of the Original Lease to Tenant W during year 3 of the term of the Original Lease. Assume further that Tenant X subsequently entered into a commercial lease for a larger space with Landlord Z (“New Lease”), immediately after assigning to Tenant W. If the Original Lease states that Tenant X is to remain jointly and severally liable following any assignment, then Tenant X will be fully liable under both the Original Lease and the New Lease for a period of at least seven years. Therefore, if Tenant W defaults under the Original Lease, Landlord Y can immediately pursue legal recourse against Tenant X.
It is important to note that the final language in the lease regarding assignment can be greatly influenced by negotiation power, and whether it is expressly addressed in the letter of intent. Regardless, prior to entering into any lease agreement, commercial tenants should ensure sufficient time is dedicated to understanding the implications of the applicable assignment provision.
The real estate team at Milgrom Daskam & Ellis is skilled at drafting and negotiating commercial leases, and whether you’re a landlord or a tenant, we would glad to help craft the solutions that work best for you. Reach out to our team for a consultation if you’re seeking assistance in your upcoming commercial real estate transactions.
