Indirect Control of Lease Transfers
Indirect Control of Lease Transfers
By Bryan Mashian, Esq.
Against the backdrop of a projected slow economic recovery, commercial landlords and tenants are battling over who will profit from future increases in real estate rents. The parties directly address this issue in the assignment and subletting provision of the lease when they decide who will benefit from increases in market rent through profit sharing or recapture rights. But many other lease provisions indirectly – but practically – impact transferability of a lease, and the parties should pay close attention.
Extension and Other Options
The landlord can indirectly restrict the practical transferability of a lease by making valuable rights and privileges of the tenant nontransferable. For example, by making an option to extend the term of the lease personal to the original tenant, fewer assignees or subtenants will be interested, since the maximum available term is shorter. Also, the landlord may require that the original tenant be in full occupancy of the premises to be qualified to exercise the extension option. These restrictions can also be imposed on other typical options, such as expansion options, right of first refusal or right of first offer to lease additional space.
To ensure a sufficient remaining lease term to allow for effective marketing, the tenant may require the extension option to be transferable. The landlord, however, may not agree to such transferability if the option term rent is predetermined or favorable to the tenant. At a minimum, the tenant should insist that such rights be transferable to the tenant’s affiliates and that any assignee be reasonably approved by the landlord.
Sign rights (such as building top, monument or pylon signs) are valuable privileges that attract potential assignees or subtenants. These rights can also be a very healthy source of revenue for the landlord. The tenant should make sure whoever buys the tenant’s business can continue to have the same signage rights.
The right to be the only tenant in a shopping center to conduct a certain type of business provides protection to a buyer of the tenant’s business or any assignee or subtenant and thereby adds to the value of a retail business.
The Use Clause
The use provision in the lease, which provides what uses and operations may be conducted on the premises, is a significant secondary means for the landlord to control, and possibly block, a proposed lease transfer. If the use of the premises by the proposed assignee or subtenant is not permitted under the lease, the landlord may, as a commercially reasonable ground, rely on such proposed change for denying consent to the proposed transfer. Often, the tenant also is limited to operating on the premises only under certain trade names. Therefore, the tenant should make sure that the use clause and the permitted trade names are sufficiently broad or, alternatively, require that the landlord cannot unreasonably withhold consent to a change of the permitted use or trade name.
Shopping center landlords often require the tenant to continuously operate a specified use on the premises during the shopping center’s hours. The tenant may require that closure of the premises to market the space or to remodel after a transfer is consummated be exempted from the continuous operation clause, or as a result of such temporary closure.
Retail landlords also often restrict the tenant from operating competing stores within a certain distance from the shopping center. If a proposed assignee or subtenant has stores within the restricted area, the landlord can argue that such assignee or subtenant is not an appropriate candidate. Thus, even a tenant that does not contemplate opening competing stores within a wide radius of the shopping center should negotiate as narrow a radius restriction as possible, if there must be a radius restriction at all.
Remodeling and Alteration
If the landlord is not required to act reasonably in response to the tenant’s request for alterations, such a restriction may chill or deter a subtenant that must extensively remodel the premises.
To provide direct assurances to the assignee or subtenant about the status of the lease, the tenant should require the landlord to provide estoppel certificates.
A major subtenant may want assurances that the sublease will continue if the tenant defaults under the master lease. Therefore, the tenant should require the landlord to provide a non-disturbance agreement to a major subtenant, provided that the rent under the sublease is at least the same rate per foot payable under the master lease.
If the tenant is seriously concerned that it may be leasing too much space or for an excessive term, then the parties can more directly address such concerns by structuring a shorter-term lease, with extension options, with the rent during the option term being the current fair market value. Alternatively, the parties can agree on cancellation or contraction rights, in return for which the tenant would make the landlord whole and pay the unamortized portion of the landlord’s costs.
In sum, many lease provisions affect the allocation of the risks and rewards of an assignment or subletting. During negotiations, the parties should consider carefully the impact of these lease provisions that indirectly determine the degree of the landlord’s practical control over lease transfers.