Making Enduring Sublease Deals

Making enduring sublease deals

By: Bryan Mashian

Subleases may present the opportunity for a subtenant to save money by renting space at below market rates or for a sublandlord to make a profit by renting space at above the master lease rent. But such a seemingly good deal may not come to fruition or last if the parties do not address the legal issues unique to subleases.

Standard leases usually require the landlord’s consent for a valid sublease. So, consummating a sublease without the requisite landlord’s consent will breach the master lease. This violation allows the master landlord to terminate the master lease, jeopardizing the tenancy of both the sublandlord and the subtenant.

The parties should obtain the master landlord’s consent as early in the process as possible to avoid spending time, effort and money on a sublease arrangement or with a proposed subtenant that the master landlord may ultimately reject. As is oftentimes done in the consent to sublease agreement (usually by a tri-party agreement between the master landlord, the sublandlord and the subtenant), the parties should also obtain from the master landlord an estoppel certificate to confirm the critical terms of the master lease and that the sublandlord is not in default.

It is important in advance to determine the master landlord’s rights and obligations in response to a request for its consent to the sublease. More recent vintage standard leases usually require the master landlord to act reasonably. But, many leases also provide the master landlord the right to recapture (i.e., terminate the master lease), share in any profits from the sublease (usually 50/50), or increase the rent to market rental rates. Knowing whether the master landlord has one or more of these options will be critical in deciding whether the sublease is viable for the subtenant and/or profitable for the sublandlord.

The subtenant should confirm that the term of the master lease is at least as long as the term of the sublease. The master lease may be scheduled to expire before the sublease but may also provide the sublandlord options to extend that lengthen the master lease term to cover at least the sublease term. In this case, the subtenant has to make sure that the sublandlord is contractually obligated to exercise such extension options.

If the sublandlord fails to timely exercise a required extension option, especially if the subleased space is the entire master leased space, then the subtenant should obtain the right to exercise the extension option on behalf of the sublandlord. Or, when obtaining the master landlord’s consent, the subtenant should enter into an attornment agreement with the master landlord to protect the subtenant’s rights to the subleased premises.

A risk inherent in any sublease is that if the master lease terminates or expires, then the subtenant will no longer have any right to occupy the subleased space. So, the subtenant can be paying rent to the sublandlord who pockets the money, fails to pay the master landlord who then evicts both the sublandlord and the subtenant for default.

A subtenant may reduce this risk to some degree by negotiating for the right to pay sublease rent directly to the master landlord and requiring that it be served with a copy of any notice of default under the master lease. This arrangement may be an important right since the master landlord may otherwise have the right to refuse rent payments from any party other than the sublandlord. However, if the subtenant is not subleasing all of the space leased under the master lease, or if the rent under the master lease is much higher than the sublease rent, then this cure right may not make sense or be of any help.

An attornment agreement will best protect the subtenant against the risk of the sublandlord’s defaults under the master lease by allowing the subtenant to continue to occupy the subleased space under the sublease agreement as a direct relationship between the master landlord and the subtenant. An attornment agreement should be obtained at the same time the sublease is signed, otherwise the master landlord will have no obligation subsequently to recognize the sublease. Whether a master landlord will enter into an attornment agreement with a subtenant is influenced by the master landlord’s perception of current market conditions, the creditworthiness of the tenant and subtenant and/or the amount of rent to be paid by the subtenant under the sublease.

Yet another risk is if the master landlord’s lender forecloses, terminating both the master lease and the sublease. The subtenant needs a subordination, non-disturbance and attornment agreement (SNDA) with the master landlord’s lender to protect the subtenant’s right to occupy. A subtenant should first determine whether the sublandlord obtained an SNDA with the master landlord’s lender, and if so, review this SNDA to determine whether it will protect the subtenant. If the existing SNDA will not benefit the subtenant or there is no SNDA in place, the subtenant should request that the master landlord’s lender execute an SNDA in its favor.
Subleases can be economically beneficial but are more complex than “direct” leases. The risks inherent in subleases can be alleviated provided the parties properly plan, document and organize at the outset of the transaction.