How To Protect Landlord Interests In Office Lease Transfers That Do Not Require Landlord Consent
Think of an office building as a castle. Where is the moat to protect it? It is in lease provisions imposing safeguards on tenant transfers that do not require the landlord’s consent.
Casey Sobhani and Alon Lagstein of Liner LLP offer suggestions on such safeguards.
Leases are typically drafted so tenant transfers, such as assignments and subleases, require the landlord’s consent. An important exception involves so-called "permitted transfers," in which a tenant may complete an internal transfer (such as a sale of its business, a merger or a sublease to an affiliated entity) without the landlord’s consent, and with the transferee obtaining rights to the leased space.
Another common exception involves “permitted users,” in which, for example, clients or partners of a tenant may use the tenant’s space without the landlord’s consent.
Why Should Landlords Care — And What Can Go Wrong?
A landlord should always care if an outside party can use its building without its consent. For example, what if the outside party has assumed sole liability as the tenant under the lease, but is in much worse financial condition than the original tenant? What seemed like a safe rental stream for the landlord would be in jeopardy. Or what if the outside party conducts a different business than the original tenant — one that can damage the reputation and value of the building? Or what if the outside party is a holdover risk that could interfere with a new lease for the space? Real-world examples of all these scenarios exist — to the detriment of landlords.
How Can Landlords Protect Themselves?
Protection begins with good lease drafting. With respect to permitted transfers, the lease should require transferees to meet financial requirements and to engage in businesses that would not diminish the building’s value. The lease should also require the tenant to notify the landlord of any permitted transfer, so the landlord can verify all conditions for the permitted transfer have been met. Finally, the lease should ensure the original tenant is not released from liability following a permitted transfer, or, if the original tenant will not survive the permitted transfer (for example, as a result of a merger), that the surviving entity meets the requirements for financial condition and reputation of business.
With respect to permitted users, the lease should restrict the size of the space that can be used by permitted users. For example, the space could be limited to just a few offices or a small percentage of the leased premises. The lease should also define permitted users as narrowly as possible, such as consisting solely of the tenant’s clients or partners that are actively working with the tenant. Any party that engages in a business or has a reputation that would diminish the value of the building should be disqualified, as should existing and prospective tenants (otherwise, a landlord would effectively be required to compete against its own tenant for new tenants).
A permitted user that would trigger a default under another lease at the building should also be disqualified. In addition, the lease should identify a permitted user’s space as a license (instead of a sublease), since licensees are easier to evict under law than subtenants. To establish contractual privity with permitted users and to obtain additional protections, the lease should require permitted users to be bound by the terms of the lease applicable to the tenant, at least as it relates to the permitted user’s space. And the tenant should always remain liable for the permitted user.
No matter what a lease says, the risk always exists that a tenant will ignore it and allow third parties to occupy its space anyway. Landlords should remain vigilant in spotting such situations. This means identifying new people in a tenant’s space, changes to a tenant’s name or signage, or rent checks being paid by a new entity. Think of such vigilance as the lookout tower that, when combined with the moat, protects the landlord’s castle.
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