If you have read the business section of the news lately, then you have probably heard the term VUCA, which is an acronym for volatile, uncertain, complex, and ambiguous. Originally a military acronym, it now refers to today’s constantly changing business landscape.
Given the VUCA situation, any business entering into a lease for office space needs to plan for future contingencies including relocation, merger or acquisition, and expansion that would eliminate the need for such space down the road. The right to assign or sublease the space if it becomes excess should be preserved in every lease.
Approval Right Considerations
There are some nuances to consider in negotiating assignment and sublease options. First, the tenant must ensure that it has the right to assign or sublease all or a portion of the space, usually subject to landlord approval but such approval not to be unreasonably withheld.
Ideally, a lease will define upon which grounds it is reasonable for the landlord to withhold consent. For instance, it would be reasonable for the landlord to withhold consent if the subtenant’s use violated the exclusivity provisions of any other tenant’s leases.
I would argue that it is not reasonable to require that the subtenant’s credit be equal to that of the tenant. This is because in a sublease situation, the sublandlord is still liable on the lease, so the landlord still has the credit of the original tenant. It therefore is unnecessarily burdensome to require equal credit from the subtenant. Since the landlord’s goal is to reduce the risk of frequent tenant turnover in the building, I would prefer landlord only be allowed to reasonably withhold consent if the subtenant’s financial strength is potentially insufficient to meet the obligations of the sublease.
Landlords also often insert language prohibiting tenants from marketing sublease space to any companies currently looking at direct space in the same building because the landlord does not want to have to compete with often-discounted sublease space. My preference is always to have such language removed from the draft entirely. However, if that is not possible, I request that the landlord modify the language to state that the clause only applies if the landlord is currently marketing vacant space equivalent in size to the sublease space so that it is truly competitive to the sublease space.
Another nuance to be considered is the landlord recapture right. With this right, the landlord can either consent to a proposed sublease or “recapture” the sublease space to do a direct deal with the potential subtenant. While this seems like a fantastic outcome for the tenant (they are completely off the hook), it is not a good outcome if the tenant is subleasing only a portion of their space for a portion of their lease term as a method to warehouse the space until they grow into it.
As an example, a law firm may lease five floors containing a total of 100,000 square feet for a fifteen year term. They may only need 90,000 square feet as of the commencement date, but desired to secure and build out expansion space so as to ensure room for planned growth. The firm may wish to sublease the 10,000 square feet of excess space for the first five years of the term. If the landlord has a recapture right, the tenant loses its future expansion space. As such, I prefer language stating that landlord may only recapture space when it is sublet for the entire remaining term of the lease.
Profits on Sublease
Landlords often insert language in a lease stating that the landlord is entitled to all profits on sublease. This means that if the market goes up and the tenant subleases space at a rental rate higher than the tenant is paying under the lease, the landlord is entitled to such excess. While this is rare, it does happen and is worth planning for.
I prefer language stating that the landlord is entitled to 50% of profits on sublease and am usually able to obtain such language as it provides an incentive for the tenant to try to secure a profit. If landlord is entitled to 100% of profits, the tenant has every incentive to lease the space as quickly as possible to any tenant that will merely cover the stated lease rent. Further, it is important to ensure that profits are calculated by deducting rent under the primary and costs of sublease (commissions, allowances, legal fees) from rent paid under the sublease.
Other lease clauses can have a very limiting effect on a tenant’s ability to sublease as well and should be addressed in the initial lease negotiations. The first clause is default. Some office landlords draft leases stating that abandonment or vacation of space is a default. While this is more common in retail leases where an empty space negatively impacts the other tenants of a property, it can appear in office leases as well.
I will ask that such language be removed because in office buildings, other tenants are not negatively impacted (and in fact may love the increasing abundance of parking spaces). Therefore, so long as my client pays rent and maintains the space, they should have the freedom to close an office and market it for sublease in a vacant condition without being put in default.
Option Language Landmines
Option language can also often be affected by sublease or assignment. Many leases contain renewal and signage option language that is negated by a sublease of tenant’s space. Before the initial lease is signed, tenant should ensure that a partial sublease or assignment does not void renewal rights. Similarly, if tenant obtains building or monument signage rights, the lease should state a minimum occupancy threshold to maintain such rights. Ideally, they will not be voided by a de minimis sublease.
All of this is a “facts and circumstances” negotiation. The give and take in the negotiation can vary from building to building and tenant to tenant. An experienced broker can help you navigate the process.