Negotiation of Lease Assignment Clauses
 
March 26, 2001
 

"O, my good lord, I have been your tenant, and your father's tenant, these fourscore years." King Lear, Act IV, Scene 1

Negotiation of the assignment and subletting clause in a retail lease can be challenging. The competing interests of the landlord and tenant must be recognized and balanced carefully. Rarely is the clause not hotly negotiated, and seldom are negotiations resolved to the complete satisfaction of either party. This article highlights the issues surrounding the assignment and subletting clause in a retail lease, including the carve-outs often requested by the tenant/assignor.

Restraints on "Alienation"

The law of real property creates a presumption against restraints on “alienation” (i.e. the transfer of interests such as the rights of a tenant pursuant to a lease). Consequently, leases are freely assignable absent a specific prohibition. Retail leases often have complex assignment and subletting clauses. From the landlord’s perspective, the existing or new tenant should always be creditworthy and have experience conducting a business which complements the overall tenant mix at the shopping center. From the tenant’s perspective, there is the need for the business flexibility provided by assignment and subletting to third parties.

Reasonableness Standard

As an accommodation to these competing interests, one solution is to create a reasonableness standard in the lease that requires the landlord to consent if the lease is assumed by the assignee, and the assignor continues to guaranty payment. The standard of “reasonableness” may not provide sufficient control to the landlord where tenant mix and retail uses are important, and may create disputes about what “reasonable” means. Anchor tenants often have the financial strength and negotiating leverage to require preferential assignment and subletting clauses. They refuse to accept “reasonableness” standards and demand a specific list of criteria to create and to determine the assignability of the lease.

Net-Worth Test

Careful thought should be given to net-worth limits requirements for tenants. In the event of an asset sale, the landlord may be willing to accommodate the assignment provided the assignee meets certain financial net worth tests, has the requisite experience and reputation and adheres to use requirements. At a minimum, the assignee’s financial net worth after the assignment (with substantiating financials), creditworthiness, business experience, character, reputation and use should be comparable to that of the assignor. A “not less than” assignor’s net-worth test (i.e. at the time the lease was entered) should be considered in lieu of a flat dollar amount since present dollar requirements may not keep pace with inflation. However, since the assignor may not have a strong financial condition, a “greater of” the assignor’s net worth or a fixed-dollar amount test (i.e. assets in excess of $20 million) may safeguard the landlord’s interest in having a financially solvent tenant.

Liability of Tenant

In any event, if feasible, the assignor should remain liable for lease obligations to the landlord. Finally, the landlord should require payment or reimbursement of its legal or administrative fees associated with review of the assignment documents. The tenant should agree to reimbursement of such actual costs to prevent delays by the landlord in reviewing the proposed transfer.

Assignments to Subsidiaries

Mergers or internal transfers by corporate tenants create a thorny set of issues. Stock transfers are generally prohibited beyond certain thresholds, but often there are “carve-out” provisions that permit assignments to various classes or entities. These include carve-outs for transfers to affiliates such as subsidiaries and parent corporations or entities under the common control of the tenant. Corporate tenants which are publicly traded clearly must be allowed to have their stock traded without triggering an assignment provision. However, one danger is that a tenant might form a wholly owned subsidiary corporation and assign the lease to the new entity. The absence of an on-going “wholly owned” requirement in the lease might permit a tenant to thereafter subvert the prohibition against assignment by transferring the stock to an unrelated third party. Each lease must contain language that “landlord’s consent to any assignment or subletting shall not release the tenant or any assignee, subtenant or occupant from the future obligation of obtaining landlord’s prior written consent to any subsequent assignment or subletting.” There should also be an express requirement that the assignee assumes all obligations of tenant under the lease. Otherwise, landlord might unwittingly be permitting a future uncontrolled assignment.

Recapture Provisions

A “recapture” provision is one way to protect the landlord from an undesirable assignee. It allows the landlord to retake and relet the premises in lieu of consent to a proposed assignment. This provision operates to terminate the lease and serves landlord’s objective of controlling the tenant mix while relieving the tenant of any further lease obligations.

Conclusion

In conclusion, when considering assignment provisions, the landlord should be careful to avoid allowing indirectly, what is prohibited from doing directly. Barring claims of bad faith, courts typically will rule against clauses that restrain alienation. The assignment provisions in the retail lease must be negotiated and drafted carefully to avoid an unwanted tenant or expensive lawsuit in the future.

Ms. Kirby is Senior Counsel in our Providence office. She can be reached at 401-553-6824 or at lakirby@hklaw.com