By Sam Kokoszka
The landlord-tenant relationship is at the core of the commercial leasing business. In an uncomplicated world, a landlord and a tenant would enter into a lease for a term of years, and at the lease’s expiration, the tenant would either vacate the premises or the parties would agree to continue their relationship. Unfortunately, experience dictates that the world of commercial leasing is anything but uncomplicated. At a national level, trends in brick-and-mortar stores continue to cause broad upheaval in the overall makeup of shopping center tenants, and the personal, more human concerns of specific tenants can affect the landlord-tenant relationship on an individual level.
Given these circumstances, it is in each landlord’s best interest to understand that the tenant with whom they enter into a lease may not be the tenant for the entire duration of that lease’s term. Accordingly, it is crucial that commercial landlords that primarily lease to smaller tenants retain control over the assignment process, and the easiest way to obtain and retain this control is at the outset of the lease negotiation process. This article is a landlord’s perspective on key concepts involved in the negotiation of tenant assignment provisions in a small-tenant commercial lease.
When it comes to negotiating assignment provisions in small-tenant commercial leases, landlords and tenants usually have completely conflicting objectives; while a tenant generally desires the ability to freely assign its interest in the lease without input from the landlord, the landlord wants to limit the tenant’s right to assign its interest in the lease as much as possible. With this in mind, the landlord’s initial position with respect to tenant assignment should be that the tenant cannot assign its interest in the lease without the landlord’s prior written consent, which consent shall be granted or denied in the landlord’s sole and absolute discretion.
Depending on the prospective tenant and the amount of leverage held by the landlord, negotiation on the tenant assignment provision may end here. However, in situations where the tenant is more sophisticated or has more leverage, a landlord may need to compromise its position. In this situation, the landlord’s first “fallback” position would be to retain sole and absolute discretion over tenant assignments to unrelated third parties, but allow the tenant to make certain “corporate” assignments (e.g. an assignment from a corporate tenant to a franchisee, or an assignment from the original tenant to an entity that purchased 100% of the original tenant’s assets) by giving the landlord prior written notice of such a “corporate” assignment.
Each tenant and lease negotiation is unique, and accordingly, it is common to see assignment provisions be negotiated beyond this point. Larger tenants with more leverage may be able to negotiate language in the assignment provision of a lease that, while still requiring landlord consent to a tenant’s assignment to a third party, limits the landlord’s discretion to grant or withhold its consent to the landlord’s “reasonable discretion, not to be withheld, conditioned, or delayed”. Although this language reduces a landlord’s ability to block a potential assignment, the landlord can retain some level of control over the assignment process by inserting criteria for a proposed new tenant that would create guidelines for a landlord’s “reasonable” discretion to consent to an assignment. Some examples of this criteria include a new tenant’s tangible net worth, the level of operating experience of a new tenant, and the business reputation of a new tenant. This type of compromise allows the landlord to retain a level of control over any tenant assignment while still giving the tenant the ability to assign to a strong replacement tenant, and gives the parties a level of certainty regarding what types of assignments will be permitted.
While negotiating the tenant’s ability to assign its interest in the lease, landlords should also be sure to address the assigning tenant’s post-assignment liability under the lease. Ideally, a landlord wants an assigning tenant to remain fully liable with the new tenant, jointly and severally, for the remainder of the term. Not only does this language create a “backstop” against a potential default by the new tenant, but it also encourages an assigning tenant to more thoroughly vet a prospective assignee; if a tenant knows it has continuing post-assignment liability under the lease, it is more likely to pick an assignee that is competent to fulfill its obligations under the lease.
Again, depending on the particular tenant and the level of leverage enjoyed by the landlord, a prospective tenant may be able to negotiate away from post-assignment liability for the entire duration of the term. In any event, landlords should strive to ensure that they are not left “holding the bag” with an assigning tenant relieved of liability and an uncollectible new tenant in default. Common compromises in this language include an assigning tenant remaining liable for a period of time that is shorter than the duration of the lease’s term (e.g. tenant liability for 5 years post-assignment on a lease with 10 years remaining on the term), or the assigning tenant being relieved of liability if it assigns the lease to a tenant that has a sufficient tangible net worth (e.g. a mom-and-pop coffee shop assigning its lease to Starbucks).
While not usually contained within the assignment section of a lease, if the lease is guaranteed by the tenant (or a representative of the tenant), that guaranty can have an effect similar to when a tenant remains fully liable for the obligations of the tenant under the lease. In order to avoid personal liability in the event of a new tenant default, the guarantor (or guarantors) will generally strive to find a strong and competent replacement tenant.
As noted above, this article was written from a landlord’s perspective, and a tenant’s lease negotiation goals will be in stark contrast to most of the suggestions above. However, a landlord acquainted with the takeaways contained within this article is set up for success, and should start lease negotiations from a strong and educated negotiating position.