§ 21.01 Transferability

• Jurisdiction: United States
• Publication year: 2022

§ 21.01 Transferability

[1]—Types of Transfers

There are four general ways tenants transfer their interest under the lease: (1) by assignment of the lease; (2) by subletting the premises; (3) by mortgaging their interests under the lease; and (4) by giving a third party a license to occupy space within the leased premises.¹ Except in the case of a ground lease, typically landlords will prohibit tenants from encumbering the leased property through a mortgage.

Rarely will a "standard" landlord lease form allow a tenant to "enter into a license agreement with a third party unless the deal specifically calls for such a transfer."² Generally, tenants transfer their interest in a lease through assignment or by a sublease.³

[1A]—Rights to Assign or Sublease

[a]—In General

The right to transfer a leasehold interest through an assignment or a sublease is of critical importance to most tenants.⁴ The exercise of a transfer right has the potential to change the character of the deal that the landlord has entered into. At the very least, it interjects a new party or parties into the situation. Therefore, the transfer provisions in a commercial lease are among the most highly contested legal clauses in the lease negotiation. In the absence of statutory or contractual restriction or limitation, the tenant has a right to transfer its leasehold interest freely without having to obtain the landlord's consent.⁵ Therefore, if the landlord wants to have a say over the tenant's rights to assign, sublet or even to license or mortgage its leasehold interest, the landlord should set forth restrictions in its lease. For example, the landlord can include a lease term stating that the lease may not be assigned, sublet, etc., without the landlord's prior written consent.

Naturally, the landlord will want to place contractual limitations on the tenant's transfer rights. At the same time, however, the tenant will want to maintain exit strategies and options.⁶ Initial drafts of leases generally prohibit the tenant from assigning or subletting without the landlord's prior consent.

The tenant will want to make sure the lease states that the landlord's consent will not be unreasonably withheld, delayed or conditioned.⁷ He will also want to carve out exceptions to requiring the landlord' consent—for example in the case of a transfer to a related entity, transfer in the case of a sale off its assets, stock or membership interests.⁸ At a minimum, the tenant will want to secure the right to assign or sublease "without notice to or the consent of the landlord, to affiliates and successors, and, in some situations, to a franchisor, or for estate planning purposes. It may also be appropriate to expressly permit ownership changes that occur when partners or shareholders in a professional entity (such as a law firm) come and go."⁹

When considering the rights to assign and sublet, the tenant will also want to make sure that other rights and responsibilities complement the transfer rights.¹⁰ The tenant will also want as broad a use clause as possible to keep open the widest range of potential subtenants. A narrowly drafted use clause will significantly restrict the tenant's ability to find a replacement tenant. Other problematic restrictions include a lease term requiring the tenant to "operate under a particular trade name, limit[ing] the "permitted uses of the space," or "prohibit[ing] alterations or new signage without the landlord's consent."¹¹ Such restrictions effectively eclipse the tenant's assignment and sublet rights. It is also advisable to include a provision requiring the landlord to "provide an estoppel certificate which can be relied on by a potential subtenant, assignee, or lender."¹² If the tenant possesses sufficient bargaining power, it may also succeed in negotiating inclusion of a provision releasing it from liability after an assignment.¹³ In any event, the parties will need to balance their needs.

Under certain circumstances, a tenant may prefer to assign its lease rather than to enter into a sublease. By definition, an assignment is a transfer of all of the tenant's rights in its space for the rest of its term and technically relieves the tenant of all of its remaining obligations. The landlord, on the other hand, will usually want the tenant to remain liable and may provide for this continuing liability under the terms of the lease. Understandably, landlords want to restrict their tenants' rights to sublet and assign. After all, the landlord qualifies his tenants based on numerous criteria—financial standing, business experience, background, etc. Additionally, the landlord may want to keep a certain image in his building and/or a given tenant mix. If the tenant can freely assign or sublet, the landlord loses control and may end up with an undesirable tenant. From the tenant's point of view, however, flexibility is very important to the success of its business. An emerging or start-up company will want the ability to expand or shrink its lease based on how its business develops. The tenant may want to have the flexibility to sell its business, in which case it will want to assign or sublet the leased space to the purchaser of the business. The lease may be an important part of the deal. It is not unusual under complex commercial lease provisions for the tenant to remain liable for its obligations under the lease after an assignment. Under these provisions, the tenant turns into a surety guaranteeing the subsequent performance by the assignee. If a tenant expects to be released from its contingent liability under the lease, it should affirmatively provide for such release in the lease document.¹⁴

Landlords must remember to reserve the right to approve or disapprove future assignments indicating that approval in one instance does not waive the right to approve or disapprove of future requests for assignment. Failure to do so will result in loss of the landlord's right to approve future assignments if and when he consents to an assignment.¹⁵ Note further that in the case of the assignment, unless the landlord enters into a separate agreement with the assignee to take over all of the rights and responsibilities of the tenant/assignor, the assignee will not be in privity with the landlord. If the assignee vacates the premises or further assigns its lease, since the assignee is not party to the prime lease, he will have no obligations to the landlord. The landlord will have to sue its prime tenant who will then seek recovery from its assignee.

Sometimes tenants will find a way around an assignment restriction by subletting or transferring interests or stock in the tenant entity. The assignment is then effectively accomplished because a new entity replaces the tenant, which continues to exist in name only.

A sublease differs from an assignment in that the former is a transfer of less than all of the tenant's rights. There are situations where the tenant may find that mode preferable to an assignment. For instance, the tenant may want to sublease the premises for less than the rest of the lease term and retain a reversionary interest after the sublease expires.¹⁶ In addition, the tenant may decide it wants to sublease the premises, but still retain its rights under the lease to renew or to exercise other options. This permits the tenant to continue to hold a valuable leasehold asset even though the tenant may not wish to occupy the premises itself for whatever reason. Under a sublease, the tenant remains primarily liable to the landlord for the performance under the lease.¹⁷

Landlords can protect themselves from these types of problems by including certain provisions in the lease. The landlord should require its consent to any and all assignments and subletting, including those involving just a part of the premises.¹⁸ Some landlords will also require their consent to transfers of stock or equity interests in the tenant. Provisions may require that the tenant obtain the landlord's approval for transfers, sales, mergers or changes in company control or stock ownership. Landlords want such restrictions generally because they are concerned about the credit-worthiness of the tenant, quality of the tenant and maintaining a certain image for the building. Tenants will balk at such a requirement, but the landlord could insist with respect to transfers that would change the tenant's majority interest holder.

Where a lease specifically prohibits an assignment or sublease, this prohibition will be strictly construed. For instance, a covenant against an assignment does not prevent a sublease; a covenant against a sublease does not prevent an assignment. If a covenant against subleasing does not specifically prohibit subleasing in part of the premises then the covenant will not be construed to prevent a subleasing of another part.

Typically, as a condition to exercise the right to assign or sublease, the lease will provide that (1) the original tenant still remains liable to the landlord; (2) the tenant fulfills all the obligations of the lease; and (3) the tenant delivers a copy of the original sublease or assignment to the landlord for consent. In addition, many assignment or subleasing clauses permit the landlord to capture the excess amount paid by the transferee over the amounts the tenant is paying to the landlord.

When a lease was silent on placing parameters on a clause prohibiting assignments without the lessor's consent, the Washington Appellate Division found no implied covenant of good faith and no reason for setting forth any standard for consent.¹⁹ The landlord argued that his denial of consent to an assignment was reasonable, but the court focused on whether or not there was an implied covenant of good faith to consent to the assignment. The reasoning here is similar to that applied with respect to the implied covenant of reasonableness that several courts had adopted in the 1980s and which many commentators saw as a trend in...