Leasing Basics - Assignments, Subleasing, and Transfers, Part 3 – Grounds for Denial
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This is Part 3 of the basic series I've been doing on assignments, subleasing and other transfers in commercial leases. As covered in Part 2, commercial leases commonly require a landlord’s consent to any assignment, sublease or other transfer of the lease, and often the parties will go one step further and include a negotiated list of grounds which the parties agree will give the landlord a reasonable basis for denying its consent to a transfer.
These grounds vary from lease to lease and may be property specific but typically relate to the transferee’s financial condition and background, the proposed use of the premises, and sometimes the terms of the transfer itself.
Below is a list of several common grounds for denial, grouped roughly by whether they relate to the transferee, the transferee's use, or the terms of the transfer. For most, the landlord's perspective is self-explanatory, so often only the tenant's countering perspective is noted.
In addition to understanding the concepts behind these grounds for denial, you should also note how they are drafted in the lease. Often the concept itself is just fine, but it is drafted in a way that's too vague or subjective to provide a workable standard. In that case, instead of fighting about whether the provision should stay or go, see whether a revision might make the issue come across more clearly and objectively.
Grounds For Denial Related to the Transferee:
1. The Transferee's creditworthiness, character or business reputation is unsatisfactory.
Tenant's Perspective: Generally acceptable. You'll see these phrased in all sorts of ways, and again, it's important that the standard be objective. What's "unsatisfactory"? A more objective standard would be that the transferee's credit and reputation are comparable to that of tenant and existing tenants in project, or even similar projects in the vicinity if the project happens to be quite small..
2. The transferee's financial condition or stability is insufficient to support its obligations under the lease or would increase the risk of default.
Tenant's Perspective: Also generally acceptable, and again, these come in all shapes and sizes. A common variation is a net worth test, requiring the transferee not to have a net worth less than the tenant. That may be fine; however, if the tenant has a net worth higher than necessary to service its obligations under the lease, this standard may be too restrictive. A strong tenant may also ask that this condition not apply to subleases (because the tenant and guarantors are still directly liable and often in possession) and, for any other transfer, take into account the continuing liability of the tenant or guarantors -- the argument being that often the landlord has less additional risk because the original parties are still on the hook.
3. The transferee is a current tenant in the project or a prospective tenant that landlord has negotiated with.
Tenant's Perspective: Generally unacceptable. Other tenants in the project or tenants a landlord has solicited are ideal transferees because they are already in, or interested in, the project. A strong tenant would delete this entirely. A tenant with less negotiating power would request exceptions (e.g., existing adjacent tenants). A tenant may also ask what the landlord's concern is and then address that concern. For example, if a landlord is concerned about tenant mix and diversity, agreeing on not transferring to certain existing tenants.
4. The transferee is a governmental agency or instrumentality.
Landlord's perspective: This is not always self-explanatory, so here is a bit of landlord's perspective: Like it or not, government uses often include denser, lower quality uses with a multitude of visitors that impact the common areas, conflict with other uses, and make the building generally less prestigious. Something I often see is a group of people lined up around a building waiting to get into the social security administration office. Most landlords (and their other tenants) don't want that.
Tenant's Perspective: Often unacceptable. Most tenants would argue (and stronger tenants often successfully) that the landlord's concerns are legitimate but covered by other factors relating to the use (like those below) and that government agencies are often made up of professionals not working with the public. If the landlord is unwilling to delete the condition altogether, a tenant may fall back to condition the restriction on there being no government use then in the project.
Grounds For Denial Related to the Transferee's Use:
1. The transferee's use is different from the permitted use in the lease.
Tenant's Perspective: Generally acceptable; however, if the permitted use is narrow, which will more often be the case in a retail lease, then a tenant many ask for the right to request a change in use subject to reasonable conditions, which may be listed in the transfer provisions themselves (i.e., the other conditions appearing below), or in the use provision.
2. The transferee's use would increase use of common area.
Tenant's Perspective: Generally acceptable with some revisions. The concept behind this ground is fine; however, to ensure it is not used to bar any sublease (which often results in additional uses and thus additional use of the common area), a tenant might ask to require that any increase in use be materialand incompatible or disproportionate to the use by other tenants in the project.
3. The transferee's use is adverse to or would interfere, conflict, or compete with use of landlord or existing tenants.
Tenant's Perspective: Generally acceptable in a retail setting; however, if this shows up in a general office lease, a tenant may request that it be deleted or inquire into what the landlord's concern is. For example, a condition on not interfering with other tenants is hard to object to, but what does competition mean in an office setting?
4. The transferee's use would violate an agreement the landlord is a party to or that affects the project.
Tenant's Perspective: Generally acceptable. This often arises in retail leases where a landlord has granted exclusives to other tenants or the project is subject to CC&Rs.
5. The transferee's use would be less prestigious or otherwise inconsistent with character and quality of project.
Tenant's Perspective: Generally unacceptable. The concept here is fine, but as expressed, it's too vague and subjective. If many of the other grounds above have been included, a tenant might reasonably argue that the landlord's concerns are covered. But if a landlord still wants a catchall provision, a better one would be that the use will not be inconsistent or incompatible with the project and the existing uses in the project. (But again -- this point may already be covered by other grounds).
6. The transferee will pay less percentage rent (i.e., its gross sales will be lower).
Tenant's Perspective: Generally acceptable in a retail setting, for obvious reasons. If the landlord negotiated base rent and percentage rent based on the tenant’s business and projected gross sales, that is the economic deal. That said, a careful tenant may ask to exclude any reduction in percentage not caused by the transfer (e.g., due to general economic conditions vs. a change in use or trade name). And if a tenant felt that it needed more wiggle room, it might request that the condition instead be based on the projected aggregate of base rent and percentage rent, since a reduction in percentage rent can be offset by increasing the base rent.
Grounds For Denial Related to the Transfer Itself:
1. The transfer is of less of less than the entire premises or term.
Tenant's Perspective: Generally unacceptable. This would prohibit most subleases, and unless the landlord is agreeing to recognize a sublease if the tenant defaults, the other conditions adequately cover any concerns a landlord may have.
2. The transfer will result in alterations.
Tenant's Perspective: Often unacceptable. Many subleases require alterations. A tenant may want to soften this, for example by providing that the transfer will not result in any alterations reasonably objectionable to the landlord (so that the fact that there will be alterations is not itself automatically a ground for denial) or even exclude alterations resulting from demising walls or other customary alterations made in connection with a sublease.
3. The transferee will pay less rent than the rent quoted by the landlord in the project.
Tenant's Perspective: Generally unacceptable. Subleases will always been discounted because, recall from Part 1, there is no direct relationship with landlord, and unless a landlord agrees to recognize a sublease, a subtenant gets wiped out if the tenant's lease is terminated. Additionally, there is little need to push a tenant to get the best deal it can on a transfer because most leases provide that the tenant will keep all or a portion of any rent in excess of that due under the lease, and even if there is no excess rent, the tenant will of course be trying to minimize its downside, that is, the difference between the rent it pays under the lease and the rent it gets under a sublease.
Landlord's Perspective: That said, a landlord may have a legitimate basis this condition, particularly if the tenant was given a below market deal with material concessions. In that case, a landlord does not want a tenant competing with it as it tries to lease up the building. If this is the case, a tenant may need to scale back from deleting the provision agree that it will apply until the building is leases or during an initial term or negotiate for a lower percentage of the rent quoted by the landlord.
4. The tenant is in default at the time it requests a transfer.
Tenant's Perspective: Generally unacceptable. This is a sort of gotcha that stronger tenants object to (and that landlord's do not need to feel guilty about deleting). If the tenant is in default, the landlord has its remedies under the lease, e.g., send a notice and demand cure, and if there is no cure, evict; however, if the landlord has decided to forbear (a typical example is when a tenant finds itself in trouble and is paying rent, but not all rent), that decision should not cut off the tenant's lifeline, which is a sublease, assignment or other transfer. The landlord should be covered by all of the other grounds discussed above.
AIR Form Comparison: The only ground for denial expressly listed in the AIR forms is that the landlord may deny any proposed assignment or subletting if the tenant is in default at the time consent is requested. This of course is the ground discussed immediately above. As for the lack of other grounds for denial in the AIR forms, as covered in part 2, including a list of grounds for denial in a lease is not required, but for larger leases has become fairly standard and may benefit both parties by providing a framework for proposed transfers.