What you Need to Know about Subleasing Commercial Real Estate
When entering into a commercial lease, the length of the lease term is one of the most important items to carefully negotiate. There are benefits and detriments to both longer term commercial leases and shorter term commercial leases. From a landlord’s perspective, a long-term commercial lease can be beneficial as it provides a reasonable estimation of fixed income that the property will generate over a long period of time. This enables the landlord to adequately value the property for sale, and can help the landlord obtain lines of credit against the property. In addition, having a good tenant locked into a long-term lease allows landlords to take a more hands-off approach to management and simply collect rents instead of constantly marketing the property for lease.
From a tenant’s perspective, a long-term lease can also be beneficial as it provides the tenant with security knowing that it has the right to possession and use of the property for a long period of time. This enables the tenant to make a larger investment since the business can expect to remain in the same location for the long term. A tenant may be less inclined to invest a large amount of money into a business if there is the risk that a lease will expire in a short number of years and the tenant could be forced to relocate.
However, short-term leases can also be beneficial to both landlords and tenants. For landlords, it may be helpful to maintain flexibility with a short-term lease in case the landlord wants to sell the building without the tenant. Alternatively, the landlord may wish to maintain the ability to replace a tenant with more desirable tenants who may be occupying a larger portion of space or paying a higher rent. For tenants, a shorter term lease also provides flexibility in not being tied down to a specific location for a long period of time. Importantly, a long-term lease exposes a tenant (and personal guarantors) to a large potential liability if a new business fails with many years remaining on the lease.
Commercial tenants who are locked into a long-term lease may look to sublease their space to another tenant prior to the expiration of their lease term. Subleasing is a critical item to address in every commercial lease. Below are some important items to consider when looking to sublease commercial real estate:
- Subleasing and Assignments – An assignment is when the tenant’s entire interest in the lease is assigned and transferred over to a new tenant. In these situations, the new tenant agrees to assume all responsibility under the original lease and the landlord typically releases the original tenant from liability and replaces with the new tenant. An assignment is always more beneficial for a tenant than a sublease, as assignments would typically allow the original tenant to be released from further obligations (along with their personal guarantors). However, if a landlord is not willing to agree to an assignment, or if a tenant cannot find someone willing to take over the entirety of the lease, a sublease may be another option. The sublease would allow the tenant to lease only a portion of their leased space to the subtenant, could be for a shorter term, and could be for more or less money that the tenant is currently paying in rent to the landlord. In a sublease, the original tenant and the new tenant typically both remain legally liable for all payments and obligations owed under the lease. The definition of what qualifies as a sublease or assignment must also be carefully drafted. Landlords will want to avoid situations where a tenant may sell the stock or membership interest of its corporation or limited liability company as a workaround against the prohibition against subleasing. Related entities or subsidiaries of the original tenant are often times excluded from the prohibition on subleasing and assignment.
- Landlord must Consent – Under Michigan law, “[i]n the absence of statutory or contractual restrictions, a lessee for years may assign or sublet his leasehold interest without the lessor’s consent or an express provision in the lease giving him such right.” See Patterson v Butterfield, 244 Mich 330; 221 NW 293 (1928). However, in almost every commercial lease, there is language stating that the tenant is not permitted to sublease or assign its lease without the express written consent of the landlord. Often times, the lease provides that the landlord has the sole discretion to determine whether or not to approve any sublease or assignment. The landlord may wish to ask the tenant to provide financial documents and tax returns of the proposed subtenant to determine the creditworthiness of the proposed subtenant/assignee.
- Exclusives – Aside from reviewing the financial implications of approving a sublease, the landlord must be sure to confirm that the proposed subtenant’s use of the property will not violate any exclusives given to any other tenants of the property and the landlord must evaluate whether the existence of the subtenant would dissuade other more desirable tenants from leasing space in the same building.
- Tenant Liability – Most commercial leases provide that if the landlord consents to a sublease, the original tenant (and any personal guarantors) remain fully liable for the payment and performance of the lease. If a landlord approves a sublease, the landlord should make sure to require the subtenant to sign a document agreeing to assume all of the original tenant’s obligations under the lease. The document should also allow the landlord to collect rent directly from the subtenant if the original tenant fails to pay on time. The landlord may not want to release the original tenant from liability even if a sublease is approved, but this is something tenants should carefully negotiate.
- Personal Guarantors – The landlord may also require the owner(s) of any approved subtenant to sign additional personal guaranties to likewise guaranty that all obligations under the lease will be performed. Similarly, when an original tenant gets a sublease approved by a landlord, the original personal guarantors may want to ask the landlord to substitute the new subtenant’s owners as new guarantors and release the original tenants from liability.
- Additional Rent – Most commercial leases require the tenant to pay any consideration it receives from the subtenant to the landlord. If a sublease is approved, any rent in excess of the amount due by the tenant under the original lease must also be paid to the landlord. Sophisticated landlords will not permit a tenant to keep the excess profit in the event a sublease is located at a higher rental amount than the original lease. Many landlords will also charge a review fee and require the tenant to pay for the landlord’s review (and possible attorney’s fees) in relation to the request to sublease.
- Security Deposit – The parties may also want to address what happens to the security deposit in the event of a sublease or assignment to a new tenant. In certain instances, an additional security deposit may be requested from the subtenant as well.
- Transfer of Utilities – If a sublease or assignment is approved by the landlord, the original tenant should also be sure to pay all final utility bills and have all utilities transferred into the name of the new subtenant/assignee.
- Termination – Sometimes, commercial leases contain provisions that permit either the landlord or the tenant to terminate the lease if the tenant proposes a sublease or assignment. These types of provisions should be carefully drafted to ensure that all parties fully understand what may happy if a sublease is requested or rejected.
- Landlord’s Right to Assign – Most commercial leases will also provide that the landlord has the right to assign the lease without the consent of the tenant and that upon any sale of the property, the landlord is released of all obligations under the lease the new owner assumes the obligations of landlord.
As set forth above, commercial leases are highly complex and should be carefully drafted with the assistance of experienced legal counsel. Similarly, legal documentation should be prepared to properly reflect any approved subleases, assignments, assumptions of liability, releases of liability, personal guarantees, and any related documents. Anyone considering entering into a sublease transaction (whether a landlord, tenant, or subtenant) should carefully review the requirements of the original lease before taking action and may wish to have legal counsel assist in negotiating the terms of the transaction and/or drafting the necessary legal documents.
Brandan A. Hallaq is a Senior Attorney with Hirzel Law, PLC where he litigates cases involving defective construction, contract disputes, shareholder/member disputes, quiet title actions to determine interests in property, enforcement of restrictive covenants, real estate foreclosure actions, and bankruptcy matters representing creditors. Mr. Hallaq is also a licensed Real Estate Broker in the State of Michigan and leads the real estate transactions department at Hirzel Law, PLC where he negotiates and prepares the necessary documents for business and real estate transactions, including purchase agreements, franchise agreements, loan/financing documents, and commercial and residential leases and mortgages. In each year from 2018 through 2022, he has been recognized as a Rising Star in the area of real estate law by Super Lawyers Magazine, a designation that is given to no more than 2.5% of the attorneys in the State of Michigan each year. He was also recognized as a 2020 Up & Coming Lawyer by Michigan Lawyer’s Weekly, an award given to no more than 30 attorneys in the state each year, and he has been recognized in the Best Lawyers in America: “Ones to Watch” list for professional excellence in real estate law in each year from 2021 through 2023. Mr. Hallaq obtained his Juris Doctor degree, cum laude, from Wayne State University Law School where he served as an editor on the Wayne Law Review. Prior to joining Hirzel Law, PLC, Mr. Hallaq worked for a Federal Judge and in a Fortune 500 corporation’s in-house legal department. He can be reached at (248) 986-2290 or at email@example.com.