Guarantor Lease Assignment Document
Assignments and Subleases
For many businesses, entering into a lease is an essential and important part of their businesses. Other than payroll, lease payments are often a business’s largest expense. However, given the complexity and sheer length of a typical commercial lease, it is a daunting proposition to review and negotiate a lease on your own. This is the third in a series of articles discussing the major issues to be considered in a typical commercial lease.
This week, we’ll explore assignments and subleases. While assignments and subleases will have varying terms and conditions on a case-by-case basis, we’ll discuss generally about the issues involved in most assignments and subleases.
An assignment of a lease occurs when an existing tenant (“Assignor”) assigns its rights and obligations under the lease to a new tenant (“Assignee”). Another form of assignment occurs when a landlord sells the property and a new landlord takes over the lease. A sublease is often used when the existing tenant (often referred to as “Sublandlord” or “Sublessor”) rents a portion of, or the entire leased premises to another tenant (“Sublessee”), typically for a limited term. Some leases provide landlords the right to terminate the lease if an existing tenant requests an assignment or lease.
A key difference between an assignment and a sublease is that an Assignor in an assignment more or less irrevocably assigns all of its interests in the lease to the premises, whereas in a sublease, a Sublessor still retains certain interests in the premises. For instance, in an assignment all of the Assignor’s rights and obligations in the lease are “assigned” to another party, the Assignee. While there are certain circumstances where the Assignor may have a right to take back the premises (such as, if an Assignee is in default of the lease), the assignment generally extinguishes the Assignors rights under the lease, but typically not its obligations. The Assignee takes the place of Assignor, physically in the premises, as well as on the lease. However, the Assignor and its guarantors, if any, are usually not released from liabilities until the end of the lease term. So if the Assignee is unable to pay rent, or defaults otherwise under the terms of the lease, the Assignor and/or its guarantors will be liable to the landlord.
Assignment clauses may also be triggered unwittingly by change of ownership, or equity transfers, in a corporate or LLC tenant. Leases frequently state that a transfer of a certain percentage of the shares or membership interest in a corporate or LLC tenant shall be construed an assignment. A tenant should always check its lease for such provisions prior to entering into an equity transfer transaction.
An assignment almost always requires the prior written consent of the landlord. Such consent may be in the landlord’s sole discretion or given under more reasonable terms. Landlords will usually review the financial information of a prospective assignee, just as it would with a new tenant. Most leases provide that a landlord may charge a small assignment fee. Some leases contain language that an Assignor must pay all or a portion of the consideration it receives as a result of the assignment to the landlord. These types of provisions can be problematic, especially if the assignment is in the context of an asset sale or corporate/LLC merger, since the “consideration” can be construed as the purchase price of the assets or equity of a business.
In a sublease, the Sublessor may retain much of the rights and obligations under the lease, the terms of which are governed by a sublease agreement between the Sublessor and the Sublessee. The Sublessor continues to pay rent to its landlord while receiving rent payments from the Sublessee. The Sublessor usually has remedies, including the right to evict the Sublessee, upon a default of the sublease.
As with assignments, the landlord must give prior written consent to a sublease. In addition, most leases contain clauses where a Sublessor must pay all, or a portion of, the excess rent (amounts over the rent paid by Sublessor to landlord) it collects from the Sublessee to the landlord.
PRACTICAL COUNSEL: In both assignments and subleases, the rights and obligations of the existing and incoming tenants are delineated in the underlying lease document. A prospective tenant should take care when reviewing a proposed lease to ensure that they understand the implications of an assignment or sublease, as they may be faced with unfavorable consequences. Whether a business needs to move out of a leased space due to growth, sell itself, or has space that is not being used, the assignment and sublease clauses will come into play and it is imperative to understand their implications. The actual assignment of lease or sublease agreements should also be drafted and negotiated carefully to conform to the underlying lease, as well as protect the best interests of the Assignor, Assignee, Sublessor or Sublessee.
30 November 2015
It is a common misconception that if you transfer (or assign) your lease you will have nothing further to do with the lease and will no longer be liable to the landlord. However, you will continue to be liable to the landlord except in some circumstances. Henry learnt this lesson the hard way.
Landlord claims $25,000 from previous tenant
Henry agreed to lease 25 hectares from Alice for cropping. Rent was $50,000 plus GST per annum. Henry and Alice signed a lease for three years. Six months into the lease some land that was suitable for cropping came up for sale. Henry decided to buy that land and Tony agreed to take over the lease.
Unfortunately Tony got into financial difficulties and he couldn’t pay the rent. When the arrears of rent reached $15,000 and the property was in a state of disrepair, Alice had had enough. She managed to find someone else willing to lease the land, but at a reduced rent. Alice went to see her solicitor. Alice’s solicitor ensured that the lease was cancelled following the correct procedure set out in the Property Law Act 2007. It soon became clear Tony did not have the means to pay the arrears. Alice’s lawyer told her that she could recover the outstanding rent and repair costs from Henry.
Henry went to see his lawyer. His lawyer reviewed the lease document and advised Henry that he would have been liable to Alice to comply with the lease until the end of the three year term if she had not cancelled the lease. As Alice had cancelled the lease, Henry would be liable for the outstanding rent and penalty interest to the date of cancellation, Alice’s legal costs, the costs of making good the land and shortfall in rent until the end of the three year term. Henry was shocked to find the total amount owing was nearly $25,000.
Henry’s lawyer also advised Henry that he would be liable to Alice even if Tony had assigned the lease to someone else. If Alice sold the land, Henry would be liable to the new owner. If the lease had included a rent review clause, Henry would be liable for the increased rent.
Liability of tenant on assignment
The Property Law Act 2007 provides that, on any transfer or assignment of a lease after 1 January 2008, the transferor or assignor of the lease remains liable to the landlord for payment of the rent and performance of all the tenant’s obligations under the lease. If the lease is varied (and the variation was not provided for in the lease at the time of assignment), the previous tenant will not be liable to the extent of the variation. If the lease is surrendered or renewed, the previous tenant will no longer be liable. However, if the lease is extended and that extension is provided for in the lease, then the tenant will remain liable during the extension. If the tenant remains in possession with the landlord’s consent after the expiry date, then the original tenant will remain liable until the lease is terminated. All of this can be changed by the landlord and tenant by providing differently in the lease document.
What can you learn from this?
Leases are complex documents and they are not all the same. The law is not simple. Any agreement to lease (including a variation or assignment of the lease) should be recorded in writing and legal advice taken before any agreement is made. As a tenant you should fully understand the extent of your obligations and potential liability under the lease. If possible you should try and exclude or limit your liability if the lease is assigned – although most landlords won’t agree to this. You should also ensure that the person taking over your lease has the financial resources and ability to meet the tenant’s obligations under the lease.
Please email me at email@example.com with your ideas for future articles. Keep an eye out for next month's column, where I will discuss another relevant rural legal issue.
Barbara McDermott is a partner of Norris Ward McKinnon, specialising in commercial and rural law. With offices in Hamilton and Huntly, we have friendly, expert legal advisors ready to help you with your business and personal legal matters.