• Landlord Unreasonably Withholds Consent To Below-Market-Rate Sublease
  • May 19, 2003 | Author: Harris Ominsky
  • Law Firm: Blank Rome LLP - Philadelphia Office
  • A recent case highlights how important it is to define standards for a landlord to approve assignments or subleasing by a tenant. In National Union Fire Insurances Co. v. Rose, 760 N.E. 2d 791 (Mass. App. Ct. 2002), a tenant with an 11-year lease of office space in downtown Boston requested the landlord's consent to a sublease, and the landlord refused on grounds that the sublease rent was inadequate. The lease provided that the landlord's consent could not be "unreasonably withheld." It also gave the landlord 75% of any subleasing "profits" made by the tenant. Essentially, that percentage was to be based on the amount of rent received from a sublease to the extent it exceeded the amount paid by the tenant under the prime lease. That was to be calculated after allowing for certain defined costs associated with facilitating the subtenacy.

    The tenant had decided to sublease to one of its major customers at the same square foot rental rate as in the prime lease, but in the period since that lease had been signed, market rates had increased. Therefore, the landlord withheld the consent on the theory that the tenant had an obligation to sublease only at market rents, and if it did not do so, it would be denying the landlord its share of excess rent as set forth in the prime lease.

    Appeals Court

    The Massachusetts Appeals Court found that the landlord had improperly withheld consent and that the rental-sharing provision in the lease did not obligate the tenant to sublease at market rates. It agreed with the lower court's conclusion that: "Profit sharing is operative only 'if' sublease rent exceeds tenants' rent, which it does not."

    Obviously, the landlord could have protected itself in the prime lease by specifically stating that it did not have to consent to a sublease at less than market rental. Because it did not do so, the court refused to imply such a provision.

    Some landlords insist on setting the sublease rent at the contract rental, as it may increase by a CPI (Consumer Price Index) formula. They may spell out that if the tenant should sublease at less than a fair market rate, it would still have to share with the landlord in the same way as if it had received a fair market rate. In effect, the tenant would have to share an "imputed profit" during the sublease. Of course, if the lease had provided for that, since the landlord would not be losing profit from the less-than-market rent, the landlord would have even less of a reason to justify turning down the sublease.

    From the tenant's perspective, the right to sublease at less-than-market rates can serve as a safety valve in offsetting its rent obligations to the landlord if it must vacate. For example, it may be going out of business or it may have to move to different or larger offices.

    Sweetheart Rent

    Unless these types of provisions are buttoned down, it would be easy to imagine a scenario where the tenant could take advantage of the landlord. For example, in National Union Fire Insurance Co., the tenant was subleasing to a major customer at below-market rates. It would be difficult for the landlord to figure out whether the customer made up for the "sweetheart rent" by benefiting the tenant in some other subtle way.

    Under different circumstances, landlords might object to subleasing at less than the market rent because they are concerned about vacancies in other parts of the building, and the competition with its own tenant for leasing prospects. The landlord could then lose a potential tenant to the subtenant because of a lower rent than it has been offering, and in addition, that lower rent could affect the ability of the landlord to receive the prevailing rental rate in other space that becomes vacant. Also, some landlords will reserve the right to withhold consent to subleasing at any rent when these landlords are attempting to rent other space either in the same building or a nearby building. These are some of the reasons why landlords will want to spell out that they will not have to consent to subleasing or assignment under those conditions.