- Assignment vs. Subletting: Do You Care Which One You Use (or Why)?
- July 10, 2003 | Authors: Seth S. Katz; Abe J. Schear; Philip G. Skinner
- Law Firm: Arnall Golden Gregory LLP - Atlanta Office
From time to time, clients ask counsel and brokers about the pros and cons of using an assignment versus a sublease to effect a transfer of possession and a transfer of obligations with respect to leased premises. With about equal frequency, questions come up regarding the differences between assignments and subleases, and "whether those differences really make a difference" after all is said and done.
While assignments and subleases are both means to achieve substantially similar ends, they do yield different legal and business results. The purpose of this article is to explain and discuss some of the similarities and some of the distinctions between assignments and subleases, both from a legal perspective and from business and practical perspectives, and to discuss some of the reasons that the different parties involved in such transactions may prefer or wish to select one of these transaction forms over the other.
A. Who Is Involved?
There are three primary parties affected by assignment and/or subletting transactions:
- The owner/landlord;
- The transferor (i.e. the tenant who will be the assignor or the sublessor); and
- The transferee (the 3rd party who will be the assignee or sublessee).
How such parties are affected by the transaction and the end results of the transaction vary depending upon which party's viewpoint you are considering and whether you choose to use an assignment or a sublease in the transaction.
Other parties that may become involved as secondary or related parties, or as parties' representatives, include the following:
- Lenders for the owner/landlord, tenant and/or transferee;
- Brokers for the owner/landlord, tenant and/or transferee;
- Guarantors of the tenant and/or transferee; and
- Counsel for the owner/landlord, tenant, transferee and guarantors.
Obviously, the complexity of a transaction and the documentation necessary to adequately address the concerns of all primary and secondary or related parties is often affected by the number of players involved, the sophistication and familiarity of the parties and their representatives in dealing with comparable transactions, the relative leverage of the parties, and the motivation of the various parties to complete the transaction. While a tenant and its proposed transferee may be highly motivated, the landlord and its lenders may have little or no incentive to facilitate an assignment or subletting transaction. In fact, the landlord and its lenders may have interests that are at cross-purposes with any such transaction. Overcoming and such inconsistent and/or competing factors is frequently critical to the successful outcome of an assignment or subleasing transaction.
In most real estate transactions one participant or its representatives end up acting as the "point person" (individually or collectively) to prepare and coordinate documentation, to facilitate negotiations, discussions and conference calls, and to cajole, convince or coerce the players involved. Such efforts are regularly needed to overcome inherent deal inertia, to motivate disinterested parties, to persuade parties with competing interests, and, simply, to force the transaction over the finish line in an acceptable manner and in a satisfactory time frame. This is certainly the case in many assignment and subletting transactions, which need a strong deal advocate. It is often critical that one individual assumes this mantle by default if not by design in order to give a transaction sufficient focus and push. In many instances the counsel or broker for the tenant ends up being the party playing this role.
B. What Interests Are Involved?
Whether you are talking about an assignment or a sublease, the current tenant is the party that desires to effect some kind of transfer of its interests. Two different kinds of interests are involved:
- The tenant's interests in, to and under the tenant's lease, which are contractual in nature, and
- The tenant's interests in the leased premises that are created by and are the subject of its lease, which are in the nature of property interests.
An assignment results in the transfer of both the tenant's contractual interests in its lease and the tenant's property interests in the leased premises. A sublease only results in the transfer of the tenant's property interests in the leased premises, and does not result in a transfer of the tenant's contractual interests in its lease. Instead, the sublease establishes a new contractual relationship between the tenant and is transferee/sublessee.
Although the transferor's contractual interests in its lease are transferred in the case of an assignment and such contractual interests are not transferred in the case of a sublease, this distinction does not mean or imply that the transferor is released from its personal liability on its lease. Virtually all landlord lease forms expressly provide that the tenant/transferor will not be released or relieved as a result of any assignment of its lease or sublease of its premises. On a case-by-case basis in the context of a specific proposed assignment and assumption transaction a tenant/assignor may be able to negotiate for a release from liability by the landlord. While this is an infrequent exception to the general rule, it is certainly true that if you don't ask to be released you won't be released 100% of the time. The tenant/assignor may get asked for some consideration for such a release, but whether an acceptable price or other concession or accommodation can be reached is a different issue entirely than whether a release is possible.
Depending upon the laws of the state in which a premises is located, the property interests involved may be characterized legally as interests in real property or interests in personal property. For instance, in Georgia leases can create either "estates for years" that are real property interests or "usufructs" that are personal property interests. As a result this legal distinction between leases and the nature of the property interests that they create can be important. As a result the lease or leases involved in a proposed transaction must be analyzed to determine the nature of the property interests that they create. In any case, the property interests that the tenant is transferring chiefly consist of the right to possess or occupy, and the right to use, the leased premises.
Other interests that are affected by an assignment or sublease are the interests and obligations of a guarantor under a lease guarantee. Guarantors are typically the owners, founders, parent companies or brother/sister companies of a tenant. As such, most guarantors are interested in the success of the tenant and are asked to provide a lease guaranty when the tenant's credit doesn't sufficiently support or underwrite the lease liability. In such cased the guarantor's present and future plans for and interests in the tenant, and belief in its future prospects, motivate the guarantor to support the tenant's lease credit via a guarantee of lease obligations. Under a properly written lease guaranty a guarantor is not released from its obligations under its guaranty as a result of either an assignment or a sublease. As a result the guarantor is left in the awkward or distasteful position of being liable or at risk under its lease guarantee for the defaults of the transferee (i.e. the assignee or sublessee).
To many a guarantor this is galling at first, because the transferee is a person or party that is, in effect a third party or stranger to the guarantor, and the guarantor enjoys no affiliation, ownership interest or other financial interest in the transferee. Depending upon the underlying reason for the assignment or sublease this can seem like a particularly bitter pill to swallow. If an assignment or sublease is being pursued in the context of the business failure of the tenant, guarantors find their continued guarantee liability to be a lingering financial reminder of their unfulfilled visions for their tenant affiliate, whose future may have seemed so bright or hopeful when the guaranty and lease were originally entered into by the parties. Even when a transfer via an assignment or sublease occurs because a business is being relocated or has outgrown its space, guarantors dislike this continued liability. While it won't make the guarantor feel better about its continued exposure, since most tenant's are not released from their lease liability by reason of an assignment, and since no tenant's are released from their lease liability by reason of a sublease, the guarantor is really continuing to provide a guaranty of such tenant's continued, unreleased lease liability. This is no more than and no less than the liability the guarantor originally bargained for. In fact, because the transferee/assignee or the transferee/sublessee (as applicable) are both paying or covering all or some portion of the tenant/transferor's unreleased lease liability, the guarantor really gets the benefit of such party's performance under the assigned lease or the sublease.
C. Key Distinctions Between Assignments and Subleases
Some of the key, distinguishing differences between an assignment and a sublease include the following:
An assignment places the transferee/assignee into a direct contractual relationship with the owner/landlord, while a sublease does not. This distinction occurs because in an assignment the tenant/assignor assigns its contractual interests in its lease to the transferee/assignee, who assumes such contractual interests, and also assigns the tenant/assignor's property interests in the leased premises. The position that the assignee ends up in is colloquially referred to as "standing in the shoes of the assignor", which simply means that the assignee has assumed the contractual position of the assignor and taken over his property interests as well. Before an assignment the landlord and tenant enjoyed "privity of contract" with one another, and the tenant had and enjoyed possession of the leased premises and all of the rights and benefits of such possession. After an assignment the landlord and the assignee enjoy privity of contract with one another and the assignee enjoys possession of the leased premises and all of the rights and benefits of such possession.
As a result of an assignment the transferee/assignee becomes the direct tenant of the owner/landlord, while a transferee/sublessee does not. This distinction arises because the transferee/assignee has the right to possess and occupy the leased premises, which are the property interests that have been transferred, and the transferee/assignee has assumed and enjoys both the benefits and the burdens of the lease, which are the contractual interests that have been assigned and assumed. As a result the assignee can enforce the assigned lease directly against the landlord and the landlord can enforce such lease directly against the assignee.
An assignee pays its rent directly to the owner/landlord, while a sublessee does not. This difference occurs because after an assignment the assignee is directly obligated to the owner/landlord to keep, observe and perform all of the tenant's covenants and obligations under the lease, while by contrast a sublessee pays its rent to the transferor/sublessor under its sublease, who in turn remains obligated to pay its rent under the owner/landlord under its lease. After an assignment the assignee's acts, omissions or other conduct of are the only ones that directly affect the landlord/tenant relationship of the owner/landlord and the assignee/tenant, not the acts, omissions or other conduct of the original tenant/assignor.
An assignor has no legal way to regain possession of the leased premises if the assignee defaults under the assigned lease, absent separate (i.e. outside of the lease) contractual covenants and agreements between the assignor and the owner/landlord, while a sublessor can exercise its rights and remedies under its sublease to regain possession from the transferee/sublessee. This critical distinction arises due to the nature of an assignment and the transfer of both privity of contract and rights of possession that results from an assignment. The assignor no longer has any right to possess or occupy the premises. But as discussed above an assignor, who typically is not released by the underlying owner/landlord as a result of an assignment, retains continued liability and responsibility for defaults under the lease. This poses an inherent risk and concern for the assignor in the event the assignee defaults. The assignor is left in the unenviable position of being "at risk" for the assignee's defaults, but if the assignor or its guarantor steps in and cures such defaults such cure redounds to the benefit of the tenant/assignee, as the assignor has no right to regain possession of the premises as a result of such cure.
A sublease creates a new, direct contractual relationship between the transferor/sublessor and the transferee/sublessee, while an assignment transfers the assignor's contractual relationship with the owner/landlord. This distinction occurs because a sublessee has no resulting contractual relationship with the underlying owner/landlord, because the contractual interests of the tenant/transferor under its underlying lease are not transferred by a sublease. The sublessee does not "stand in the shoes" of the sublessor; it stands only "in its own shoes". The contract that directly governs the sublessor and sublessee and their relationship is the sublease, not the underlying lease to which the sublessor is and remains a party as the tenant. The owner/landlord is not a party to the sublease, and is not obligated to perform pursuant to the sublease, but, absent separate (i.e. outside of the sublease) contractual covenants between the owner/landlord and the sublessee, the owner/landlord also has no right to enforce the sublease.
All of the rights and interests of the sublessor and sublessee created via the sublease are subject to the terms and conditions of the underlying lease, which remains in effect as between the owner/landlord and the tenant/sublessor while the sublease is in effect, while all of the rights and interests of the assignee are created by the lease itself. This crucial difference exists because the rights and interests created by a sublease are derivative interests created out of or from the interest of the tenant, and are subordinate to the underlying lease. Even the property interests consisting of the sublessee's right to possess and enjoy the premises are subject to the underlying lease. This poses an inherent risk and concern for the sublessee in the event the tenant/sublessor defaults under its underlying lease. This risk to the sublessee would not exist in the context of an assignment.
Even if a sublessee has kept, observed and performed all of the terms and conditions of its sublease, the acts, omissions or other conduct of the tenant/sublessor vis-à-vis its landlord subsequent to the effective date of the sublease can adversely affect the rights and/or possession of the sublessee, while under an assignment this is not the case. Once again, this critical distinction arises because the sublessee's interests are derived from and subject to the lease. The termination of a lease due to the uncured default of the tenant will automatically terminate a subordinate sublease even though the sublessee is not in default under its sublease, absent some separate (i.e. outside of the sublease) contractual covenants between the owner/landlord and the sublessee. Absent such special provisions to the contrary, the sublessee, who has no privity of contract with the owner/landlord, has no right to cure or perform the obligations of the tenant/sublessor under the tenant/sublessor's underlying lease with the owner/landlord. For example, the tenant/sublessor could fail to pay rent to its landlord under its lease even though it has received the sublessee's rent under the sublease, and such failure, which could result in a default and termination of the lease, could result in a termination of the sublease.
D. Analyzing the Underlying Lease
An existing lease's terms and conditions is the starting point for an analysis of whether an assignment or sublease will work and/or which transaction form is more appropriate. Most landlord form leases have detailed provisions governing what can, and what cannot, happen in assignment and subletting transactions. Pro-landlord leases typically contain a lengthy "Tenant shall not" proscription that goes on to describe each and every direct and indirect way in which a lease and/or possession of the premises can be transferred by the tenant. Such leases frequently tie the right to assign or to sublease to the consent of the landlord. Depending on the form there may be no "consent standard" in the document, the lease may have a consent standard of, "in landlord's sole discretion", or their may be some version of a "reasonable consent" standard.
Well written landlord lease forms also include provisions that treat the transfer of a controlling equity interest in the tenant as a "deemed assignment" for purposes of the lease. The lease may also treat mergers, consolidations and reorganizations as a "deemed assignment." Lease forms also typically obligate the tenant to pay a "review fee" and/or to pay for the landlord's attorneys' fees incurred in connection with the proposed assignment or sublease. In addition, the tenant is frequently obligated to pay to the landlord all of the "profit" or "excess" consideration received by tenant from the assignee or sublessee. Such profit or excess is usually described as any sums or consideration greater than the rent payable by tenant to landlord under the lease.
Finally, many landlord lease forms require prior written notice from the tenant a specified number of days in advance of a proposed transaction, and require that certain specified information be included with such information. Such information may include the name, address, credit information and banking references for the tenant, a copy of the proposed form of assignment or sublease, a detailed description of the financial elements of the proposed transaction and a description of any change in use and/or any alterations or additions to the premises needed by the transferee.
While many of these lease provisions may have been negotiable on the front end of the lease transaction, if they were not in fact negotiated and revised they may constitute hurdles to clear, at best, or impediments, at worst, for a proposed assignment or subletting transaction. If a transaction involves multiple leases and locations, then each lease must be scrutinized to understand the nature of the "anti-assignment" provisions, restrictions and requirements that it contains and to determine what proposed transaction form will work under the lease. The answer may be "none", and you will likely get different answers from different leases.
Whether such provisions are viewed as hurdles or impediments, they represent problems to the successful conclusion of the transaction by the tenant and its transferee. As such, both such parties should be motivated to work to find or create solutions that will allow the proposed transaction to be concluded.
The landlord may or may not be motivated to facilitate a proposed transfer via assignment or sublease or to consent to such a transfer. Relevant factors can be both internal and external to the lease, including: whether the landlord has other vacancies in its property; whether the rents under the lease in question are above or below current market rents; and whether the lease provisions regarding assignments and subleases put the landlord or the tenant "in the driver's seat". Where the transaction is subject to the review and approval of the landlord without a "reasonable consent" standard the tenant and the transferee may need to think of ways to motivate the landlord to consent to the transaction. In the context of a distressed or failing tenant finding motivation may be as simple as bringing a creditworthy replacement tenant to the table. The parties can consider offering an increased security deposit to the landlord. The parties, their brokers and/or their counsel may have professional or personal relationships with the landlord, its broker and/or its counsel that can by utilized to establish a working dialogue that facilitates a favorable review of the proposed transaction, or at least a review in a non-adversarial context.
E. What Should A Landlord, Tenant, Broker or Counsel Do?
Obviously, there are legal pros and cons to both assignments and subleases, as well as practical considerations and business risks and concerns. As a result, there is no single, simple, correct or right answer to the question of which vehicle to use when an existing tenant wants to get out of some space and cover some of its leasehold obligations. Depending upon whether you are the owner/landlord, the tenant or the transferee, or are representing the owner/landlord, the tenant or the transferee as a counsel or as a broker, your questions, analysis, answers and resulting concerns will vary. For example, a transferee with excellent credit may be viewed by a transferor and its landlord as a better candidate for an assignment than a transferee with questionable credit, for whom a sublease may be more appropriate due to certain of the distinctions outlined above. In any case, the legal pros and cons and the legal distinctions involved must be considered concurrently with the business and practical issues that are involved in a pending transaction in order to structure the transaction in a mutually acceptable manner.
The nature of the transaction ultimately pursued may in part be determined based upon the analysis of the provisions of the existing lease. As a result, each transaction has to be analyzed on its own based upon the terms and conditions of the lease, the identities, creditworthiness and relationships of the parties, and a host of other circumstances that vary from case-to-case. In addition, there are many different ways to craft an assignment's or sublease's legal and business provisions and terminology; and the impact upon each party can vary with the craftsmanship of the brokers and counsel involved in a given transaction.
The current leasehold marketplace contains many opportunities for tenants and potential assignees and sublessees. As such, it holds a similar opportunity for brokers and counsel to become involved in a proactive and productive manner to help plan the transaction based upon the interests of the client, and to help manage the transaction and craft the documentation that will yield the desired results. We hope this article will help you in such efforts, and will serve as a starting point for your analysis of how to structure your next assignment or sublease transaction.