Sublease Considerations for Commercial Tenant

Commercial Real Estate, Landlord/Tenant Disputes, and Real Estate Law by Simon Offord, Esq.

Commercial subleases can be good bargain options for tenants, but there are certain risks involved.  This article is intended to assist tenants in identifying these risks and understanding what can be done to mitigate them.

There are many issues for tenants to consider when subleasing, and this article is the first in a series of articles that will highlight these matters.

Protection from Sublessor’s Default

One of the more important issues for a sublessee to do to protect themselves is to try and ensure they are protected in the event the sublessor/master tenant defaults.  What does this mean?  The sublessee generally has an agreement with the master tenant, not directly with the landlord.  So, unless protections are added, if the master tenant defaults and its lease is terminated, that also means the sublessee loses its rights!  If the sublessee has expended significant resources to move into the new space and the master tenant defaults a few months later, this could be a significant loss.

So, what can the sublessee do?  In a perfect world hey can try and obtain a recognition agreement from the landlord whereby the landlord agrees to recognize the sublease as a direct lease between the landlord and the sublessee in the event that the tenant defaults under the terms of the master lease.  This allows the sublessee to remain in the property as if nothing has changed (other than the master tenant being gone!).  That said, landlords can be reluctant to provide such agreements, but there are other actions the sublessee take.

First, the sublessee should investigate the financial health of the master tenant.  Does the master tenant always pay rent in time?  Do they have liquid assets to pay future rent, or a strong revenue stream?  Have they been in default on any lease terms in the past?  This are crucial considerations for the sublessee to consider and investigate.

Moreover, the commercial tenant sublessee should require the landlord, or at least the master tenant, to provide any default notices to the sublessee.  This will allow the sublessee to possible cure, or assist in curing, any defaults to preserve their lease (sometimes called an attornment agreement).

Understand the Master Lease

This may go without saying, but it is critical for the sublessee to understand and approve the terms of the master lease.  This can be lost in the shuffle when entering into a sublease, as the sublease itself may be 20-plus pages long, and some much time is spent negotiating the sublease, the sublessee forgets to make sure the master lease is acceptable.

It is highly unlikely that the landlord will agree to amend the master lease, but is nonetheless critical for the sublessee to make sure that the master lease does not have egregious terms or otherwise make subleasing impractical (ie limitations on use of the property that make doing business impossible).

Along these same lines, it is also critical to know if the landlord will allow the sublease or not.  One can spend weeks or longer negotiating the terms of the sublease, paying attorney fees etc. to later find out the master landlord will not allow the sublease.  Thus, in a perfect world, the sublessee will get early confirmation of this, and preferably include it in the sublease (as opposed to executing the sublease subject to landlord approval).

Obtain Warranties from the Sublessor

As it is important to understand what is in the master lease, it is also critical to understand whether that is the current status as well.  Thus, in come representations and warranties.

It is critical for the sublessee to obtain certain representations from the sublessor about the status of the lease and property.  Common representations and/or warranties from the sublessor include

  1. the master lease is the entire agreement between the parties, and there are no other agreements between the landlord and the sublessee;
  2. there are no existing defaults or set of circumstances which would lead to a default under the master lease by either the landlord or sublessor;
  3. the premises and the improvements therein are in compliance with all applicable laws; and
  4. the premises, improvements and building systems are in good working order and condition.

These are just some of the critical issues that commercial tenants need to ensure are included in their sublease.  Future articles will address other issues, including use of the space, utilities, shared functions, and other matters.

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