Issues To Consider ForThe G rowing Tenant (With S ample Clauses)

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1 Issues To Consider ForThe G rowing Tenant (With S ample Clauses) Linda D. White Linda D. White is a member of the firm of S onnenschein Nath & Rosenthal LLP, in Chicago. A commerciallease should change with a tenant s business goals, not hinder them. A TENANT S AIM in negotiating a commercial lease is to maintain flexibility. T he tenant realizes that during the term of the lease the tenant s business may grow, thus requiring more space in the existing facility or in a different facility. T he tenant may merge or sell its assets. S o the lease should follow not dictate the business needs of the tenant. The landlord, on the other hand, wants to maximize the profit from the leased space and to maintain control over the identity of its tenants. T he landlord will want to accommodate the tenant s needs. But the bottom line for the landlord is making sure that the property will make money. The lease clauses that affect the tenant s ability to grow or contract, and to control its business needs, are: The assignment and subletting clause; The expansion clauses (expansion rights, rights of first refusal, rights of first offer); The renewal clause; Clauses dealing with options to reduce space and early termination rights; Clauses allowing the landlord to substitute premises; and The yield-up (costs to vacate) clause. This article discusses some of the issues that the parties should consider regarding these clauses, and provides some samples. Remember: T hese sample clauses are a starting point, and with all such drafting, you need to make changes that tailor the document to the specifics of the agreement. ASSIGNMENT/ SUBLETTING CLAUSES Both the landlord and the tenant will consider the same issues in the question of subleasing, but they will do it from very different perspectives. S o it helps for each to understand what the other s needs may be.

2 Landlord s Perspective From the landlord s perspective, the maj or question is whether to permit assignment or subletting at all. As an initial matter, you may need to research the law of the j urisdiction to find out if state law requires a reasonableness standard on refusing to sublet. In any case, the landlord who is willing to consider permitting the tenant to assign the lease or sublet will probably want provisions that: Require assurances of the financial condition and character of subtenant; E xplicitly set forth the nature of proposed use by subtenant (subtenant must not breach another tenant s exclusive use clause); Prohibit subleasing to other tenants in the building; Prohibit subleasing to governmental entities; Limit the number of multiple subtenants (issues involved in converting a single-tenant floor to a multi-tenant floor); Require that the tenant must not be in default; Limit or revoke the tenant s expansion/extension rights; Limit certain benefits, such as caps on taxes/operating expenses (items personal to tenant). Consent Letter The consent letter is for the landlord s protection; it is not a non-disturbance agreement, and the landlord thus doesn t agree to honor subrent on tenant default. T he consent letter should: Restrict sub-subleasing or amendment without the landlord s consent; S pecify no release of the prime tenant s liability; Permit the landlord to collect subrent and building charges directly; Add the subtenant to indemnity and insurance obligations; Give the landlord the option to keep the subtenant if the prime tenant defaults; and S pecify that certain rights are personal to the prime tenant. Recapture And Profit- sharing Another issue is whether the landlord should have the right to recapture. T his may depend on whether the lease is for office or retail space, since different economic realities drive those situations. And, of course, there are matters of non-competition and exclusive use to consider, depending on the nature of the proposed subtenant. Recapture poses its own specialized questions. When should the right of recapture be triggered? Upon the prime tenant s decision to sublease or presentation of an actual subtenant? If the landlord initially passes on the recapture right but the tenant fails to find a

3 subtenant or assignee within a given time frame, should the landlord s rights kick in again? If there is to be some profit-sharing: What is the right percentage? S hould the prime tenant recover its costs of subletting before any sharing with the landlord or prorate over sublease term? What costs are included? S hould the prime tenant s cost of carrying the space while it is seeking a subtenant be deemed a recoverable cost? Controlling In Substance Assignments When an assignment happens in substance because of some maj or structuring change, the landlord will want some assurance that its rights under the lease will survive the change. S o the landlord will want: To provide that the sale of stock or partnership interests is subj ect to the assignment restrictions; Use of net worth test; Reaffirmation of guaranties; Assurances on tenant-mix issues (again, this is a question of exclusives); To avoid release of liability on transfers to affiliates. From The Prime Tenant s Perspective The prime tenant will want to be sure that it will not suffer any harm from the subtenant s behavior. S o the prime tenant will want: E xplicit limitations on its liability. (For the prime tenant, the best-case scenario is to obtain a release of liability from the landlord); To be held harmless by the subtenant for landlord s failure to perform; A security deposit and indemnities from subtenant; To require the subtenant to carry insurance naming both landlord and prime tenant. The prime tenant will also want the sublease to address: The subtenant s ability to comply with use clause and prime lease restrictions; The interrelationship of fire and casualty provisions in the sublease and prime lease; and The interrelationship of holdover provisions in the sublease and prime lease. LaterAssignment,

4 Subleasing, Sale Of Business The prime tenant has to anticipate how later assignment, subleasing, or sale of business would affect its rights after the sublease ends. For example, the prime tenant has to consider: Would an assignment or subletting later restrict the prime tenant from restructuring the lease with the landlord upon a further downsizing of the prime tenant? S ince the prime tenant no longer has any possessory rights to the leased space (even though it still has the obligation to pay rent) once it assigns the prime lease, what can the prime tenant do to mitigate its loss upon an assignee s bankruptcy? Would the restrictions on subleasing and assignment preclude the prime tenant from selling its business? Must the landlord s consent be obtained? And what happens if the landlord does not consent? Would the restrictions on subleasing and assignment affect mergers, acquisitions, and restructures? What is the effect of the death, disability, or withdrawal of one or more partners in a partnership tenant? Will this be deemed an impermissible assignment of the prime lease? Will such assignment constitute a default under the prime lease? From The Subtenant s Perspective There are risks in subleasing for the prospective subtenant. T he subtenant will want: Information regarding the respective financial conditions of the prime tenant and the landlord; Assurances of its position in the event the landlord goes bankrupt; A non-disturbance agreement from the landlord (the subtenant will want the rent to remain the same if its sublease becomes a prime lease); The ability to cure prime tenant defaults; and To obtain services from landlord. Flexibility As discussed at the outset, a commercial tenant s aim in negotiating lease terms is to maximize flexibility, and this is the case for the subtenant as well. S o the issues are: Maintaining expansion and extension rights contained in the prime lease. Will the landlord limit the prime tenant s rights to expand or extend the term upon a subletting? Will the subtenant or assignee be able to exercise rights if prime tenant fails to exercise them? Whether there any other rights which are personal to prime tenant which will not be available to subtenant or assignee.

5 EXPANSION RIG HTS T he tenant s right to expand can be the most important of the rights it has under the lease, since this gives it the ability to put its business goals first, and to avoid having them hobbled by the lease. T he expansion rights can be grouped into the following general categories: S pecific rights to expand. When must the tenant deliver notice of its exercise? How should you define the time period in which the landlord must deliver the space? Right of first refusal. Is it to be a continuing right or a one-time right? How much time does the tenant have to decide to take the space? What is the effect on the landlord s ability to market the space? Right of first offer. Is it to be a continuing right or a one-time right? When must the landlord again give tenant notice if no third party has been obtained to date or if the economic terms of the transaction change? The general terms. (Discussed below). Terms Of The Expansion The main questions for the tenant are typically as follows: What is the rental? C urrent rental rate or market rental rate? And how is it defined? If it is to be market rent is it in comparison with the market rent in other buildings or the market rent for tenants in the same building who have also expanded? What is the impact of concessions? Will arbitration be allowed? How much space can the tenant expand into and where is it? Is it contiguous to the existing premises? Must the tenant take all of the space offered? Can the tenant improve the expansion space? Does the tenant take the space as-is? Will the landlord provide a prorated or market tenant improvement allowance? Is the term for the expansion space coterminous with the existing term? S hould tenant s failure to exercise the first option preclude it from exercising the second option? What remedies does the tenant have when faced with the inability of landlord to deliver (for example, failing to get the existing tenant to vacate the expansion space)? REN EWAL RIG HTS In negotiating the renewal rights, the important points are: The number of options; The timing of exercise; The determination of rental rate (the same concerns arise in this context as in the expansion arena); and Partial renewal.