Subleasing: There’s More to It Than You May Think

January 12, 2010

Clients or fellow attorneys from other practice areas often come to commercial real estate practitioners and request assistance with subleases. They invariably say, “Can you just look at this sublease quickly? Please don’t spend a lot of time on it. It’s just a sublease.”

Just a sublease. We try to break the news gently that adequate legal advice on a sublease does not mean a “shorter” or “less serious” review than the advice we might give on a direct lease. In fact, adequate legal advice on a sublease – whether on behalf of the proposed subtenant, prime tenant/sub landlord or landlord – can often be more complex and require more time than a lease review.

In the current market, space available for sublet is increasing as sublessors (prime tenants) look to shed excess space, and some businesses (potential subtenants) seek shorter terms and lower rents in what they hope will be better space than what they could afford a year ago. Below are a few of the many reasons why it pays to have a complete professional review of a sublease.

1. The Prime Lease

For a subtenant, the most important legal service a lawyer can provide is review of not only the sublease, but also of the prime lease between its immediate landlord (prime tenant) and the landlord. A subtenant has no contract with the landlord enabling the subtenant to occupy its space. A subtenant’s rights to the space are only as good as its sub landlord’s rights to that space.

Therefore, reading the sublease alone is never adequate. The prime lease may contain time restrictions, use restrictions, or form estoppels that are unworkable for the subtenant, and let’s not even mention the prime lease that terminates by its terms if the space is sublet.

2. Landlord’s Right to Approve

Most leases require that a tenant obtain written consent from its landlord before subleasing any portion of the tenant’s space. The landlord’s review right may be in its “sole and absolute discretion” (which translates as “arbitrary” or “no reason”), or “reasonable discretion” or “conditioned” upon various specified conditions.

But no matter what, a landlord’s review takes time. For a subtenant, it is critical to know (1) how much time a landlord has to review the proposed sublease (Fifteen days? Thirty days? A reasonable period? Unspecified?); and (2) whether there are specific materials the landlord will require to complete its review, such as written materials demonstrating the financial strength of the subtenant, a description of the subtenant’s proposed use, or a requirement that the initial tenant remain liable on the lease, to name a few.

No subtenant wants to be surprised at the end of a 30-day or 45-day waiting period with rejection by a landlord well within its rights for a reason that was not specified in the sublease, but rather plainly in the lease.

3. Financial Conditions of the Sublessor

While a sublessor in financial straits with too much space may be willing to offer bargain prices on rental rates just to lower its losses, the subtenant should carefully consider the sublessor’s financial condition. In a bankruptcy, a lease is an asset to the bankrupt estate. A bankrupt sublessor will have two lease assets: one lease up stream to its lessor, and one down stream to its sublessee. Both these leases are subject to special treatment in the sublessor’s bankruptcy.

We have covered bankruptcy issues of lessors and lessees in other McGuireWoods Washington Baltimore Transactional Real Estate Group articles (6/11/09 and  6/18/09) but it bears repeating that a bankrupt sublessor spells complications for the landlord and the subtenant.

4. Three-way Conversation

While it may appear that the landlord can just approve or disapprove a sublease, the lease may contain a pass-through for legal fees the landlord can charge for review of a sublease. Some of these fees can be substantial, while others are capped. Or it may be that the language of the lease is more favorable to a sublease and prohibits an assignment of lease. Or the sublease may specifically limit the actions or remedies of the subtenant in the premises to what is permitted under the prime lease, and the sublessor may not be able to compel the landlord to cure its default under the sublease.

A performing subtenant without a documented non-disturbance with the landlord (or its lender) may find itself dispossessed of its space if the prime tenant defaults on the lease (or the landlord on its loan). Any of these circumstances could require the sublessor to intermediate between its landlord and proposed subtenant during negotiation of the sublease, conveying messages and positions of those parties as all three parties negotiate to a conclusion.

Despite the pressure to create a simple and straightforward sublease document quickly and cheaply, these are only a few of the reasons why it is always wise to engage a knowledgeable commercial leasing attorney to check the prime lease and tailor the sublease to meet the specific needs of the parties.