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Wins & Insights

Tenant Leasing Illustrated – Aug 2012 – The Lease Legacy

The Lease Legacy

Talented, resourceful, lethal, intelligent, buff; he walks into a new situation and, with his years of training, instinctively plots exit strategies in case of changed circumstances.

Yes, I could be talking about your typical commercial leasing lawyer, but I was actually thinking about the Jason Bourne character from the Robert Ludlum novels and Universal Studios action/spy thriller film series.

I love the Bourne series and admit to compulsively getting drawn in whenever coming upon the movies while channel surfing. I am also looking forward to the new movie, The Bourne Legacy, slated to come out this summer. Not that I ever understand the plot, but the films are fun and fast moving, and who can object to a little gratuitous violence?

Other than being fun and fast moving with gratuitous violence, how does this relate to leasing?

Well, in structuring its lease a tenant also needs to focus on having the necessary flexibility to adapt to changed circumstances.

Inevitably, a tenant’s space needs are going to evolve over a ten or fifteen year term. The exit strategies necessary to provide sufficient flexibility over such an extended period of time cover a broad range of lease provisions, including expansion rights, rights of first offer, termination options and assignment and subletting.

These topics are too broad to cover in one newsletter, so today we focus on one critical aspect: the necessary flexibility for a tenant to complete major transactions, including the sale, merger or reorganization of its business, without undue interference from the landlord.

Landlords do have legitimate reasons to restrict the rights of tenants to assign and sublease and most leases include either a general prohibition or significant restrictions on such rights. These restrictions typically also prevent transfers of the equity interests in the tenant that are intended to circumvent the assignment and subleasing provisions of the lease.

That being said, tenants must have the flexibility to pursue legitimate business transactions without landlord’s consent. Otherwise, a landlord can extort unreasonable and costly concessions from a tenant as a condition to providing its consent to critical transactions not directly related to the lease.

A nightmare scenario for a tenant (not to mention its attorney!) is to have negotiated its merger, sale or reorganization agreement, or perhaps even executed the formal agreement, only to discover that one or more of its leases would be in default and subject to termination because of the transaction.

To make sure that you sleep soundly, cover the following nine points in your assignment/subletting provision:

  • You should be entitled, without the consent of the landlord, to transfer to an entity created by merger, reorganization or recapitalization of your entity or a purchaser of all or substantially all of your assets or stock, provided the successor entity assumes your obligations under the lease, the transfer is for a valid business purpose (i.e., not principally to transfer the lease) and the resulting entity has reasonably sufficient financial viability.

Be sure to work with your real estate professionals (attorneys, brokers, consultants) to structure the provision in a manner that works for your business. Mom and pop shops, partnerships, public corporations and start-up companies all will have different needs for flexibility.

  • Transfers to or use of the premises by an affiliated entity should also be allowed under the same standards as in the bullet point above, except that no financial viability test should be required since your original entity remains viable. Affiliates are entities controlled by, controlling or under common control with you and “control” should be defined broadly to mean the power to direct the business and affairs of the entity in question.​
  • Specifically permit intercompany transfers among equity holders, interfamily transfers without landlord’s consent and new equity interests. The reallocation of ownership interests in your entity and transfers for estate planning purposes should not trigger the need for the landlord’s consent. Neither should the admission of new holders of ownership interests.
  • The lease should permit corporate transactions in public markets. The lease should allow the transfer of your shares (by persons other than those deemed “insiders” under SEC rules) if such sale is effected through the “over-the-counter market” or any recognized stock exchange (including a public offering).
  • If you are a partnership (e.g., law firm, accounting firm) be sure to permit the admission, withdrawal, removal, incompetency, death and retirement of partners without landlord’s consent, since without a specific provision these transactions are often defined as “assignments” under typical lease clauses.
  • Certain retail uses, in particular restaurants or nightclubs, can be tricky since some landlords consider the location as part of your business and look to get a piece of the action on a sale. This should be resisted to the extent possible, but if unavoidable provide the landlord with a specific and limited “vig” without any consent rights.
  • Determine the surviving entity’s financial strength with an objective test. Many leases provide that the net worth of the surviving entity must be the greater of the tenant’s net worth immediately prior to such transaction or its net worth on the date of the lease. Try to limit this test to your net worth immediately prior to the transaction since it is the most relevant value.

If your entity has a high net worth that far exceeds what is needed to pay the rent, net worth may not be the appropriate standard. Again, structure with your particular entity in mind since other valuation methods may be more appropriate, such as EBITDA, your corporate rating or some multiple of the rent.

  • In addition to not requiring landlord’s consent, make sure that other inapplicable assignment/sublet provisions do not apply. For example, landlord should have no right to recapture and net “profits” should not be split.
  • Make sure that these same provisions would apply to a similar transaction by your subtenant (or sub-subtenant, if possible). This will make it easier to complete a sublease of the space down the road, without having to ask the landlord for this flexibility as part of its consent to the sublease.

Completing a major business transaction can be stressful enough. Channel your inner Bourne and address these points in your assignment/subletting clause so that the leasing portion of the transaction does not itself become too much of an action thriller.​