Recapture: The Achilles Heel of Subleasing
In Homer’s epic poem about the Trojan War, The Iliad, the Greek King Agamemnon first allows the warrior Achilles to keep a captured young woman (Briseis) and then later, as circumstances change, takes her back, incurring Achilles’ wrath. Every kindergartener will tell you, “that’s not fair.”
Although most of our leases are epic and frankly, quite poetic, what does Achilles have to do with leases?
Maybe nothing, but bear with me. When tenants want to assign or sublease (i.e., circumstances change), most landlords demand a right to recapture the affected space (thus altering the basic business deal) either by terminating the lease, or by taking an assignment of the lease or sublease of the space. Is this fair?
Assignment and subletting rights afford tenants needed flexibility over a long term (often ten or fifteen year) commitment. Landlords, on the other hand, want to control who is in their building and at best will only agree to act reasonably in granting approval, feeling that only they should be entitled to profit from a favorable market.
Whatever the equities, unless the tenant has a good deal of leverage, it will have to accept recapture in some form. In all too many leases, however, the Landlord’s recapture rights become a Trojan Horse that can effectively destroy the tenant’s ability to assign or sublease.
How do you protect yourself? Try to address the following ten issues (let’s focus on subleases since assignments are so rare):
1. Limit the scope of the recapture right. Limit the recapture right to proposed subleases of all or substantially all of the premises for all or substantially all of the balance of the term. This will decrease the instances in which recapture is applicable and will only arise when you are already planning to vacate for the balance of the term.
If not possible, then try to exempt subleases up to some agreed upon size (e.g., a full floor or less) or length of time (e.g., less than the balance of the term). This allows you to preserve flexibility and expand back into the space.
2. Obligate the landlord to decide up front. Many leases require that the tenant engage a broker, find a subtenant and enter into a fully negotiated sublease before the landlord has to make its determination regarding recapture. This has an obvious chilling effect on your ability to sublease.
Ideally, the landlord should be required to decide after you first indicate a desire to sublease and then you should have an agreed upon period of time to finalize a sublease (e.g., 6 months) before you need to go back to the landlord. This minimizes the time and cost involved in marketing the space and negotiating a sublease.
If the landlord insists on first understanding the terms of a proposed sublease and the identity of the proposed subtenant, then require that the landlord decide based on a detailed term sheet, rather than a fully negotiated sublease. You may then be required to go back to the landlord after an agreed upon period of time or if the net effective economic terms become more favorable to the subtenant.
3. Require the landlord to decide quickly. The landlord should be obligated to decide within a set period of time (e.g., 10 or 20 days) or the recapture right deemed waived.
4. Be careful with the implementation. Many leases allow the landlord to choose among termination, assignment (you remain liable under the lease but lose control of the space) or sublease (you remain liable under the lease, but can take the space back).
If you are leaving the building, termination is best. If you are subleasing a portion of the space for less than the full term, you may not want to terminate with respect to that portion of the space since you may someday want the space back.
5. Do not get boxed in regarding the effective date. The effective date of the recapture should put you in no worse position than if the landlord had approved your proposed sublease and should match up with your plans.
6. In the event of a sublease to the landlord or its designee, make the landlord responsible for your obligations under the lease. Any default by the landlord (or its designee) should not give rise to a default by you under the lease (including a default in paying rent, except to the extent the lease rent exceeds the sublease rent).
Ideally, the landlord should also indemnify you for any liability arising from the subleasing of your space by the landlord (or its designee), although your ability to obtain this indemnity will depend on your leverage.
7. Do not get stuck with restoration obligations. In the case of a sublease for less than all of the term, improvements made by the sublessee should, at your option, be removed prior to the expiration date of such sublease, and in the case of a sublease for the remainder of the term, should not become your obligation to remove.
8. Recapture should not apply with respect to “permitted transfers”. Transfers that do not require the landlord’s consent should not be subject to recapture, e.g., transfers to related entities, or with respect to mergers or sales of your business.
9. Address concerns with any subtenant sharing occupancy. You should prohibit subleasing to a direct competitor or for an incompatible use.
10. Consider some aggressive approaches. Some tenants obtain a refund of the unamortized cost of improvements made by the tenant at its expense during the term (including if reimbursed by any work allowance to the extent repaid through fixed rent). As you can imagine, this is not a customary landlord give.
Although most landlords will not agree, some tenants obtain the right to withdraw the request if the landlord does recapture, giving added flexibility.
Protect your assignment and subletting rights by addressing these concerns and you will prevent a recapture right from becoming the Achilles Heel of your lease. And now you know why law was a better option for me than majoring in classics.