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Wins & Insights

Tenant Leasing Illustrated – May 2013 – Fire Breathing Assignment and Subletting Clauses

Fire Breathing Assignment and Subletting Clauses

It looks like spring is here in the Northeast. Which means all good commercial real estate attorneys are unleashing their dragons, unsheathing their swords and getting in touch with their inner direwolf.

That’s right. Spring also means season three of A Game of Thrones, the HBO television drama.

I admit I am hooked, as are many of our readers, since we received more email for our prior Game of Thrones edition than any other (curiously, even more than the breath taking issue on operating expense escalations; imagine that!).

My favorite take on the series is from Saturday Night Live, where the “creative genius” behind the show is revealed to be a 13-year old boy whose suggestion for each scene involves more nudity.

My 17-year old son, Noah, introduced me to the series. But Noah has grown impatient with my inability to use proper G.O.T. terminology and general sloppiness in identifying characters (“you know, the bearded guy who chopped off the head of the zombie guy…”).

So Noah has shamed me into reading the Song of Ice and Fire books, by George R.R. Martin, on which the series is based. Yes, sad but true; I need remedial Game of Thrones review.

What does this have to do with leasing? I have no idea; but I had to get your attention.

Seriously, careful attention to terminology and definitions is always important in leases. Recently, we have seen that it is of particular importance under assignment and subletting provisions for multi-tiered tenants.

By multi-tiered tenant, we mean a tenant entity where all or substantially all of its stock or other equity interests is owned by another entity, and perhaps that parent entity is similarly owned by one or more other entities.

As we have discussed in past newslettersalmost all leases restrict the rights of tenants to assign and sublease, including restrictions on transfers of the tenant’s equity interests if intended to sidestep the assignment and subleasing restrictions, but tenants need the ability, without landlord’s consent, to undertake legitimate business transactions.

Surprisingly, we have found that under some leases changes in control in upper tier entities are prohibited (to avoid tenant transfers designed to circumvent the assignment and subletting restrictions of the lease), but the right for such upper tier entity to transfer the stock or assets of the tenant entity as part of a legitimate corporate transaction or sale is not clearly permitted, even when the parties’ intent at the time the lease was negotiated was to address this concern.

The result can be ambiguity as to whether or not the landlord’s consent is required (never a good thing).

Keep the following four suggestions in mind with respect to assignment and subletting for multi-tiered entities:

  • Always permit, without the consent of the landlord, transfers to an affiliated entity and to a financially sound entity created by merger, reorganization or recapitalization of your entity or a financially sound purchaser of all or substantially all of your assets or stock. This may be assignment and subletting 101, but this is the basic building block necessary to create the appropriate flexibility for any tenant, multi-tiered or otherwise, and some leases (albeit a minority) do not cover this basic tenant need.​
  • When creating flexibility for multi-tiered tenants, make sure that the solution directly addresses the lease’s prohibition. This is where careful attention to terminology comes into play. Some leases specifically state that a change in control of a tenant’s parent entity is prohibited, but attempt to provide the needed flexibility by excluding from the requirement for landlord’s consent an assignment to a successor entity purchasing the tenant’s business. But if the change in control occurs at an upper tier level, the actual tenant entity does not change and there will be no assignment. In other words, the exclusion from the requirement of obtaining the landlord’s consent does not match up with the prohibition which requires such consent in the first place.

One way to avoid this problem is for the lease to specifically define changes in control of upper tier entities as “assignments”, so that the exclusion matches up with the prohibition.​

  • Make Noah proud and focus on the definitions as follows:​

○​  Make the restrictions requiring landlord’s consent as narrow as possible. If the lease provides that “transfers”, including changes in control, require landlord’s consent, then specifically exclude from the definition of transfers changes in control as part of a legitimate transfer of your business or transaction with a related entity.​

○​  Make the exclusions from landlord’s consent as broad as possible. This exclusion should cover more than just the typical assignments as part of mergers and sales and subleases to related entities. Cover any reorganization, sale of a division, spin off or splitting of your entity and any transfers, “directly or indirectly”, i.e. at any level of your entity.​

  • For the most comprehensive approach, allow the freedom to transfer without the landlord’s consent with respect to any “Change in Control Event”. In addition to the typical rights to transfer without consent in the event of mergers, consolidations and sales and to related entities, the best way to protect a multi-tiered tenant is to create a broad category of transactions encompassing all bona fide changes in control. This should not be objectionable to a sophisticated landlord and should be defined as a transfer for a legitimate business purpose, however accomplished, which results in a change in control.​

I must admit that I have moved up from the back of the class and now have a certain strut in my step as I show off my knowledge of dragons, Whitewalkers and other minutia of the seven kingdoms of A Game of Thrones. Use the four suggestions above and you can avoid Noah’s wrath and maybe even the need for remedial assignment and subletting work for multi-tiered tenants.​