November 2016 – Issue #58
Generally, a tenant will have to accept some form of recapture in connection with a proposed assignment or sublease unless it has a good deal of leverage. When a landlord recaptures by subleasing back the space that the tenant intended to sublease, it presents particular challenges and risks to the tenant.
In today’s issue, we focus on seven issues to address with recapture subleases.
Mintz & Gold LLP
Bears seem to be in the news more than at any time since Yogi and Boo Boo roamed Jellystone Park.
Not only does New Jersey have Springsteen and some painful to watch NFL football, it also has “Pedals”, a black bear who walks on his hind legs.
Pedals looks like a guy in a bad bear suit, but sadly he has two maimed front paws so he has learned to walk upright. Pretty impressive to me, since I barely walk upright.
Apparently, there has been a bit of a dispute between animal lovers who want to help Pedals and state wildlife biologists who feel that humans should back off since Pedals has adapted well in the wild.
If only Pedals was a grizzly bear, he could avoid the controversy and get some honest work. According to the Wall Street Journal, some grizzlies out west have become very adept consumer product consultants.
Yes, you heard that correctly. In Montana, some bears who are caught too many times stealing human food are put to work at the Grizzly and Wolf Discovery Center helping manufacturers of outdoor gear obtain the coveted “bear resistant” label.
The bear keepers might, for example, put some tasty treats (perhaps a pic-a-nic basket!) in a container and leave it in the grizzly enclosure and let the bears have at it. If the container lasts the mauling for sixty minutes, it is deemed bear resistant.
One bear named Kobuk is so skillful at defeating various products he is nicknamed “The Destroyer”.
Kobuk previously represented landlords in lease negotiations, which is not surprising since many tenants feel like a barely bear resistant container that has gone ten rounds with Kobuk after negotiating their recapture provisions.
Assignment and subletting rights afford tenants needed flexibility over a long lease term. Not surprisingly, landlords want to control who is in their building and to profit from a favorable market, so often landlords demand a right to recapture the space that their tenants wish to assign or sublease, either by terminating the lease (or terminating the lease as to the portion of the space in question), by taking an assignment of the lease or by subleasing the space.
As we have said in past newsletters, most tenants will have difficulty avoiding recapture absent a large amount of leverage. Today we focus specifically on how that recapture is implemented by sublease.
Most tenants looking to sublet all or a portion of its space for all or substantially all of the remainder of its term or to assign its lease would be happy to have its landlord exercise its recapture right by terminating the lease (or applicable portion) and taking the space off of the tenant’s hands.
But sometimes a landlord will not agree to terminate and instead will want to keep the tenant in the mix by requiring that the tenant assign the lease or sublease such space to the landlord or its designee. This allows the landlord to keep any profit from the assignment or sublease without terminating the tenant’s obligations and possibly triggering consent rights of the landlord’s lender.
Assignment is a different animal and, if possible, it is best to eliminate the landlord’s right to take by assignment. As with a sublease, an assignor under an assignment remains liable for performance under the lease, but unlike a sublessor, an assignor has no ability to enforce the obligations of its assignee or take back the space. If the landlord insists on recapture by assignment, the assignor should not be responsible for any unpaid rental or other obligations under the lease after the assignment.
It is much harder to get a landlord to give up its rights to recapture by sublease. The landlord wants the ability to profit from the real estate if the sublease rental exceeds the rental under the lease.
Unfortunately, recapture subleases can get very complicated and lead to many hidden risks if the tenant is not careful.
So when negotiating recapture by sublease provisions, a tenant needs to stand up on its hind legs, let out a roar, and cover the following seven issues:
- Avoid defaults. Performance by your landlord or its designee under the sublease should be deemed performance by you of any similar obligation under your lease related to such space and any default under such sublease should not give rise to a default under your lease.
- Allow for offsets. You should be entitled to offset the rent under your lease by any unpaid rent under such sublease (i.e., you should only be liable for the difference, if any).
- Obtain a Landlord indemnity. Your landlord should indemnify you from any liability arising from the use or occupancy of the sublet space. This should include claims made by any brokers for commissions in connection with the sublease.
- Set your terms. Your landlord should be obligated to recapture under the same terms as you were prepared to offer the subtenant to the extent applicable (based on the proposed sublease that you sent to your landlord for approval).
- Sometimes, you can negotiate a right to have your landlord make its recapture decision earlier in the process based on a term sheet with a proposed subtenant or even a “marketing notice” of intended terms before you have a subtenant. This allows you to know where you stand before spending time and money negotiating a sublease. In such event, the term sheet or marketing notice should govern the terms of the recapture sublease.
- Rental rate. Your landlord may require that the rental rate under the recapture sublease be at the lower of the rent (per rentable square foot) under your lease and the rent under your proposed sublease (so that you are not receiving any profit on the recaptured space). If the lower rate is the rent payable under your lease, your landlord should not be entitled to any concessions that you were prepared to offer to the potential subtenant.
- Protect yourself regarding alterations. Your landlord will want the right to make alterations under the recapture sublease, but you should provide that these alterations must be removed at the end of the term if the space is returned to you and that you have no obligation to remove these alterations if the sublease is for the balance of your term.Try to eliminate your obligation to remove your own alterations in the space at the end of the term since you will have no access to the space to perform such removal. At a minimum, have all your removal obligations be subject to the terms of your proposed sublease so that you are in no worse position than if there had been no recapture.
- Consider use. Generally, a recapture sublease may be used for any purpose in the landlord’s discretion. You may want to limit this use to preclude competitors or at least to conform to the use restrictions under your lease.
Disclosure: most of our leases have garnered coveted bear resistant status. Full disclosure: we could not find a grizzly that stayed awake long enough to make it through one of our leases. Follow the seven suggestions above, and at least your lease will be recapture resistant.