Not surprisingly, the global pandemic and subsequent economic slowdown are having a dramatic impact on commercial real estate markets. Many commercial tenants suddenly find themselves paying rent for far more office space than they need because they’ve had to lay off a portion of their workforce, they and their employees are learning that they can do much of their work remotely and efficiently—or both.
Faced with commercial leases that usually don’t offer tenants an easy way out, many tenants are considering whether an assignment or sublease could be the answer to their problems. However, depending on the nature of their lease and disposition of their landlord, tenants may have a contract dispute on their hands.
Assignment vs. sublease
An assignment of a commercial lease transfers all of the original tenant’s rights and obligations to the assignee (i.e., the new tenant). After an assignment is executed, the new tenant stands in the shoes of the original tenant and has a contractual relationship with the landlord. However, the original tenant, as assignor, also maintains its contractual relationship with the landlord. Thus, unless the landlord releases the original tenant from its obligations under the lease, the original tenant could find itself liable in the future for the new tenant’s breaches of the lease. For example, if the new tenant fails to pay rent, the landlord could choose to sue either or both tenants.
In a sublease, on the other hand, the original tenant retains some kind of interest in the lease. That interest could be significant—e.g., the original tenant could retain part of the space it has rented; or it could be nominal—e.g., the sublease could end one day earlier than the original lease. In either case, the original tenant will generally continue to pay rent to the landlord, while the new tenant pays rent to the original tenant. The new tenant usually does not have a contractual relationship with the landlord and will have to look to the original tenant to enforce provisions of the lease.
There are pros and cons to each. An assignment has the effect of more thoroughly (but not entirely) relieving the original tenant of its responsibilities under the lease, but also forecloses the original tenant from any ongoing interest or use in the rental space. With a sublease, on the other hand, the original tenant retains more flexibility to sublet only a portion of their space, and possibly for only a short period of time. However, the original tenant will have to assume certain landlord-like responsibilities managing its sub-tenant.
Can you assign or sublet your space?
Tenants contemplating a downsize should examine their lease to see whether and what it says about their right to assign or sublease their space. Although the default rule in Illinois permits tenants to do so, almost all modern commercial leases contain provisions prohibiting an assignment or sublease without the landlord’s consent. Other provisions may give the landlord a right to take the space back if the tenant wants to assign or sublease.
Such provisions authorize the landlord to reject a potential sub-lessee, but not without cause. Illinois courts generally forbid landlords from unreasonably withholding consent. If the tenant can secure a sub-lessee that meets “reasonable commercial standards” and is “ready, willing and able” to occupy the premises and pay rent, a landlord who refuses to give consent is probably overstepping its rights and is exposing itself to a suit from the tenant. Successful remedies could include compensation for economic losses resulting from the rejected assignment or sublease, and/or a court order requiring the landlord to accept the assignment or sublease (known as specific performance).
Landlords can also waive their right to approve a sublease by acknowledging the sublease without objection, or through other conduct that indicates that they do not object to the sublessee taking possession of the space.
Drafting considerations
Assignments tends to be simpler to draft than subleases. There are several key items to keep in mind when drafting an assignment of a commercial lease. For example:
- Do the parties need the landlord’s consent, and how should they go about getting it?
- Will the new tenant agree to assume all of the original tenant’s obligations under the lease?
- Will the original tenant indemnify the new tenant for any pre-assignment breaches?
- How will the parties handle a security deposition paid by the original tenant to the landlord?
- Does the original lease contain a renewal provision, and how will the parties deal with such a provision?
- Will the landlord release the original tenant from its obligations under the lease?
Drafting a sublease is usually more complicated because, on the one hand, the new tenant will not have any contractual obligations to the landlord yet; on the other hand, the original tenant will want the new tenant to be responsible for performing most/all of the original tenant’s obligations under the original lease. Important items to consider include:
- How much rent will the new tenant pay to the original tenant?
- Will the new tenant agree to look to the landlord to perform obligations that the original tenant cannot perform (e.g., repairing the physical building)?
- What kinds of indemnification provisions will be included?
- Who pays utility expenses?
- Do the parties have obligations to secure insurance?
- What happens when the sublease terminates?
Market conditions are prompting commercial real estate tenants to consider an assignment or sublease of its space. However, the same market conditions have created a number of potential legal pitfalls for the unwary.
About the author Brian Cohen is a partner at Novack and Macey LLP, a litigation boutique in Chicago. He helps his commercial real estate clients resolve disputes involving breach of contracts, office and retail leases, sublease and assignments problems, and the fiduciary and other duties that arise in the context of owning, developing, buying and selling real estate.
