Subleasing commercial space to mitigate lease costs
A sluggish economy and the transition to a largely mobile workforce during the COVID-19 pandemic have forced many commercial tenants to re-evaluate their space needs. Many businesses are now paying for space they no longer need or can’t afford and are exploring the option of subleasing commercial property to another business in order to meet some or all of their ongoing rent obligations. In Chicago, for example, space available for sublease rose 35% during the first half of 2020.
There are a number of issues to consider when subleasing, beginning with determining whether subleasing is even permitted under the terms of the existing lease.
Sublease or assignment?
Even if a commercial lease allows subleasing, the tenant will almost always be required to get their landlord’s approval and the terms of the sublease will still need to be negotiated. Leases that don’t have a sublease clause will need to be renegotiated and re-drafted as well, assuming the landlord is amenable to changing the terms of the lease.
If the tenant does not expect to have any use for the space in the future, they may instead want to consider negotiating a lease “assignment,” which transfers all of the tenant’s rights and obligations to the new tenant and relieves the original tenant of the responsibility of collecting rent on behalf of the landlord, as they must under a sublease arrangement. However, the downside of an assignment arrangement is that the original tenant remains liable for the tenant's lease obligations. If the new tenant is in default under the lease, the original tenant can be sued by the landlord, unless the landlord expressly releases the original tenant from its ongoing liability.
Competition for subtenants
If the primary tenant wants to sublease and the landlord agrees in principle, the landlord will still want to know who is going to be using the space and may be able to withhold its consent for any number of reasons.
Finding a suitable subtenant during the pandemic can be a significant challenge, however, and there is currently a glut of commercial space across the country, so competition for paying tenants is fierce. Depending on the market conditions in the area, a potential subtenant may be unwilling to cover the entire rent obligation of the tenant, so the latter would have to make up the difference. If language in the lease requires subtenants to pay the same rate as the tenant, the rate or payment arrangement may need to be renegotiated as well.
Finding a suitable subtenant
It is usually the tenant’s responsibility to find an acceptable subtenant, but subleasing clauses often contain consent restrictions as to who may sublease the space. Parties often negotiate that the landlord's consent may not be unreasonably withheld.
The reasonableness standard may vary from state to state but common "reasonable” criteria that a landlord may use to withhold consent are:
- The subtenant's ability to pay rent
- Subtenants whose business viability or reputation are questionable
- Subtenants whose proposed use of the space conflicts with terms in the lease or the law
Landlords generally cannot withhold their consent for reasons of personal self-interest, such as a grudge against a business or the desire to charge a new subtenant more rent than the original tenant. But many commercial leases do give landlords a “recapture right” to terminate the original lease if they have no desire to allow the tenant to enter into a sublease arrangement.
Drafting a sublease
If a suitable subtenant is found and the landlord’s consent is secured, a new sublease will have to be drafted defining the relationship between the landlord, tenant, and subtenant.
Under a sublease, the tenant takes over many of the responsibilities of the landlord, because for the duration of the subleasing period the primary tenant is still contractually obligated to ensure the terms of the lease are met. Thus, the tenant is responsible for collecting rent from the subtenant and for ensuring the subtenant meets all or most of the terms of the lease. Therefore, it is important for the sublease to delineate who is responsible for what.
Some questions the sublease should address are:
- What portion of the space will be sublet? All or some?
- If the space needs to be modified, who is responsible and under what terms?
- If the space is being shared, does the sublease include access to shared areas such as a lunchroom or conference rooms?
- Will the subtenant be buying or leasing any existing furniture or office equipment from the tenant?
- Are parking privileges included?
- Who is responsible for building repairs and maintenance?
- How much will the rent be and when will it be due?
- Who assumes the risk, and to what degree, if the subtenant defaults or breaches the terms of the lease?
- Who will be paying for utilities and in what proportions?
- Should extra insurance be purchased by all or some parties?
- How will communication between the landlord, tenant, and subtenant be managed?
- What happens when the sublease agreement expires?
- What happens if the lease expires and the subtenant wants to remain?
Other factors may come into play if the subtenant wants concessions above and beyond those contained in the lease. In general, the tenant/sublandlord cannot grant concessions that violate the terms of the lease, but separate concessions that the tenant is unwilling or unable to provide can be negotiated separately between the landlord and the subtenant.
Responsibilities of a sublandlord
The main benefit of subleasing is relief from paying rent and avoiding the consequences of defaulting on a lease — but that relief comes with other costs. In a sublease arrangement, the tenant on the lease essentially becomes a sublandlord, and is responsible for making sure that the subtenant fulfills their obligations under the sublease agreement.
In general, that means:
- Collecting rent from the subtenant
- Paying the landlord, whether or not rent is collected from the subtenant
- Ensuring the subtenant is using the space appropriately
- Fielding service requests or complaints from the subtenant
- Acting as liaison between the subtenant and the landlord
In most subleases the landlord remains responsible for building maintenance and services. Unless other arrangements have been made, the subtenant typically contacts the sublandlord if they have an issue with building services (electricity, plumbing, HVAC, etc.), and the sublandlord is responsible for contacting the landlord and making sure the issue is resolved.
Language in the sublease agreement should specify what happens if the landlord fails to provide required services or otherwise defaults under the terms of the lease. In the event that services are interrupted, the sublease agreement may include “self-help rights” that allow the sublandlord or subtenant to fix the problem themselves and charge it back to the landlord, often in the form of rent reduction.
Final thoughts on subleasing commercial property
Although the objective is to decrease costs when subleasing space, the tenant can increase its responsibilities and obligations as both the tenant and sublandlord. Due to the complexity of commercial leases and subleases, the tenant should consult with a real estate attorney familiar with the local laws and customs and the local real estate market before seeking out a subtenant to ensure the tenant meets its objective to decrease costs without subjecting itself to increased liability.
This article is based upon several Practice Notes addressing commercial lease assignment and subleasing, just a few of the more than 70,000 resources available in Practical Law.