How to reduce or eliminate a lease obligation
An assignment is the transfer to a third party of all rights and interests the tenant holds under a lease. In a sublease, the transfer usually covers a portion of the leased space or the entire property for a period shorter than the lease term. If your lease says nothing about subleasing or assignments, you’re free to do either. Most landlords, however, are acutely aware of the profit potential this would give you. Usually they’re also concerned about controlling the character and quality of tenants in their buildings. Often the landlord’s lease flatly prohibits a tenant from assigning or subleasing its space. In a variation that is little better, a landlord will permit subleasing only with their consent, and they’ll agree to be "reasonable."
Subleasing. Flexibility could be crucial to your company in a changing and competitive business environment. Unless you have a tiny space or short lease-term, negotiate for the right to sublease part of your space without the landlord’s approval. This allows you to warehouse unneeded space but gives you the option of easily regaining it from your subtenant.
If your lease requires the landlord’s consent before subleasing and says the landlord must be "reasonable," define what this means. Prospective subtenants probably won’t wait while you wrangle with the landlord over the terms under which you can sublease. The landlord’s rejection of prospective subtenants should be for limited, objective reasons, like financial inability to handle lease payments or bad reputation. Also limit the landlord’s time to decide on any proposed subtenant. A "yes" that comes too late will cost you a subtenant as surely as a "no."
Whether you’re required to turn over 100% of sublease profits or only a portion, define sublease profits to make sure your expenses are covered. You should be able to deduct from rents you receive any expenses like advertising, the cost of negotiating and drafting the lease, and concessions like free rent, carpeting and painting, as well as the unamortized cost of your own improvements in the subleased space. Negotiate, too, to deduct rent you pay while your space sits vacant as you try to sublease it. Agree to pay your landlord only when and if you’re paid. If your subtenant defaults, leaving you without a promised income stream, you don’t want to be obligated to pay illusory profit to your landlord.
Some landlords will insist on the right to take back space you want to sublease. This allows a landlord to regain space in a rising market and rent it out itself, perhaps negotiating a longer term with another tenant. If your lease contains a clause like this, make sure the landlord is limited to taking back only the space you want to sublease for the time you want to sublease it.
Assignment. Be especially wary of leases that flatly prohibit assignments or give your landlord unfettered discretion to prohibit one. In many cases, a merger or acquisition will result in an assignment because your lease is transferred to a new legal entity. This means you’d be in default and could be forced out – especially in a rising market. The landlord also may try to impose capitalization requirements on an assignee, demanding, for example, that any potential merger partner have assets at least equal to yours. Yet in a merger you may not be in control. Similarly, your landlord may require that any subsidiary to whom you assign your lease have assets as solid as yours. But subsidiaries are seldom as well endowed as their parent companies. A clause like this seriously hampers your business flexibility, especially if your landlord requires you to remain primarily liable even after you assign the lease, and gives the landlord little more protection.
Make sure you can assign to any subsidiary or affiliate as long as you own at least 33-1/3%; you’re safest to negotiate a deal with no capitalization restrictions on companies with which you may merge. If you think you may be acquired, preserve your flexibility by retaining the right to assign the lease to any acquiring company that meets certain capitalization requirements, for example, that it have a net worth at least equal to yours at the date of acquisition.
Negotiating the workletter. The workletter is a separate contract that sets out rights and liabilities for finishing off a building’s interior space before you move in. It covers installation of interior walls, fixtures, flooring – all the finishing work – and provides a timetable for completion.
Many landlords propose workletters that recognize two kinds of delay: "tenant-caused delay" and "force majeure," or excusable delay. With tenant delays, you pay, usually by reimbursing the landlord for extra out-of-pocket costs and by paying rent even before you can move into your space. But many landlords, concerned about their expenses, try to make tenants responsible for delays they can’t control. Similarly, landlords may penalize tenants for delays that are actually part of the normal back-and-forth required to get everyone to sign off on working drawings or unit prices.
To protect yourself, check the definition of tenant-caused delay. It should cover only those situations you can control. Make sure your workletter includes a realistic schedule for producing and reviewing drawings, bidding out the work, and so on. And make sure you’re paying only for delays that affect a project’s critical path – the schedule of dates that tells your landlord when each task must be finished so that it doesn’t interfere with any other.
In addition, see that your workletter allows you enough time to review design drawings and other documents you must approve. A landlord’s delay in delivering the documents shouldn’t cut into your allotted time.
Force majeure, or excusable delay, is supposed to cover events the landlord can’t control – flood, strikes, hurricane. Be sure that it applies only to those few situations the landlord can’t reasonably be held responsible for. Otherwise, this becomes a catchall that excuses your landlord from managing the work you’ve hired it to do.
Your remedy if there’s an excusable delay? Landlords normally propose that no matter how long the delay, or how much it costs you to make alternative arrangements, you can’t break the contract. You can only push back the date you start paying rent. In other words, you have to wait around. But you need assurance that your business will continue with minimal interruption. Protect yourself with a specific walk date. Except for delays you cause, if your space isn’t ready after a reasonable time, you should have the right to terminate your lease and go elsewhere – without having to pay rent on two leases.
With or without a workletter, tenants often get an interiors allowance for the initial fit-up work: landlords provide a credit of so many dollars per square foot or they provide certain standard items like electrical outlets, doors, latchsets, lighting fixtures, plasterboard, and carpet.
Most tenants prefer better quality or simply need something other than the building standard – but, unless you negotiate it, your lease may permit no credit for items you don’t want.
The tenant portion of fit-up can quickly reach $40 or $50 a foot for interiors that aren’t lavish. So refuse a clause that obliges you to use resident contractors because you’ll likely get a better price by bidding out work to general contractors.
Make sure you understand precisely how the lease distinguishes between "base building," which the landlord pays for, and your premises, which you pay for. Otherwise, you may find you’re obligated to pay for expensive wiring, duct work, etc., you hadn’t planned on.
Renewals. An extension option can be valuable. Economics aside, it ensures that you can continue operating your business, uninterrupted, at the same location for more than a short three, five, or ten years. If you agree to a fixed rent during the renewal term, both you and the landlord are gambling on a future market. For that reason, leases frequently include a formula – usually tied to the fair market rate – to determine rent during the extended term.
The fair market rate depends on many individual considerations, like a tenant’s credit rating (for instance, IBM will probably get discount over a two-year startup because the landlord’s risk is lower), the formula for calculating operating expenses, and the lease term. If you agree to a fair market value renewal option, specify factors that would be especially important in your case. Moreover, insist that the space be valued for use as office space, even if that’s not its highest and best use" at renewal time.
Quite a few leases don’t require the landlord to commit to the renewal term rental rate until after the term has started. Though the mechanism for determining the renewal rate may be clear, it’s unlikely you’ll want to commit to pay for space unless you know the cost in advance. Make sure your landlord specifies a firm rate far enough in advance to permit you to shop for alternatives. Otherwise, you give up leverage that could help ensure you a fair renewal rate. An ambiguous arrangement has another hidden cost if you do decide to move: you may have to pay steep holdover rates – 1-1/2 to 2 times the normal rent while you shop for new quarters.
Whatever you do, specify the essential terms of your extension option. Don’t postpone the decision with a vague lease clause that "agrees to agree." This invites costly litigation and could leave you with no office space.