Ensure Percentage Rent Flow When Tenant Assigns or Sublets
Percentage rent is typically based on the gross sales generated from the leased space rather than a tenant’s gross sales. So, an assignment or sublet by a tenant with strong sales to a business with weaker sales could take a significant bite out of percentage rent. You could even end up collecting only minimum rent if the assignee or subtenant’s gross sales fall below the percentage rent breakpoint.
Landlord Gets Stuck with Minimum Rent
A Wisconsin landlord learned this lesson the hard way. The retail lease set the minimum rent and percentage rent. The tenant later shut down the store at the site and sublet the space to an athleisure store. Meanwhile, it continued paying the minimum rent, but the athleisure store’s gross sales were too low to generate percentage rent. The landlord sued, claiming that paying only minimum rent violated the tenant’s implied promise to pay a reasonable rent for the space.
But the Wisconsin federal court was unpersuaded, ruling that the landlord was entitled to nothing more than the minimum rent. Implied covenants shouldn’t be read into a lease, the court reasoned, especially when, as in this case, the lease agreement specifically said that there were no such implied promises. And the lease gave the tenant the right to sublet without providing the landlord more than minimum rent [Plaza Forty-Eight v. Great Atlantic & Pacific Tea, 817 F. Supp. 774].
Increase Minimum Rent for Assignment or Sublet
You can avoid suffering the same fate by giving yourself the right to increase the tenant’s minimum rent in the event it assigns or sublets the space. Consider making the increase equal to the average monthly percentage rent you got from the tenant before the assignment or sublet. Provide for some flexibility in calculating the increase amount. One approach: Specify that you can raise the rent by whichever of the following is greater:
- One-twelfth of the percentage rent paid by the tenant during the immediately preceding 12 months of the lease; or
- One-twelfth of the average annual percentage rent paid by the tenant during the immediately preceding 36 months of the lease.
The extended 36-month period affords you protection if the tenant’s business has declined in the past year. That’s probably why the tenant in the Plaza Forty-Eight case closed its doors. If the tenant has fared better previously, the average monthly percentage rent for the prior 36 months will be higher.
Example: A lease sets a minimum rent of $8,000 per month. The tenant sublets the space in August 2022. Its average percentage rent was $1,500 per month in the preceding 12 months, and $1,800 in the preceding 36 months. Under the second option, the landlord can increase the minimum monthly rent $1,800 to $9,800.
If Assignee or Subtenant Is Successful
Raising the minimum rent after an assignment or sublet won’t cost you anything as long as the assignee or subtenant is still on the hook for percentage rent. Thus, for example, suppose you calculate percentage rent using a “natural” breakpoint based on the tenant’s minimum rent. The breakpoint will automatically adjust to a higher amount if the minimum rent increases. If the assignee or subtenant generates sales above that increased breakpoint, you’ll be in line for percentage rent in addition to the minimum rent increase.
If your lease uses an artificial breakpoint, or specific dollar amount set in the lease, the breakpoint will remain the same in the event of assignment or sublet. So, if the assignee or subtenant is successful, you’ll make more money than you would have had the original tenant remained in the space. In essence, you’ll get a higher minimum rent plus the same amount of percentage rent you’d be getting if the tenant were still in the space.
If you use an artificial breakpoint, the tenant may demand lease language providing for the breakpoint to increase in the event of an assignment or sublet. You can accept this demand without giving up any rent by ensuring that the breakpoint increase corresponds to the minimum rent increase.
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