How to Get Prepared for Tenant’s Early Departure

January 5, 2017
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The ability to turn a profit by selling products online has in recent years drastically reduced some business’s need for physical space, but commercial real estate leases tend to have terms that span several years, and sometimes decades, so a tenant could’ve signed a 20-year lease at a time when the Internet was still in its infancy. New tenants want to have the option of getting rid of some of their space if online sales soar and they don’t have a need for much of a storefront operation. Smart tenants like those are negotiating leases to demand a sublease recognition clause.

Including the clause would make the space more attractive to subtenants if it became necessary to sublet in the future. A sublease recognition clause prevents you from ousting a subtenant from the sublet space if the lease terminates early. You “recognize” the sublease and it becomes an agreement between you and the subtenant, rather than between the tenant and subtenant.

But you should require a tenant to meet multiple conditions before you agree to recognize a sublease. As a jumping off point, consider these three conditions for your sublease recognition clause.

Condition #1: Limit when clause is triggered. Set limits on when the sublease recognition clause will be triggered. For instance, agree that the clause will be triggered only if you terminate the lease because the tenant caused an “event of default” or if the tenant rejects the lease after becoming bankrupt. This way, you won’t have to recognize a sublease if the lease is voluntarily terminated—for example, if the tenant exercises a termination option. Otherwise, you could be stuck with a subtenant even though you and the tenant negotiated an early lease termination.

Condition #2: Require sublease to have met lease requirements. Say that the sublease must have met the requirements of your lease’s assignment and subletting clause before the lease was terminated or rejected. This way, you can’t be forced to recognize an invalid sublease.

Condition #3: Require subtenant to again meet lease standards. Say that the subtenant must meet the standards set out in the lease’s assignment and subletting clause (for example, the net worth requirement) a second time—on the date the lease is terminated or rejected. Otherwise, the subtenant could argue, and a court may agree, that the lease requires the subtenant to meet those standards only on the date that the sublease was signed. But the subtenant might have since become financially shaky. You don’t want to be stuck recognizing a sublease if the subtenant is on the verge of failing.

For 20 more conditions to use in your sublease recognition clause, and a model sublease recognition clause you can adapt for your situation, see “Require Tenant to Meet 23 Conditions Before You Agree to Recognize Sublease,” available to subscribers here