Spell Out Right to Keep Unapproved Sublet Profits

When you negotiate a lease with a tenant, you and your attorney try to cover all your bases—drafting provisions that protect you in every conceivable circumstance under which the tenant would breach the lease during the lease term. However, one situation isn’t as common as other types of breaches, so you might forget to include language to cover it.

When you negotiate a lease with a tenant, you and your attorney try to cover all your bases—drafting provisions that protect you in every conceivable circumstance under which the tenant would breach the lease during the lease term. However, one situation isn’t as common as other types of breaches, so you might forget to include language to cover it.

The tenant could try to make a profit from subletting its space without your approval. But if you haven’t reserved the right to recoup any money the tenant has made from this type of breach, you could be left in a situation where the tenant no longer occupies and pays rent for the space because you’ve terminated the lease, but walks away with a windfall anyway.

To plug this loophole, you’ll need to make sure that you specify that any profits from a breach like this belong to you.

Understand How Windfall Could Happen

When plugging this loophole—where a tenant makes a profit on a breach of the lease—it’s helpful to understand the ways in which a tenant could do so. One scenario happens when a retail tenant that signs a lease with the owner of a storage space facility to store its excess inventory no longer needs that space because it’s suddenly able to store its inventory at its shopping center. If it doesn’t want to incur costs from trying to get out of the storage space lease early, or it projects that it might need the space at a later date, the tenant might decide to sublet it. But instead of notifying the owner and getting its consent if necessary, it sublets to another tenant and collects any profit secretly. This is a common scenario because the nature of storage space is that it requires no or very minimal buildouts or modifications, so it would be very easy to find a subtenant who wouldn’t be a disturbance and whom the owner might not discover.

Typically, in an approved sublet the owner would keep any profit made if the tenant collects more rent than it pays. But it’s important to contemplate when drafting your lease what you should do if this happens because of an unapproved sublease. Language that allows you to keep the profit—despite how it’s gotten by the tenant—is key. After protracted litigation, a Utah owner learned the hard way that it was missing this key specification.

Recognize Unapproved Sublet Pitfall

In that case, where a lucrative sublet wasn’t approved by a landlord, the tenant was nonetheless allowed to keep the profit. This case shows that lease terms still govern, whether the outcome seems fair or not. The main reason the tenant prevailed in terms of keeping the profit was because the lease didn’t specify—although subletting without permission was a breach—that the owner would keep the profits. So if you haven’t specified in your lease that you keep these profits, you could be out of luck.

In that case, a landlord and tenant signed a lease for a warehouse building for a two-year term. The lease prohibited the tenant from subleasing the warehouse without prior written consent. However, the tenant made an oral agreement to sublet the warehouse to a subtenant—the same day the lease went into effect—without the landlord’s written consent.

When the landlord discovered that the tenant was subletting the warehouse, it sent the tenant a letter, giving the tenant written notice of its default of the sublease provision and giving it 10 days to cure—that is, fix the problem—by paying the landlord $30,000. Because the tenant chose not to cure the breach, the landlord terminated the lease pursuant to its default provisions. The tenant promptly vacated the warehouse.

The landlord sued the tenant, alleging that it unlawfully detained the warehouse, breached the lease, and was unjustly enriched by the sublease—in other words, that the tenant collected money that it wasn’t entitled to. The landlord claimed that it had been damaged by the sublease in the amount of $53,100, arguing that it would have agreed to the sublease if the tenant had paid it the difference between the tenant’s rent and what the tenant received from the subtenant. The landlord said that the sublease amounted to an unlawful detainer under state statutes. It brought claims for breach of contract or unjust enrichment, stating that “it would be unjust for the tenant to retain the benefit from the sublet rent that it received.”

The tenant and the landlord each asked a district court for a judgment in its favor without a trial. The trial court ruled in favor of the tenant, and the landlord appealed. A Utah appeals court affirmed.

On appeal, the tenant asserted that the landlord’s unlawful detainer claim failed because the tenant returned possession of the warehouse to the landlord before the term of the notice expired. It further argued that the landlord had no remedy for breach of contract because the lease allowed the landlord to terminate the lease, which it did, and charge the tenant a penalty, which the tenant paid. But, according to the tenant, nothing in the lease entitled the landlord to the rent from the sublease. Finally, it argued that without evidence of an unlawful detainer or a provision in the lease that would entitle the landlord to such damages, the landlord couldn’t claim that the tenant was unjustly enriched from the rent collected under the sublease.

The district court had concluded that nothing in the unlawful detainer statute or the lease supported the landlord’s claim for damages for rent the tenant obtained from the subtenant. The court determined that “the only remedy [Landlord] appears to be entitled to is a declaration under [the unlawful detainer statute] that the [lease] is forfeited due to [Tenant’s] failure to perform a condition or covenant therein.” The district court said that the tenant complied with the landlord’s notice to vacate when it elected to promptly vacate the warehouse rather than cure the breach and therefore did not unlawfully possess it. The court further concluded that even if the tenant was in “unlawful detainer” of the warehouse under state statutes, for unauthorized subletting, that section “does not specifically provide for damages for unauthorized subletting,” and neither did the lease.

But the appeals court agreed with the district court that the lease “does not provide for damages as requested by [Landlord].” The landlord argued that “the law must provide a remedy in damages” and that “damages are properly measured by the amount necessary to place the nonbreaching party in as good a position as if the contract had been performed.” It also asserted that “it is an undisputed material fact that [it] would have agreed to the sublease if [Tenant] had paid [it] the difference between [Tenant’s] rent and what [Tenant] received from [Subtenant].” The landlord argued that, had the parties entered into that agreement, it would have been paid the excess rent it now seeks.

The appeals court said that, though this might be true, it didn’t see how this legally entitled the landlord to the excess rent from the sublease without a provision in the lease providing for those damages. Instead, “it appears the landlord is requesting the court to enforce ‘an alternative benefit to the bargain’ than the agreement it reached with the tenant in the lease based on ‘something it might have contracted for under different circumstances,’” said the appeals court. There was no agreement to pay the difference between the tenant and the subtenant’s rent, and there is nothing in the record to suggest that the tenant would have agreed to the landlord’s conditions for consenting to the sublease, the appeals court pointed out [Gardiner v. Anderson, August 2018].

Plug Loophole in Sublet Clause

Typically, subletting provisions will specify who keeps the sublet profit, if there is one. In many cases, the owner keeps the entire profit. Occasionally, a tenant is allowed to keep some small portion of it. This discourages tenants from using a landlord’s shopping center, office building, or commercial storage space as a source of direct income. Your sublet provision should spell out who keeps the profit from an approved sublet, or how it’s split if that’s the case. But you should tweak basic lease language to reflect what will happen to unapproved sublet profits as well. Ask your attorney about adapting this language for your sublet clause.

Model Lease Language

If Tenant exercises its right to sublet the Premises under the terms of this Lease pursuant to the provisions of Clause [insert #], or sublets the Premises without the approval of Landlord, in no event shall Tenant be entitled to any proceeds derived from or relating to (directly or indirectly) this sublet.