The most frequent and detailed negotiations in triple net leases often center around a tenant’s ability to assign or sublet a lease without a landlord’s consent. If both parties are able to agree to reasonable compromises in a negotiation of the assignment and subletting provisions of a lease, balance can be achieved between the interest of a tenant in obtaining flexibility on assignment or subletting and a landlord’s interest in ensuring that a creditworthy and experienced tenant occupies the property that intends to use it as a key part of its operating business.
Landlord’s criteria for granting tenant assignment and subletting rights
To state the obvious, restrictions on a tenant’s ability to assign or sublet its lease obligations are tied to a landlord’s aim of ensuring that the lease obligations will be performed for the entire term of the lease agreement, especially payment of rent and other material economic obligations under the lease. That certainty related to performance is tied to two primary principles: (1) creditworthiness of the tenant and (2) the importance of the leased asset to the tenant’s business operations. A savvy landlord will seek to preserve these two components (or a balance of the two components that sufficiently ensures continued performance under the lease agreement) in any assignee or subtenant of a leased asset. A tenant will want some flexibility on these points as, often, an assignee may not satisfy one or the other criteria that are important to a landlord. To bridge that gap, landlords and tenants must often negotiate detailed financial metrics or other credit support that an assignee of a lease must satisfy in order to obtain the desired flexibility on assignment and subletting in a lease.
Navigating the creditworthiness standard
The financial metrics required by landlords often boil down to the fact that a landlord does not want a tenant following an assignment that is less creditworthy than the original tenant at the time the lease was signed. The metrics are often stated in terms of EBITDA(R), net worth or funded debt, but, essentially, it can all be simplified to a requirement that the landlord will not get a tenant less likely to pay the lease obligations than the assignor of the lease. If a proposed assignee is unable to meet the financial metrics test, a landlord should consider accepting other credit support in the form of a letter of credit from assignor or assignee for a significant portion of the lease obligations (e.g. one year of base rent) as an alternative. Upon meeting the financial metrics or credit support requirements, the nuts and bolts of the assignment or subletting to a third party should still be followed (i.e. proper assignment agreement, new lease guarantors, etc.), but the uncertainty of a tenant’s ability to assign and landlord’s certainty in being repaid can be mitigated to provide the flexibility needed for tenants, while preserving the landlord’s interest in performance of the tenant’s lease obligations.
Assuring asset value to tenants, subtenants and assignees
The second primary principle may be less important to some landlords, however, the critical nature of an asset to a tenant can have significant implications for the certainty that a tenant will perform its lease obligations. If a tenant can consolidate or remove an asset from its operations, a landlord for that site is in danger of owning a diminished asset (as a non-essential asset will not be properly repaired, maintained, etc.) and, in bankruptcy, a tenant is likely to reject a non-essential lease. These consequences could be significant to a landlord in terms of dealing with creditors, assets sales and other administrative matters that a distressed tenant will bring, and, could be even more significant, depending on the marketability of an asset to other users. Without some discretion in terms of a landlord’s approval right to an assignment on this point, a landlord’s ability to be repaid could be diminished even if the creditworthiness of a tenant is adequate for an assignment of a lease agreement.
Negotiation of a lease agreement may fail if adequate flexibility of a tenant to assign or sublet a lease cannot be agreed to by the parties, so some flexibility is needed by both parties in any lease negotiation. However, a landlord should always consider factors in addition to the creditworthiness of a tenant in the hardwired assignment and subletting provisions in a lease agreement if it wants to increase the chances that a new tenant will perform the underlying lease obligations.
Michael Gibson is an attorney with Bass, Berry & Sims PLC in the firm’s Washington, D.C. office. He represents companies, developers and investors in commercial real estate acquisitions and dispositions, leasing and financing matters. Gibson can be reached at [email protected].