Assignments and Subleases

in Today's Commercial Real Estate Market

by William A. Kozub

A lease is an agreement between a landlord and a tenant for the use of property. When a tenant executes the lease, she becomes liable for all obligations contained in the lease agreement, and ordinarily will remain liable until the end of the lease period. However, circumstances affecting the tenant's business may change. When such a change occurs, the tenant likely will want the ability to find other users for a portion or all of the space subject to the lease agreement, and even to avoid responsibility for the legal obligations created by the lease agreement. To this end, the tenant will often want to either sublease or assign his or her interest in the lease to a third party and obtain a release from any future legal responsibility.

The landlord, on the other hand, wants to be able to control who occupies the property, as well as the uses of the property. Landlords want tenants that are credit worthy, will not negatively affect the value or reputation of the property, will not expose the landlord to unacceptable risks of ownership, and will not cause harm to other tenants.

This article, and the one appearing in this space next month, will explore assignments and subleases under Arizona law from both the landlords and tenants perspective, and provide various drafting points that will allow parties to commercial leases to clearly outline their intentions in writing.

Overview of Subleases and Assignments:

Options for subleases and assignments: When considering subleases and assignments, there are two options for the landlord and tenant to consider. A tenant may sublease or assign his or her lease interest to a subtenant, but remain liable to the landlord for the obligations created under the lease agreement, or assign his or her interest in the lease to the subtenant and obtain, from the landlord, a release from any future obligations under the lease agreement. Under the first option, the landlord may proceed against the tenant (and perhaps the subtenant) for any breach of the lease. The tenant will then have the burden of proceeding against the subtenant. The tenant will retain his or her interest in the lease and merely transfer the right to occupy a portion or all of the leased premises to the subtenant. Often, the subtenant will pay rent directly to the tenant, who will then ensure that the landlord is paid.

Under the second option, the landlord may proceed only against the subtenant for a breach of the lease. However, because the landlord has the ability to evict a non-paying or non-performing subtenant, the landlord is in a better position to control performance under the lease agreement. Absent the consent of the landlord in providing a release, the tenant will generally be unable to avoid continued liability under the lease agreement even after an assignment or sublease.

Tenants' right to assign: Arizona law generally provides that, absent an express restriction in the lease agreement, tenants have an unrestricted right to assign or sublet his or her lease as he or she wishes. However, unless the tenant has obtained a release, as described above, the tenant's assignment or sublease will not terminate his or her liability to the landlord under the lease agreement, should the subtenant default on some provision.

Lease provisions prohibiting assignment without consent of the landlord: Commercial real estate landlords are aware of a tenant's general right to assign under Arizona law. Accordingly, it is common for a commercial lease to contain a provision prohibiting the assignment of a lease without the written consent of the landlord. Although such provisions are generally upheld, they are strictly construed against the landlord. In addition, they are interpreted by the Arizona courts as impliedly imposing a standard of reasonableness on the part of the landlord in withholding his or her consent, unless the lease agreement expressly states a different standard.

The landlord's reason for refusing to consent to a sublease, in order for the refusal to be reasonable, must be objectively sensible and of some significance. The standard under which the landlord accepted the lessee as a tenant, will generally be the standard used in determining whether the lessor acted reasonably in withholding consent from the tenant for an assignment of the lease. If the landlord's refusal to consent to a sublease is challenged, the landlord will have the burden of proving that he or she acted reasonably in withholding his or her consent from the tenant to sublease when the lease agreement is silent on the issue.

Finally, it should be noted that Arizona law generally does not allow a landlord to charge more rent when the subtenant's financial condition is not in question absent a provision in the lease agreement providing this right. The landlord is thus generally prohibited from withholding consent to the assignment in exchange for an increase in rent.

Lease provision prohibiting any assignment or sublease: As explained above, the Arizona courts will imply a standard of reasonableness on the part of the landlord in withholding its consent for an assignment of lease unless the lease agreement expressly states a different standard. However, this implied standard can easily be overcome by including in the lease a lease provision giving the landlord absolute and sole discretion to withhold consent. Such provisions generally will be upheld by the court. In addition, the parties may agree to the inclusion of a provision prohibiting any assignment or sublease under any circumstance.

Exceptions to restrictions on assignments or subleases: It is likely that certain types of assignments and subleases will not be subject to the general lease provisions providing restrictions to assignments or subleases. Transfers by an individual tenant to a entity controlled by the tenant, transfers by a tenant to an affiliated entity, and transfers by way of merger or sale of stock to a new or different entity should not generally trigger a lease provision restricting assignments or subleases. The writer notes that these issues have not been addressed by Arizona's courts and that this opinion is based on a review of the trend in this area of law by the courts in other states.

Landlord's liability to tenant for wrongfully opposing assignment or sublease: Landlords may find they are subject to any number of legal sanctions for failing to act within the implied standard of reasonableness in withholding consent to a sublease or assignment. The landlord may find themselves party to a lawsuit for breach of the implied terms of the lease agreement.

More significant from a damages point of view is the threat of a lawsuit for interference with contractual relations. Arizona law provides that a person who, without a privilege to do so, induces or otherwise purposely causes a third party not to perform a contract with another or to enter into or continue a business relation with another is liable to the other for the harm caused thereby under the doctrine known as the intentional intereference with contractual relations. Accordingly, even though a landlord is a party to the underlying lease agreement with a tenant, the landlord is generally not a party to the tenant's contract with the proposed subtenant. If the landlord's unreasonable withholding of consent to sublease negatively impacts a contractual relationship between the tenant and proposed subtenant, the landlord could be held liable in tort for intentional interference with contractual relations on the theory that, by wrongfully refusing to consent to assignment of lease, the landlord wrongfully interfered with the tenant's separate contract with the proposed subtenant.

An example of this threat to the landlord is the attempt by a tenant to sell the business. The sale may include an assignment of the lease to the purchaser. If the landlord fails to provide reasonable consent to the assignment, then the landlord may find itself liable for the damages to the tenant by the failed sale of the business.