Online sales continue to impact retail “brick and mortar” locations, and “Should I Stay or Should I Go” is, unfortunately, becoming an increasingly familiar tune for retail tenants. When a retail tenant and landlord have agreed that the tenant will “go,” and have elected not to Clash through litigation, each party must determine if a sublease, lease assignment, or lease termination is the best method for the tenant to vacate the premises. This article discusses these various options from a retail landlord and retail tenant perspective, with apologies to those who can’t get the following tunes “out of their head.”
Sublease - “Stuck in the Middle With You”
A retail tenant that subleases its premises to another tenant is truly “stuck in the middle” between the new subtenant and the landlord. The tenant remains liable for its obligations under the lease and is as an essential intermediary between the landlord and the subtenant. The landlord continues to be liable to the tenant for the obligations of the lease, and the tenant is responsible for the acts and omissions of its subtenant. Further, the sublease creates a “landlord and tenant” relationship between the tenant and the subtenant, and the landlord and the subtenant generally must look to the tenant to enforce the applicable terms and conditions of the lease.
While the sublease does not release the retail tenant from its obligations to the landlord under the lease, it benefits the tenant since the subtenant becomes obligated to the tenant to discharge the lease obligations in whole or in part. Remaining “stuck in the middle” as the intermediary between the landlord and the subtenant can be an administrative burden for the retail tenant. However, it also provides the tenant with an ability to ensure that tenant obligations under the lease are met.
For a retail landlord, not having the ability to enforce the lease or sublease directly against the subtenant can be cumbersome. However, the sublease benefits the landlord since the tenant remains obligated to the landlord under the lease, the subtenant keeps the premises from becoming vacant and the subtenant assists the tenant in meeting its obligations under the lease.
To optimize the sublease benefits, the retail landlord with the requisite sublease consent rights should require that (i) the subtenant’s use does not violate any exclusive covenants of other tenants at the retail center and otherwise fits the retail center tenant mix and (ii) the subtenant has the financial ability to meet the sublease obligations. A retail landlord also should be aware that any percentage rent based on gross sales provisions in the lease will be impacted by the tenant’s failure to occupy the premises and generate gross sales during the term of the sublease. In connection with the sublease consent, the landlord may, therefore, require that minimum rent due under the existing lease be increased to account for any loss of percentage rent.
Lease Assignment - “Never Can Say Goodbye”
A retail tenant that assigns its lease to a new assignee tenant that assumes the lease may not remain “stuck in the middle,” but it does remain liable to the landlord for the lease obligations. Therefore, unless the landlord agrees to release the tenant from the lease obligations, the tenant “never can say goodbye” until the end of the lease term (and after the lease term for any liabilities that survive termination or expiration of the lease).
By not serving as the intermediary between the landlord and the assignee tenant, the retail tenant avoids what can be an administrative headache. However, remaining liable for the lease obligations without having an ability as the intermediary to ensure that such lease obligations are met is risky. Therefore, a tenant should request a landlord release of the tenant’s lease obligations in connection with a lease assignment. The fact that a tenant typically cannot obtain that tenant release from the landlord is a primary reason subleases are utilized more frequently than lease assignments.
A lease assignment benefits the retail landlord since (i) the assignee tenant assumes the lease obligations while the tenant remains liable under the lease and (ii) the assignee tenant keeps the premises from becoming vacant. The landlord may prefer a lease assignment to a sublease since it has a direct relationship with the assignee tenant who has assumed and is bound by the terms of the lease. However, loss of the existing tenant as the primary party paying rent may result in collection problems. Therefore, a landlord with the requisite lease assignment consent rights should require that the assignee tenant provide financial information that demonstrates the assignee tenant’s ability to pay rent and otherwise perform its assumed obligations under the lease.
As with a sublease, the consenting landlord also should require that the assignee tenant’s use does not violate any exclusive covenants at the retail center and otherwise fits the retail center tenant mix. Finally, if the retail tenant pays percentage rent based on its gross sales in addition to minimum rent, the lease rent provisions may need to be adjusted in connection with the lease assignment to account for lower gross sales by the assignee tenant and a corresponding loss of percentage rent to the landlord. For example, the retail landlord can require that the minimum rent for any assignee tenant be increased to the average minimum rent and percentage rent previously paid by the tenant.
Lease Termination - “Breaking Up is Hard to Do”
“And they say that breaking up is hard to do”… but sometimes it is best for the retail landlord and tenant to simply terminate the lease rather than continue the relationship with a sublease or lease assignment. The financial condition of the tenant, and the terms of the lease termination agreement, will determine if the retail landlord and tenant agree to “break up.”
Unlike a sublease and lease assignment, a lease termination generally releases the retail tenant from its lease obligations. Therefore, a tenant will often seek to negotiate a lease termination agreement with the landlord. The benefit of the lease termination to the retail tenant, however, will depend upon the amount of the termination payment required by the landlord and the breadth of the landlord’s release of the lease obligations as documented in the lease termination agreement.
Unless there is a significant risk that the tenant will not be able to pay its rent and meet its other lease obligations, a retail landlord will generally not agree to terminate the lease, release the retail tenant from its lease obligations and let the premises become vacant. If that risk exists, the landlord may prefer to terminate the lease and take a termination payment from the tenant. The landlord may also prefer to terminate the lease since it allows the landlord to lease the premises to a new retail tenant without tenant involvement. This may enhance the landlord’s ability to (i) obtain a new tenant that fits the tenant mix of the retail center, has a retail use that does not violate any retail center exclusive covenants and has the financial ability to meet the lease obligations and (ii) negotiate percentage rent and minimum rent provisions that are appropriate for the new retail tenant.
A sublease, lease assignment and lease termination each have unique benefits and deficiencies for a retail landlord and tenant that have agreed that the tenant will vacate the premises without litigation. The retail tenant and the retail landlord should (i) analyze the positives and negatives of each option and (ii) negotiate and prepare a sublease, lease assignment, or lease termination document that protects its respective interest by preserving the benefits and minimizing the deficiencies of the agreed upon option.