Buy Any Kind Of Assignment Of Lease

I.            INTRODUCTION.

Assignments and subleases are commonplace.  The difference between the two is a product of common law.  Without a thorough understanding of the differing rights among landlords, tenants and transferees resulting from assignments and subleases, parties may find themselves unpleasantly surprised.  This article will outline the fundamental differences between assignments and subleases, how the common law arranges the on-going rights among the parties, and the advisability of certain express agreements that change the common law results.

II.            DISTINGUISHING BETWEEN AN ASSIGNMENT AND A SUBLEASE.

The quantity of interest transferred distinguishes an assignment from a sublease.  This distinction can be summarized as follows:

Assignment.   When a tenant transfers its entire interest in a leasehold estate, the transfer is an assignment.  To qualify as such, the transfer must include the tenant's entire estate for the duration of the lease.

Sublease.   When a tenant transfers less than the remaining term or less than the tenant's entire estate, thus leaving the original tenant with a reversionary interest in the lease, the transfer is a sublease.

For these purposes "estate" is tantamount to term.  Determination of whether a tenant has retained a portion of the estate does not depend on the whether the tenant receives less rent than it owes under the lease, or even on whether the tenant transferred the entire premises.  An assignment can occur regardless.  But, retention by the tenant of even the smallest right with respect to the term constitutes a "reversionary interest" and creates a sublease.  For instance, courts have construed a transfer as a sublease where the original tenant retained an option to terminate, extend or renew the prime lease.  In fact, the reversionary interest need not even be under the control of the original tenant to qualify the transaction as a sublease.  At least one court has held that a tenant may have retained a reversionary interest where a third party to whom premises are conveyed has the option to terminate the conveyance.[1]

Surprisingly, one factor that does not distinguish an assignment from a sublease is the portion of premises involved.  As long as the tenant relinquishes its interest in the portion of the premises transferred for the entire term of the lease, an "assignment pro tanto" occurs.  Such a transfer carries all the legal implications of any other assignment, except that the assignee has liability for only a portion of the rent proportionate to the interest it receives in the premises.  Most people would think that a sublease has occurred, because less than the entire premises has been conveyed.  However, such a transfer creates a form of assignment.  This means that the assignee will have privity of estate with the landlord, and may have privity of contract as well.

Landlords and tenants may not find pro tanto assignments desirable.  A landlord will be concerned about dealing with two separate tenant interests under one lease document.  For instance, what if the original tenant defaults under the lease with respect to its space, but the assignee continues to meet its obligations under the lease for its portion of the premises?  Would the landlord be forced to terminate the lease for only a portion of the premises?  The landlord certainly did not intend this result when it entered into the lease.  Although the landlord might be able to control this risk if the lease requires its consent for a transfer, what if the lease is silent?  From the assignee's or tenant's perspective, what if it wants to terminate the lease? Can it do so without the consent of the other party?  What if either the tenant or assignee bankrupts?  If the trustee rejects the lease, does this terminate the assignment?  No easy answers exist for these issues.  Comprehensive transfer provisions in leases and assignment documents provide the only real solution.

III.            WHAT'S AT STAKE: THE LEGAL IMPLICATIONS OF IDENTIFYING A TRANSFER.  

A.             Privity of Estate v. Privity of Contract.   The classification of a leasehold transfer as an assignment or sublease carries differing legal implications regarding future liability arising under the prime lease.  A party's liability under the terms of the prime lease ultimately depends upon the somewhat archaic term of "privity."  The common law recognizes two general types of privity: (a) privity of estate and (b) privity of contract.

Privity of Estate.   Privity of estate rests upon a landlord-tenant relationship.  Acquisition of a leasehold interest by the new tenant, regardless of whether it is an assignment or sublease, establishes privity of estate.

Privity of Contract.   Privity of contract rests upon the existence of an agreement, regardless of whether a landlord-tenant relationship exists.  Privity of contract does not run with the land, unlike privity of estate.  Accordingly, the original lease will not bind a new tenant under privity of contract unless the new tenant assumes the lease.

The original landlord and tenant under a lease have both privity of estate and privity of contract.  When the original tenant transfers its interest in the lease to a third party, these relationships inevitably change.  The manner and extent of the transfer determine what forms of privity will thereafter exist.

B.             Assignment.  If the original tenant assigns its interest in the lease, its privity of estate terminates, but its privity of contract remains intact.  In other words, assignment of the lease ends its right to possession, but, absent an express release under the terms of the lease, its liability under the lease continues.  When the assignee takes possession of the premises, the assignee obtains privity of estate.  Privity of estate binds the landlord and assignee to the terms of any covenants running with the land, but only so long as the privity of estate continues.  As a result, the assignee becomes liable to the landlord for the payment of rent and the breach of any other lease covenants running with the land.  Likewise, the landlord becomes liable to the assignee for the covenant of quiet enjoyment.  However, the assignee does not come into privity of contract with the landlord unless the assignee expressly assumes the tenant’s obligations under the lease.  Without an assumption, the assignee would not be liable for contractual agreements that do not run with the land, such as an original tenant/assignor's undertaking to pay a note made in favor of the Landlord.[2]   Further, absent the assignee's assumption of the lease, a subsequent assignment will end the assignee's privity of estate, and with it, all of that party's obligations to the landlord.  Thus, the absence of privity of contract between the landlord and assignee prevents the assignee from being liable for any breach committed by the original tenant or any prior or subsequent assignee.

As previously alluded, the tenant cannot relieve itself from liability under the lease merely by assigning the lease to a third party.  Despite an assignment, the tenant remains secondarily liable for the obligations of the assignee under the lease.  This means that if the landlord cannot recover from the assignee, it can thereafter pursue the tenant.  From the landlord's perspective, it would prefer to pursue either or both of the tenant and assignee, at its election and without exhausting remedies against one or the other. To achieve this end, the lease must expressly provide that the original tenant remains primarily liable notwithstanding a transfer of its interest.

If the assignee assumes the obligations of the tenant under the lease through agreement with the assignor, both the tenant and the assignee have privity of contract, while only the assignee has privity of estate.  The landlord can enforce the lease against the assignee as a third party beneficiary, regardless of whether the landlord was a party to the assignment/assumption agreement.  However, some jurisdictions have held that in limited circumstances, when a landlord has accepted the assignee in place of the assigning tenant, either expressly or by implication, then the assigning tenant is released from liability arising under the terms of the lease.[3]

Notwithstanding its initial liability under the lease following an assignment, the original tenant may later be released from liability, if the terms of the lease are amended by agreement between the landlord and the assignee.  Thus, from the landlord's perspective, it is important for the lease to provide that the tenant remains liable, at least for the initial lease obligations, regardless of any later amendment of the lease terms.

C.             Sublease.       A sublease, unlike an assignment, does not establish privity of estate or privity of contract between the landlord and the subtenant.  Instead, when a sublease occurs, the original tenant retains both privity of estate and privity of contract with the landlord.  No legal relationship exists between landlord and subtenant.  A sublease therefore does not transfer any of the original tenant's rights or obligations under the lease to the subtenant.  Accordingly, the landlord cannot hold the subtenant liable for a breach of the lease, even if caused by the subtenant, nor can the subtenant enforce the terms of the lease against the landlord.

Despite the lack of privity between the landlord and subtenant, a sublease does establish a new leasehold estate between the tenant and subtenant, creating both privity of estate and privity of contract.  Thus, the sublease document will control whether and to what extent the subtenant can hold the tenant liable for breaches of the lease by the landlord, and what happens if the subtenant's failure to perform under the sublease creates liability for the tenant under the lease.  These agreements do not, however, disturb the privity of contract and estate existing between the landlord and tenant, despite the subtenant's possession of the premises.  Thus, for either the landlord to have rights against the subtenant or vice versa, the landlord and subtenant must execute a separate document establishing them.

IV.             CONSENT, WAIVER AND BREACH:

The law favors free transferability of rights.  As such, a party may prohibit assignment or subletting only through the use of express prohibitions in the lease.  Absent such prohibitions, tenants may sublease or assign their leasehold interests freely.  However, simple restrictions on transfer in the lease may not be sufficient.  Many courts perceive restrictions against assignment or sublease as restraints on alienation.  As a result, courts often interpret restrictive language against the landlord.  For instance, a prohibition only against assignments does not preclude subleases, and vice versa.[4]   Furthermore, under the majority rule, a simple covenant against subletting would not bar subletting only a portion of the premises.[5]

Some states have enacted statutory limitations upon a tenant's right to transfer its leasehold interest.   For instance, a Texas statute prohibits tenants from subleasing or assigning a leasehold interest without the consent of the landlord.[6]   Other states have adopted similar restrictions, but only as to short term leases.[7]

Given the common law, and absent satisfactory statutory provisions that change the common law result, most leases contain language requiring landlord consent for transfers of the tenant's leasehold estate.  Where a requirement for landlord consent exists, in most jurisdictions the tenant's failure to obtain such consent will enable the landlord to recover damages.  However, in certain circumstances or where a statute or the language of a landlord consent requirement expressly provides, a landlord may be able to declare the assignment or sublease void, sue the tenant for breach of covenant or obtain an injunction.[8]   It is important to note, however, that the breach of covenant prohibiting assignment or sublease does not, in and of itself, terminate the lease.[9]   While an assignment in breach of the restriction may provide the basis for forfeiture, the assignee will still receive good title to the lease as a result of the assignment.  As such, the landlord is still entitled to recover rent from the assignee despite the breach.[10]

To ensure that the landlord can terminate the lease or void an unauthorized transfer regardless of jurisdiction, the lease should expressly provide such rights, at its election.  A landlord may, however, waive the breach of a transfer restriction against or otherwise prevent itself from objecting.  As such, although a lease may prohibit assignment or sublease without consent, the landlord may expressly, or by implication, be deemed to have waived a transfer in violation of the lease by acting in a manner that implies that the breach of this covenant has been waived.  For instance, the landlord's knowing acceptance of rent from an assignee or subtenant may constitute such a waiver, and prevent the landlord from declaring a lease forfeiture.

Another pitfall arises after a landlord has either consented to a transfer or waived a breach of a non-assignment clause.  Unless the lease expressly provides to the contrary, the restriction on transfer will terminate for future transfers.

V.            PRACTICAL ASPECTS

An assignment can differ from a sublease in only the most nominal way – at the very limit a transfer for an hour less than the full term constitutes a sublease, while a transfer for one hour longer constitutes an assignment.  In either case, the original tenant will remain liable to the landlord for the lease obligations.  But the rights of the landlord and transferee will differ.  In case of an assignment, the assignee will at least have privity of estate and therefore certain rights against the landlord and vice versa.  In case of a sublease, the subtenant has no rights against the landlord, nor does the landlord have any rights against the subtenant.

Each party will have different goals.  The landlord will want to enforce the lease against both the tenant and transferee to the maximum extent possible.  It would therefore prefer an assignment where the tenant agrees to remain primarily liable under the lease.  The transferee will want the freedom to enforce the essential lease obligations against the landlord with minimum liability.  It would therefore prefer and assignment without assumption.  The tenant would prefer either to have total absolution or total control.  Thus, it may prefer an assignment with assumption by the assignee and release of the tenant.  If the tenant cannot absolve itself of liability under the lease, it may opt for the other end of the spectrum, and create a sublease, retaining a nominal portion of the estate, in order to prevent the transferee from having direct dealings with the landlord.

Any of the foregoing results and infinite variations can arise.  The trick comes in making the results intentional.  A tightly crafted transfer clause in the lease provides the best solution.  The following list comprises the key elements to include:

1.          No transfer of all or any portion of the premises or the tenant's leasehold estate may occur without the landlord's consent.

2.          Any transfer without the landlord's consent is voidable, at the landlord's option.

3.          Any transfer without the landlord's consent may result in a forfeiture of the lease, at the landlord's option.

4.          The acceptance of rent by the landlord from any transferee will not be deemed to be a waiver of the landlord's right to consent or declare the lease forfeited or the transfer void.

5.          The landlord's consent to one transfer will not be deemed to be a waiver of the right to consent to any future transfer.

6.          Following an assignment, the tenant will remain primarily liable under the lease.  If the assignee defaults, the landlord may proceed directly against the tenant without the necessity of exhausting remedies against the assignee.

7.          The landlord may consent to subsequent sublettings or assignments or amendments or modifications to the lease by transferees without notifying the tenant, and without obtaining the tenant's consent thereto.  No such actions will relieve the tenant from primary liability under the lease.

VI.             CONCLUSION.

Under the common law and some state statutes, assignment and subletting create specific sets of rights among the landlord, tenant and transferee.   These pre-established results may be undesirable from the standpoint of the parties and the structure of a particular transaction.  Thus, drafting a comprehensive transfer clause plays an essential role in ensuring results consistent with the expectations of the parties.



[1]See Orchard Shopping Center, Inc. v. Campo, 485 N.E.2d 1248 (Ill. App. 5th Dist. 1985) (holding that where, as a term of a lease transfer, a Sublessee retains the right to terminate the sublease for any reason upon seven days notice, a reversion is retained by the transferor and, as a result, the transaction is a sublease). See also Indian Refining Co. v. Roberts, 181 N.E. 283 (Ind. App. 1932).

[2] Gateway Company v. DiNoia, 654 A.2d 342 (Conn. 1995) (fn. 8); Dolph v. White, 12 N.Y. 296 (1855).

[3]See 185 Madison Associated v. Ryan, 174 A.D.2d 461 (N.Y.A.D. 1991) (stating "[i]t is well settled that in order to relieve the original tenant-assignor from its continuing liability after assignment, it must be expressly shown that the lessor not only consented to the assignment, but accepted the assignee in place of the tenant and such release of the tenant must either be express or implied from facts other than the lessor's mere consent to the assignment and its acceptance of rent from the assignee").  But see, De Hart v. Allen, 161 P.2d 453 (Cal. 1945) (maintaining that an assignor/lessee of lease remains as primary obligor under the lease).

[4]See, e.g., Board of Commissioners v. Lions Del. County Fair, Inc., 580 N.E.2d 280 (Ind. App. 1991); Smith v. Hegg, 214 N.W.2d 789 (S.D. 1974); Gagne v. Hartmeier, 611 S.W.2d 194 (Ark. App. 1981); Rogers v. Hall, 42 S.E.2d 347 (NC 1947).  See also, M. Friedman on leases, § 7.303.

[5]See Drake v. Eggleston, 108 N.E.2d 67 (Ind. App. 1952). For minority view, see Minneapolis, St. Paul & Sault St. Marie R.R. v. Duvall, 67 N.W.2d 593 (N.D. 1954).

[6]V.T.C.A. Property Code § 91.005 (1995), discussed in 718 Associates, Ltd. v. Sunwest N.O.P., Inc., 1 S.W.3d 355 (Tex. Civ. App. 1999); Lawther v. Super X Drugs of Texas, Inc., 671 S.W.2d 591 (Tex. Civ. App. 1984).

[7]See M. Friedman on Leases, § 7.301 (citing Sooner Pipe & Iron Co. v. Bartholomew, 248 P.2d 225 (Okla. 1952)).

[8]See generally, Shropshire v. Prahalis, 419 S.E.2d 829 (S.C. App. 1992) (allowing a forfeiture remedy where the lease contained a forfeiture clause); Clasen v. Moore Bros. Realty Corp., 413 S.W.2d 592 (Mo. App. 1967); Artesia Medical Development Co. v. Regency Association, Ltd., 214 Cal App. 3d 957 (Cal 2d Dist. 1989); Twelve Oaks Tower I, Ltd. v. Premier Allergy, Inc., 938 S.W.2d 102 (Tex. Civ. App. 1997) (providing that under a Texas statute, failure by a tenant to obtain consent to assignment renders the lease voidable at option of lessor, and is not terminated unless landlord undertakes to terminate it, declare forfeiture or reenter). See also M. Friedman on Leases § 7.304.

[9]See Chessport Millworks, Inc. v. Solie, 522 P.2d 812 (N.M. 1974); Cities Serv. Oil Co. v. Taylor, 45 S.W.2d 1039 (Ky. 1932).

[10]See Klee v. United States, 53 F.2d 58 (9th Cir. 1931); Fink v. Montgomery Elevator Co., 421 P.2d 735 (Colo. 1975).

In many transactions involving the purchase and sale of a business, the seller may not own the property where the business is carried on but may have an existing lease of the property.  In a situation where there is a lease, the buyer often requires the continuation of the lease in order to carry on the business after the completion of the transaction.  This can involve an industrial, retail or office lease.  Take, for example, the purchase of a warehouse and distribution business, the purchase of a chain of restaurants or retail stores, or even the purchase of a professional or other service firm.  In each of these cases, the lease will likely be a key element to the ongoing operation and ultimately the success (or failure) of the business.  It is important, therefore, to carry out a review of the lease.  The extent and detail of the review will depend on the nature of the transaction.  An experienced commercial leasing lawyer and commercial leasing agent are the best people to help and guide you through the lease review process.  Set out below are a number of factors that should be considered in reviewing the lease.  This is not an exhaustive list, and all factors may not apply to your lease review.

Lease and Parties

Begin your lease review by obtaining a complete copy of the lease, all lease extension and amending agreements, all prior assignments, subleases, estoppel certificates, leasehold mortgages, if any, and similar related documents.  Note all the parties, beginning with the landlord and the tenant.  The current landlord and tenant may be different from what is shown on the current lease documents.  You will need to obtain the necessary documents in order to establish that you are dealing with the current landlord and the current tenant.  There may also be an indemnifier or guarantor.  There may even be a leasehold mortgage which will have to be dealt with as part of the transaction.

Preliminary Searches

When you are determining the parties to the lease, it is important for your lawyer to carry out due diligence with respect to title and zoning.  Even though the seller is not the owner of the property where the business is carried on, the seller, in our situation, has a leasehold interest.  A leasehold interest is more than a contractual right; it is also an interest in land.  In most cases, it is not necessary to carry out a full title search.  As a matter of fact, it is rarely done.  Most titles in Ontario are registered under the land titles system.  (Based on most recently available information, approximately 96% of all properties in Ontario are governed by the provisions of the Land Titles Act).  The title search will provide you with the name(s) of the current owner, any existing mortgagees (including leasehold mortgagees), and any registered restrictions affecting the property.  It will also disclose whether notice of the lease has been registered.  Notices of lease are particularly important where there is an extended term with extension and other special rights.  This will be discussed more fully below.  The current owner should be the landlord, but this is not always the case.  The landlord may be a former owner or may even be a tenant under a head lease.  This means that the lease being taken over is not a lease but a sublease.  Any default by the sublandlord as tenant under the head lease puts the subtenant at risk unless there is a non-disturbance or similar agreement with the head landlord.  Similarly, any default by the landlord under any existing mortgage or debenture can also put the tenant at risk, unless there is a non-disturbance agreement in place between the tenant and the mortgagee or debenture holder.  All of this information is important in order to assess the extent to which the tenant’s leasehold interest may be at risk.  Any termination or other forfeiture of the tenant’s leasehold interest will place the continuation of the business at risk.

Permitted Uses

Regarding use, there are three things to check.  Check the permitted uses under the lease.  Check the applicable zoning bylaws regarding permitted uses.  Check the title search to determine if there are any exclusive or prohibited uses set out in any prior notices of lease or other instruments on title.

Rent

Most commercial leases, whether industrial, retail or office, are net leases; that is, there is a base (or minimum) rent component, as well as an additional rent component consisting of operating costs, realty taxes and utilities.  Retail leases often include an additional percentage rent component.  With respect to additional rent and percentage rent (if any), these amounts are based on current estimates and will be subject to adjustments after the completion of the current fiscal year.  For that reason, it is important to include reciprocal undertakings to readjust these items of rent after closing.  While the amount of base rent is a fixed amount, all other components of additional rent are variable, which from a realistic point of view means that these amounts will increase.  Note the major items included in and excluded from operating costs, particularly the tenant’s obligation to pay its share of extensive capital repairs.  Are utilities (in particular, electricity) separately metered or bulk metered?  What is the amount of the management fee and to what items of additional rent is the management fee applied?  These are some of the basic type questions that should be answered.

Deposits

Determine if any deposits have been paid.  If yes, there would be a credit to the seller provided the buyer obtains confirmation from the landlord that it is holding the deposit to the credit of the tenant.  (This statement is usually included in the estoppel certificate discussed below.)  The deposit may be in the form of a letter of credit which will have to be replaced by a letter of credit provided by the buyer’s bank and the old letter of credit surrendered to the seller.

Premises

It goes without saying that the location of the premises is of paramount importance.  Look for a plan, sketch or other description that clearly outlines the extent of the premises.  Base rent, additional rent and percentage rent (if any) are usually based on a price per square foot.  The calculation of the area of the property being leased is therefore important.  Try to obtain an area certificate that confirms the calculation of the area in accordance with the terms of the lease or, alternatively, confirmation of the area in the landlord’s estoppel certificate.  There may be related facilities such as storage, parking and outdoor areas that should also be checked.  In many cases, storage and parking are covered by separate licenses.  Ensure that these licenses have been included in the lease documentation that you received at the beginning of the transaction and that the leases or licences of storage, parking and outside areas can be assigned.

Term

The remaining term of the lease and any unexercised extension rights should be carefully noted.  Pay close attention to the conditions of exercising any extension rights.  Many leases have provisions that make extension rights non-assignable.

Assignment/Sublet Provisions

The assignment and sublet provisions require careful scrutiny not only to determine whether the landlord’s consent is required but also what conditions can be imposed by the landlord in giving its consent.  The place to start when reviewing these provisions is the definition of “assignment” and “sublease”.  Quite frequently the defined term “transfer” is used to include not only an assignment and sublease but also a change of corporate control.  In the more “landlord friendly” leases, it is common to find a landlord’s termination right in the event a tenant requests consent to transfer the lease.  This would be an obvious “deal breaker” if the lease is essential to the continued operation of the business.  The same “landlord friendly” leases often give the landlord the opportunity to amend the terms of the lease and to require additional financial security.  It is evident that the landlord’s cooperation in providing its consent on reasonable terms is a critical part of the transaction.  Assessing the position of the landlord is one of the critical first elements of the entire transaction where consent to the transfer is required.  Even if no consent is required, there will likely be a provision requiring notice to the landlord along with an assumption agreement to be entered into between the landlord and the buyer.  Such terms are not particularly onerous.  What can become an issue in many transfers is the loss of special rights under the lease.  The possible loss of extension rights has already been discussed.  Other special rights such as tenant signage, expansion rights, exclusive uses, audit rights, and parking are a few of the more common examples of special rights that may be lost in the event of a transfer.  Look for defined terms such as “required conditions” or “threshold conditions” in the lease that set out a variety of requirements that must be met before these special rights can be exercised.

Estoppel Certificate

What is also important from a buyer’s perspective is to obtain an estoppel certificate from the landlord.  It may be surprising to some that a tenant may not have the right to require the landlord to provide an estoppel certificate.  In many “landlord friendly” leases, only a landlord has the right to require the tenant to produce such a certificate and, as indicated, such right to a certificate is not necessarily reciprocal.  The main point to remember is that the landlord’s cooperation is essential in these transactions for a variety of reasons.

Improvements/Fixtures

The distinction between tenant leasehold improvements and trade fixtures is by no means clear-cut.  The point to remember is that in most, if not all, leases there are both leasehold improvements and trade fixtures.  Many leases will contain a somewhat circular definition of leasehold improvements similar to the following:

“Leasehold Improvements” means all fixtures, improvements, installations, alterations and additions from time to time made, erected or installed by or on behalf of the Tenant or any former occupant of the Premises, including doors, hardware, partitions (including moveable partitions) and wall-to-wall carpeting, but excluding trade fixtures and furniture and equipment not in the nature of fixtures;

Many commercial leases provide that the landlord is the owner of all leasehold improvements regardless of who paid for them.  This may be an important element when determining the allocation of any purchase price with respect to leasehold improvements. (Note that many commercial leases contain restrictions on tenants obtaining any compensation for leasehold improvements.) Also, leasehold improvements constitute alterations that, in most cases, require the landlord’s consent.  If an existing tenant has carried out alterations to the premises without the required consent, the assignee tenant will be at risk unless the estoppel certificate confirms that all leasehold improvements have been approved.  Having confirmation that all leasehold improvements have been approved does not, however, protect the assignee tenant from any restoration obligation.  The restoration obligation is discussed below. With respect to trade fixtures and other personal property, these may be subject to a general security agreement provision found in some commercial leases.  Such provisions will likely conflict with other security agreements between the buyer and its lender.

Other Clauses to Look For

      (i)               Sale Demolition

The effect of this clause is to allow the landlord to terminate the lease in the event of any sale of the property or any demolition of the building.  Obviously such a clause can have a serious impact on the tenant’s ability to continue to operate the business.

    (ii)               Repair Obligations

Repair obligations vary considerably from one lease to the other.  In order to make sense of these obligations, check the definition of the premises which sets out the boundaries or limits.  The repair obligations with respect to the premises would only apply within those boundaries or limits.  For example, if the upper limit extends to the underside surface of the ceiling tile, the space between the ceiling tile and the ceiling slab would not form part of the premises.  Ideally, the tenant would only want to be responsible for interior non-structural repairs and ordinary cleanliness.

   (iii)               Restoration

The requirement for the tenant to restore and return the premises to a base building condition on termination can be a very costly obligation for a tenant, especially when there have been significant leasehold improvements and other alterations.

  (iv)               Post-Dated Cheques

Surprisingly, most commercial leases still contain a requirement for post-dated cheques although as a matter of practice, few landlords enforce this provision.  The more current requirement is to provide for payment by way of automatic debit and this may be problematic for some tenants.

    (v)             Risers and Conduits

The right to access and use the risers and conduits in a building is not necessarily assured.  While such access may not be much of an issue in industrial and retail premises, it can definitely be an issue in office buildings, in particular, older office buildings.  There may be no room for additional wires or cabling and this would be a serious impediment to the tenant’s ability to communicate electronically.  It should not however be an issue for an existing lease situation where all the cables and wires are presumably already in place.  It may become an issue in the event the tenant assignee needs to upgrade its communication systems.

  (vi)               Environmental Audits

Many industrial leases include the right of the landlord to require an environmental audit.  Not only is there a significant cost involved, there is also the potential risk that the tenant assignee may be held responsible for environmental contamination caused by previous tenants.  Depending on the nature of the business transaction, it may be appropriate for an environmental audit to be carried out before the completion of the transaction as protection for the tenant assignee.

 (vii)             Repayment of Improvement Allowance

In many commercial leases, new tenants may have benefited from a leasehold improvement allowance.  Normally, the cost of the leasehold improvement allowance is included in the base rent amortized over the initial term of the lease.  Some leases however do not blend the leasehold improvement allowance into the base rent and treat such allowance as a debt repayable in addition to the base rent.  While the end result may be the same, it may be appropriate, depending on the nature of the business transaction, to adjust for such debt in a different manner than the base rent.

(viii)             Relocation

The landlord’s right to relocate is found frequently in commercial leases of tenants occupying smaller premises.  If there is a relocation clause and the premises in their current location are of considerable importance to the ongoing business operation, the tenant assignee will be at risk.  Location can be particularly important to a retail tenant.  Despite the risk involved, it is rare to find a commercial lease where a landlord does not pay the cost of the relocation.

  (ix)             Insurance Requirements

The first step in dealing with the tenant’s insurance requirements is to bring it to the attention of the tenant’s insurance advisors to ensure that the proper insurance will be in place and a certificate of insurance provided in order to provide evidence to the landlord that this requirement has been met.  In this context, the insurance coverage placed by the tenant assignee (or by any tenant, for that matter) should not only look to the minimum requirements of the lease but also to the extent and nature of the risks that are allocated to the tenant under the lease.  For example, if the lease requires the tenant to obtain commercial general liability insurance in an amount not less than $2 million on the one hand and, on the other hand, allocates all of the risk to the tenant for any losses that may be incurred in the premises, however caused, together with a complete indemnity of the landlord, it is quite likely that an insurance advisor would recommend a greater amount of insurance.  The main point to remember is that the insurance provisions cannot be viewed in isolation, but must be considered in light of all of the related provisions such as landlord releases and indemnities.

Special Rights

         (i)          Expansion

Expansion rights can be covered in a number of different ways.  Keeping in mind that this right and other special rights may be limited in their application to tenant assignees, there are basically three different types of expansion rights:

(a)           Option

This right allows the tenant during a certain period of time on giving of prescribed notice to expand its premises into a particular location usually adjoining the existing premises.

(b)           Right of First Refusal

This right allows the tenant to match any offer received by the landlord with respect to a designated area (usually adjoining).  The landlord is required to give notice of such offer to the tenant and the tenant has a prescribed period time in which to respond.

(c)           Right of First Offer

This right requires the landlord to offer any available space to the tenant at fair market value before offering such space to third parties.

While the option is likely the most valuable of the various expansion rights, the others should not be discounted.  All are valuable tools to allow for future growth.

        (ii)           Contraction/Partial Surrender

This right is the reverse of the expansion right.  It allows the tenant, on giving notice of a prescribed (usually lengthy) period, to give back part of its premises to the landlord usually on payment of a termination fee.  It is not often found in commercial leases and is usually tenant specific, that is, it cannot be assigned to subsequent tenants.

      (iii)           Early Termination

This is a variation of the contraction right in that it allows the tenant to advance the expiry date of the lease on payment of a prescribed termination fee and on giving a prescribed period of notice.  As with the contraction right, the early termination right is usually tenant specific.

      (iv)           Audit

The audit right is a valuable tool for any tenant to control the amount of additional rent payable under the lease.  The amount of operating costs, property taxes and even utilities are all determined by the landlord and those employed or retained by the landlord.  The information provided by the landlord to the tenant at the end of each fiscal year can be sketchy and light on details.  The tenant right to audit gives the tenant the opportunity to satisfy itself.  The cost of the audit is normally borne by the tenant but many leases provide that if there is an error or other discrepancy greater than a certain percentage, the landlord will pay.

       (v)           Self Help

It is safe to say that all commercial leases allow the landlord to perform the tenant’s obligations if the tenant fails to do so.  For example, if the tenant fails to repair or maintain its premises in accordance with the requirements under the lease, the landlord, after notice, can do so and all amounts spent by the landlord in carrying out the tenant’s work (and usually an additional 15% administration fee) are added to the rent and can be collected as rent.  It is very seldom that a tenant has a reciprocal right to perform a landlord’s obligations if the landlord fails to do so.  In many situations, it is not practical to have such a self-help right in a multi-tenant facility.  The self-help right is usually found in large single tenant facilities or large retail stores where a tenant would have considerably greater negotiating clout than most other tenants.

      (vi)           Signage

A tenant right to install its trade name, logo or other identifying sign on the exterior of a building or other prominent place is of considerable value, especially to retail tenants.  As with other special rights, such signage rights are often not transferable to assignees or subtenants.

    (vii)           Exclusives

The right of a tenant to an exclusive use within a building or shopping center is equally important, especially to retail tenants.  Commercial landlords tend to be very careful about how such rights are negotiated.  As can be expected, there are numerous conditions similar to “required conditions” referred to earlier.

   (viii)           Purchase Option

It is very unlikely that a lease will contain a purchase option, in particular, in multi-tenant facilities.

      (ix)           “Go Dark”

One of the standard default provisions in a commercial lease arises when the premises become vacant and unoccupied, usually for a period in excess of 10 days.  A “go dark” right allows the tenant to vacate the premises and, so long as all the rent is paid and all other obligations are performed, it does not constitute a default under the lease.  This right may become a valuable asset to some tenants as part of a business restructuring or similar undertaking.

       (x)           Roof Top/Generator

The right of access to the rooftop and other restricted areas not included in the definition of premises is a valuable right for those tenants who need to install telecommunications equipment and backup generators in order to ensure continued business operations.

Conclusion

Unfortunately there is no “fast track” process for carrying out a lease review.  It is not advisable to rely on third party lease summaries.  The better course of action would be to retain a commercial leasing lawyer or agent to review the lease and determine the tenant’s rights and obligations with respect to each of the factors listed above, as well as any others that are unique to your transaction.  This will provide a reliable assessment of a key element of the business being purchased.

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