Get Protection if Tenant's Lender Wants to Assign Lease or Sublet Space

November 1, 2006

To entice a very strong tenant (such as an anchor) to sign or extend a lease, you may have agreed in the lease to let the tenant use the lease as collateral for a loan. Although it's unlikely that a strong tenant will default on its loan, if a default does occur, the situation could get very sticky for you. The lender can take over the lease and force the tenant out of its large space. But a lender won't want to occupy that space (nor would you want it to), and will instead assign the lease or sublet the space.

To get the lender to accept the lease as collateral, you'll probably have to agree that the lender's proposed assignee or subtenant won't have to meet the long list of conditions your lease's assignment/sublet clause requires for a tenant's prospective assignee or subtenant before you'll consent to the assignment or sublet.

But beware: If you don't require the lender's proposed assignee or subtenant to meet any conditions, you could end up with an assignee or subtenant that disrupts your center's tenant mix, violates another tenant's exclusive clause, or is simply undesirable.

To prevent that outcome and protect your interests, add a clause to the lease saying the lender can't assign or sublet unless a proposed assignee meets four critical conditions, and a proposed subtenant meets three of those conditions, advises Chicago attorney Daniel Pomerantz. There's a Model Lease Clause on p. 5 that you can adapt and use in your lease that includes these conditions.

Set Critical Assignee/Subtenant Conditions

Your lease clause, like our Model Lease Clause, should set the following conditions that a lender's proposed assignee or subtenant must meet for an assignment or sublet. All four conditions apply to the lender's assignee, the first three apply to a subtenant. The conditions apply if a lender takes over the lease after a tenant defaults—even if the lender didn't sign the lease. Legally, the lender is stepping into the tenant's shoes and is bound by all the lease's clauses:

Net worth exceeds set amount. Require the assignee's or subtenant's net worth to be greater than a set dollar amount, says Pomerantz [Clause, Par. a(i)]. It's a good idea to set the dollar amount at the net worth of the tenant at the time the lease was signed, he notes. This condition helps ensure that the assignee or subtenant will be financially sound.

No violation of uses/exclusives. Don't let the lender assign or sublet to anyone that's primarily engaged in a use that the lease bars, says Pomerantz. List the uses that are barred. You also don't want the lender to assign or sublet to an existing tenant's competitor (especially if the existing tenant has an exclusive), he adds. So list those barred competitors [Clause, Par. a(ii)]. Otherwise, you could end up being sued by the existing tenant for violating its exclusive.

Use requirement met. To control the tenant mix at your center, say how the assignee or subtenant can use its space, says Pomerantz [Clause, Par. a(iii)]. For instance, if the tenant was a restaurant, you may want the assignee or subtenant to also be in the restaurant business. Be careful not to list uses that could lead to the assignee's violating other tenants' exclusives.

Lease obligations assumed. If the lender assigns the lease, require that the assignee assume all of the tenant's lease obligations, advises Pomerantz [Clause, Par. a(iv)]. Otherwise, the assignee may not be bound by all of those obligations.

Take Action if Lender Violates Conditions

What if the assignee or subtenant doesn't meet your critical conditions, but the lender goes ahead with the assignment or sublet anyway? To protect yourself in such an event, state in the lease that the lender will have caused an “Event of Default,” says Pomerantz. Also state that in that event, you can exercise against the lender whatever remedies your lease's remedies clause allows, he says [Clause, Par. b]. For example, you may be able to terminate the lease if you want to. This should give the lender an incentive to find an assignee or a subtenant that meets your critical conditions.

Negotiate Possible Lender Modifications

Expect a tenant to try to modify your critical conditions on behalf of its lender. It may ask for some lender protections when it's negotiating your lease or later when it asks a lender for a loan. For instance, the tenant may present these lender demands:

Easier conditions. A lender may want to make some or all of the conditions less stringent, says Pomerantz. For instance, it might try to make the net worth condition easier to meet by having it say that the assignee or subtenant must have only at least the net worth of the tenant at the time the lender takes over the lease, not at the time the tenant signed the lease. And it may try to expand the uses permitted for the space to increase the pool of prospective assignees and subtenants.

Try to resist giving in to those demands. If you don't, you could end up with an undesirable, financially unstable tenant or one that clashes with your tenant mix, warns Pomerantz.

Lender keeps all assignment/sublet profits. Expect a savvy lender to demand that it be allowed keep all profits from the assignment or sublet, says Pomerantz. You can try to negotiate this point, but unless the lease is drastically below market, the lender probably won't budge on its demand.

Lender released from liability. A lender may demand that you agree to release it from all liability under the lease after an assignment, says Pomerantz. You may want the extra security of a financial institution backing the lease after an assignee takes over, but most lenders don't see themselves filling that role, he says. Try to resist the release if you can, although you may have to agree to it in the end, he notes.

CLLI Source

Daniel M. Pomerantz, Esq.: Ungaretti & Harris, 3500 Three First National Plaza, Chicago, IL 60602; (312) 977-4345; dmpomerantz@uhlaw.com.

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