Get Right to Collect Rent Directly from Subtenant if Tenant Defaults

May 31, 2007

When you let a tenant sublet its space, the subtenant pays the tenant its rent due under the sublease, and the tenant pays you its rent or percentage rent due under the lease. But what should you do if the tenant doesn't pay?

A standard lease or sublet consent form gives you only one option: Sue the tenant for the rent due. But if you exercise this option, you might waste time and money on a lawsuit to collect rent that is rightfully yours. And there is no guarantee the deadbeat tenant will ever come up with the rent due—even if you win the lawsuit.

When you let a tenant sublet its space, the subtenant pays the tenant its rent due under the sublease, and the tenant pays you its rent or percentage rent due under the lease. But what should you do if the tenant doesn't pay?

A standard lease or sublet consent form gives you only one option: Sue the tenant for the rent due. But if you exercise this option, you might waste time and money on a lawsuit to collect rent that is rightfully yours. And there is no guarantee the deadbeat tenant will ever come up with the rent due—even if you win the lawsuit.

Even worse, the tenant could file for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code, warns Chicago attorney Neil T. Neumark. This would: delay your ability to terminate the lease and evict the tenant; allow the tenant to continue collecting sublet rents until the bankruptcy trustee rejects the lease; and force you to share with the tenant's other general creditors any residual sublet rents remaining upon final disposition of the tenant's bankruptcy estate, he says.

You can avoid this trap by adding a clause to a lease or sublet consent form that you, the tenant, and the subtenant sign, says Neumark. The clause creates an assignment of sublet rents by the tenant to you. And the clause requires the subtenant to pay rent to you directly if the tenant doesn't pay. Although this assignment of sublet revenues is made when the tenant signs the lease, it doesn't take effect until the tenant defaults under its lease, he explains. This clause is similar to a “Collateral Assignment of Rents and Leases,” which is a document often included in real estate loan documents, Neumark adds.

Be aware that if the sublet rent you get under the assignment of sublet rents clause is less than the lease rent that you are owed, you may need to sue the tenant for the difference. But at least this clause will enable you to get some of the rent due.

Neumark typically includes the assignment of sublet rents clause in his leases. For instance, he is currently working on three retail leases in which he has included this clause.

We will give you a Model Clause that you can adapt and include in your lease or sublet consent form (see p. 3), and tell you some demands a smart tenant may make regarding this clause.

What Clause Should Say

Your assignment of sublet rents clause should do the following, says Neumark:

Create license. Start by making the tenant assign to you all of its right to the sublet rents, says Neumark. However, in return, you must grant the tenant a license to collect the sublet rents, he adds. The license will remain in effect as long as the tenant doesn't default under the lease [Clause, par. a].

Let you revoke license upon tenant's default. If the tenant defaults, get the right to revoke the license and demand that the subtenant pay you its sublet rent directly, says Neumark [Clause, par. b].

Get tenant's acknowledgments. Include certain subtenant protections in the assignment of sublet rents clause. For example, require the tenant to authorize the subtenant to pay you directly when the tenant defaults. Also, have the tenant agree that:

  • The subtenant is obligated and entitled to pay the sublet rent to you, even if the tenant gives the subtenant contrary instructions; and

  • The subtenant will not be liable to the tenant for paying you sublet rents paid under the assignment of sublet rents clause [Clause, par. b].

Why do you care about such subtenant protections? Because without those protections, the subtenant may refuse to pay you the sublet rents for fear the tenant may take action against it, Neumark explains.

Indicate how to apply sublet rents. To make the assignment of sublet rents clause more palatable to a tenant, agree that you won't use sublet rents except for the purpose of:

  • Applying them against the tenant's unfulfilled lease obligations—in other words, to cure the tenant's default;

  • Getting reimbursed for costs you incurred as a result of the tenant's default; or

  • Being compensated for other damages that you suffered because of the tenant's default [Clause, par. c].

Require you to deliver unused sublet rents to tenant. Suppose there are sublet rents remaining after you have applied them to curing the tenant's default, reimbursing your costs, and getting compensated for your other damages. What should you do with them? Promise to deliver the remainder to the tenant, says Neumark [Clause, par. d].

Include protections for you. To protect your interests, Neumark says you must clarify that your acceptance of the sublet rent directly from the subtenant does not mean you are:

  • Consenting to the sublet;

  • Assuming—that is, taking on—any of the tenant's duties to the subtenant;

  • Creating a legal relationship—known as “privity”—between you and the subtenant; or

  • Agreeing to sign a nondisturbance or recognition agreement by which you say you would recognize the subtenant and honor its sublease if you terminate the tenant's lease [Clause, par. e].

Without this language, if a subtenant ever takes you to court, a judge might find that you consented to its sublease and are obligated to sign an agreement recognizing the subtenant, if you had not done so already. Also, you could become responsible for providing the subtenant with services that you usually provide to the tenant—such as heat, electricity, and parking, says Neumark.

Negotiate Smart Tenant's Demands

Neumark says he has inserted the Model Clause in his leases and sublet consent forms for years, and the parties involved generally have not objected to it. But a smart tenant may demand the following additions to the clause, which you will have to negotiate, he says:

  • That you will give the tenant notice of and an opportunity to cure a lease violation before it becomes a default requiring the subtenant to pay you the sublet rents directly; and

  • That you will stop accepting rent from the subtenant if the tenant cures the violation before it becomes a default. If the tenant makes this demand—and you agree to it—indicate in the lease or sublet consent form that the tenant must remain in good standing for a set amount of time—for example, six months after curing the violation—before you will stop accepting rent from the subtenant, suggests Neumark.

CLLI Source

Neil T. Neumark, Esq.: Principal, Schwartz Cooper Chartered, 180 N. LaSalle St., Ste. 2700, Chicago, IL 60601; (312) 845-5402; NNeumark@schwartzcooper.com.

Sidebar

PRACTICAL POINTER: A subtenant may ask for language in the sublet consent form that says the tenant must credit any rent the subtenant pays directly to you against the rent due to the tenant under the sublease. There is no reason for you to object to this request, says Neumark. But let the tenant decide whether to add such language to the sublet consent form, as it affects only the tenant-subtenant relationship.

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