Require 20 Conditions to Be Met Before You'll ‘Recognize’ Sublease

With so much sublet space on the market, there's fierce competition for subtenants—especially among tenants that have had to downsize their operations and now need to generate money from their excess space. That has led some smart tenants negotiating leases to demand a sublease recognition clause. Including the clause would make the space more attractive to subtenants if it became necessary to sublet in the future. The sublease recognition clause prevents you from ousting a subtenant from the sublet space if the lease terminates early. You “recognize” the sublease and it becomes an agreement between you and the subtenant, rather than between the tenant and subtenant.

If you're like some owners, you may have to give into a tenant's demand for this clause. But if a sublease recognition clause is drafted badly, you could get burned, warns San Francisco attorney Richard C. Mallory. For example, a badly drafted clause may leave you with a subtenant that's paying you below-market rent.

That's why CLLI, with the help of Mallory, and Washington, D.C., attorney Peter W. Segal, has put together a checklist of 20 conditions that your sublease recognition clause should include, along with a requirement that the conditions must be met before you'll recognize the sublease. We'll also tell you about three additional provisions you should include in your clause. And there's a Model Lease Clause on pp. 3–4 that you can adapt. It includes these conditions and provisions.

20 CONDITIONS FOR SUBLEASE RECOGNITION CLAUSE

Make sure that your sublease recognition clause, like our Model Lease Clause, says you'll recognize the sublease only if the following 20 conditions are met:

Limit When Clause Is Triggered

Set limits on when the sublease recognition clause will be triggered, says Mallory. For instance, agree that the clause will be triggered only if you terminate the lease because the tenant caused an “event of default” or if the tenant rejects the lease after becoming bankrupt, he says [Clause, par. a]. This way, you won't have to recognize a sublease if the lease is voluntarily terminated—for example, if the tenant exercises a termination option. Otherwise, you could be stuck with a subtenant even though you and the tenant negotiated an early lease termination, he warns.

Require Sublease to Have Met Lease Requirements

Say that the sublease must have met the requirements of your lease's assignment and subletting clause before the lease was terminated or rejected, says Mallory [Clause, par. a]. This way, you can't be forced to recognize an invalid sublease, he explains.

Require Subtenant to Again Meet Lease Standards

Say that the subtenant must meet the standards set out in the lease's assignment and subletting clause (for example, the net worth requirement) a second time—on the date the lease is terminated or rejected, says Segal [Clause, par. a(i)]. Otherwise, the subtenant could argue, and a court may agree, that the lease requires the subtenant to meet those standards only on the date that the sublease was signed, he says. But the subtenant might have since become financially shaky, he warns. You don't want to be stuck recognizing a sublease if the subtenant is on the verge of failing, he explains.

Require Lender's Approval

Say that your lender must approve the sublease, when the lender requires it, says Segal [Clause, par. a(xi)]. Why is this necessary? Because you might have changed lenders since the sublease was signed, he says. Or you may not have had a lender when the sublease was signed, but you have one now, he adds.

Make Sure Subtenant Isn't in Default

Say that on the date the lease is terminated or rejected, the subtenant must not be in default—that is, still in violation of the sublease after the time to cure that violation has elapsed, says Segal [Clause, par. a(ii)(A)]. You don't want to be forced to accept a deadbeat subtenant in place of a deadbeat tenant, says Mallory.

Make Sure Subtenant Isn't Tenant's Affiliate

Say that the subtenant must not be an affiliate of the tenant, says Segal [Clause, par. a(ii)(B)]. This prevents the tenant from occupying the space under the guise of a subtenant, he explains.

Require Sublet Space and Remainder to Be ‘Leasable’

If the subtenant is subletting less than all of the space, say that both the sublet space and the remaining unsublet portion must be “leasable”—that is, a size and configuration that other parties would be willing to rent, says Segal [Clause, par. a(iv)]. Otherwise, you may be unable to relet the remaining portion of the space, he warns.

Require Subtenant to Attorn

Require the sublease to say that the subtenant agrees to attorn—that is, recognize—and accept you as its new “direct sublandlord” for the remainder of the sublease after the lease ends, says Mallory [Clause, par. a(v)(A)]. This gives you the subtenant's formal acknowledgment that the sublease would become an agreement between you and the subtenant, with you taking over the tenant's role under the sublease, he says. So the subtenant would no longer owe its obligations under the sublease to the tenant, but to you, he explains.

Require Subtenant to Follow Lease and Sublease Obligations

Require the sublease to say that the subtenant agrees to comply with all the terms of the lease—as well as the sublease—even though the lease terminated, says Segal. This means that the subtenant must perform all of its obligations set by the sublease, as well as the tenant's lease obligations for the sublet space, he says [Clause, par. a(v)(B)]. Otherwise, the subtenant would be responsible to you only for its sublease obligations—which may be less than those the lease sets for the tenant, he says.

Bar Any Increase in Sub-tenant's Rights and Remedies

Require the subtenant to agree in the sublease that you won't have to give it any rights and remedies in the sublease that are greater than the tenant's rights and remedies in the lease, says Segal [Clause, par. a(viii)(A)]. So, for example, if the tenant agreed to give the subtenant a renewal option but you didn't agree in the lease to do the same for the tenant, the subtenant doesn't have a renewal option, he explains.

Name Special Rights/Options that Subtenant Can't Inherit

Indicate which special perks you gave the tenant in the lease that the subtenant can't inherit, says Segal. Also, say that the tenant can't exercise those perks on the subtenant's behalf, he adds [Clause, par. a(v)(F)]. Perks are typically given to a desirable tenant to induce it to sign a lease. But you probably didn't intend these perks to pass to subtenants—especially after a lease termination, he explains.

Bar Sublease from Increasing Your Obligations

Require the subtenant to agree in the sublease that you don't have to follow any sublease provision that gives you obligations that are broader than your lease obligations to the tenant, says Segal [Clause, par. a(viii)(B)]. Otherwise, the subtenant could force you to perform duties—such as repair work or trash removal—that were the tenant's duties under the lease, he explains.

List Tenant's Obligations that Aren't Your Responsibility

Require the sublease to say that the subtenant agrees that you and your successors and assigns won't be:

• Subject to any credits, offsets, defenses, or claims that the subtenant might have against the tenant;

• Liable for something the tenant did wrong; or

• Required to complete, or pay for, any improvements to the sublet space [Clause, par. a(vi)].

This way, you can't be held responsible or liable to the subtenant for any of those obligations, says Mallory. And you're not stuck cleaning up the tenant's messes.

Allow Your Direct Communi-cation with Subtenant

Require the sublease to say that you can communicate directly with the subtenant and enforce all of its sublease obligations and the tenant's lease obligations against the subtenant, says Segal. You also want the sublease to say that you're not required to send any notice to the tenant about the enforcement, he adds [Clause, par. a(vii)]. This way, the subtenant acknowledges that you have a direct relationship with it, and that you can sue it directly if it violates the sublease or lease, he explains.

Require Subtenant to Pay Highest Minimum Rent

Get the most minimum rent for the sublet space. To do this, require the subtenant to pay minimum sublet rent that equals or exceeds the higher of: 1) the minimum rent per square foot then due under the lease (prorated for the sublet space); 2) the minimum rent per square foot then due under the sublease; or 3) the prevailing market minimum rent for space that's comparable to the sublet space in your building or center, says Segal [Clause, par. a(iii)].

Otherwise, you may be stuck with minimum rent for the sublet space that's lower than what you were getting from the tenant or below market, he explains.

Require Subtenant to Pay You Directly

The sublease must make subtenant pay the new minimum sublet rent and all other amounts due under the sublease to you directly, says Mallory [Clause, par. a(v)(C)]. Otherwise, the subtenant might continue to pay them directly to the tenant, he explains.

Require Subtenant to Pay Additional Rent

Also require the subtenant to agree in the sublease to pay the same share (prorated) of the building's operating expenses (or the center's CAM costs) and other additional rent that the tenant was paying under the lease for the sublet space to you directly, says Mallory [Clause, par. a(v)(D)]. This way, you won't lose out on any additional rent for the sublet space.

Require Subtenant to Provide Additional Security

Require the subtenant to agree in the sublease to give you a security deposit, says Segal [Clause, par. a(v)(E)]. The amount of the security deposit should equal one or more months of the new minimum sublet rent, he adds. You'll have to decide how much security deposit you'll need to protect your interests and the sublet space. The extra security is important in case the subtenant uses the space in a way that increases the wear and tear to it, he explains.

Practical Pointer: Have the subtenant agree in the sublease that you're not responsible to account for money being held by the tenant as a security deposit, says Segal. Rather, you'll want to be responsible to account for only the security deposit you got directly from the subtenant, Segal says [Clause, par. a(vi)(D)].

Keep Tenant on the Hook

Make the tenant agree that it will stay on the hook for all of its lease obligations—including paying rent—after the lease terminates because of the tenant's default and you recognize the sublease, says Mallory. The tenant should agree to this in return for your consent to including the sublease recognition clause in its lease, he explains. And make sure the tenant remains “primarily liable” for all of the subtenant's payment and performance obligations under the sublease, says Segal [Clause, par. a(ix)]. That means that you can still demand payment directly from the tenant, he explains.

You'll have to decide whether the clause should say that the tenant is still on the hook if it goes bankrupt. Bankruptcy laws may prevent you from demanding any payment from the tenant, warns Mallory. And if you evict the tenant because it's a deadbeat, it's unlikely that it will have the money to pay you, he adds. But it still may be worth adding this condition, he adds.

Practical Pointer: It's a good idea to recognize a sublease if a tenant goes bankrupt, even though you may not be able to keep the tenant on the hook, says Mallory. At least you would continue to get rent on the sublet portion of the space, he says. And that should make your lender happy, he explains.

Keep Tenant Liable if Sublease Changes

Make sure you can continue to keep the tenant on the hook even if you and the subtenant agree to a change, transfer, or renewal of the sublease, or sign a new lease, says Segal [Clause, par. a(x)]. Otherwise, the tenant may claim that the change, transfer, renewal, or new lease releases it from further liability to you, he explains.

Add Three Additional Provisions

In addition to the above 20 conditions, include the following provisions in the clause.

Make Recognition Right Personal to Tenant

Say that this sublease recognition right is personal to the original tenant only, says Segal. So the right can't be transferred to anyone else, he adds [Clause, par. b] Otherwise, assignees and subtenants of the original tenant may say that you must recognize their subleases (or sub-subleases) too, he explains.

Get Tenant's Indemnification

Make the tenant indemnify you—that is, reimburse you—if you must pay any brokerage commissions, finders’ fees, or any other charges in connection with recognizing the sublease, says Segal [Clause, par. c]. Otherwise, the tenant might claim that it's not responsible for paying these costs—you are, he explains.

Say Clause ‘Survives’ Lease Termination/Rejection

Say that the terms of the sublease recognition clause remain in effect—in legal terms “survive”—after the lease terminates or is rejected, says Mallory [Clause, par. d]. This is intended to keep the sublease recognition clause enforceable even though the lease ended, he explains. But this survival provision may be unenforceable in your locality. So check with your attorney to find out, says Segal. It's a good idea to include it in your leases anyway, though.

CLLI Sources

Richard C. Mallory, Esq.: Managing Partner, Allen Matkins Leck Gamble & Mallory, LLP, 333 Bush St., 17th Fl., San Francisco, CA 94104-2806; rmallory@allenmatkins.com.

Peter W. Segal, Esq.: Partner, Powell, Goldstein, Frazer & Murphy LLP, 1001 Pennsylvania Ave. NW, 6th Fl., Washington, DC 20004; (202) 347-0066.

Sidebar

Amend Sublease After Recognition

If all conditions of the sublease recognition clause are met and you must recognize the sublease, you and the subtenant should then amend the sublease, says San Francisco attorney Richard C. Mallory. The amendment should confirm these new key terms: 1) the new sublet minimum rent; 2) the sublease's new termination date, since you and subtenant might agree to a longer term now that you're in a direct relationship; and 3) the names of the current owner and current subtenant, since they may be successors of the parties who originally signed the lease and sublease, he says.