Is Tenant Liable to Landlord for Subtenant’s Lease Violation?

Tenants are generally allowed to transfer their lease interests to a third party as long as the landlord is notified and provides consent in advance. The two basic ways to structure such arrangements are as:

• A sublease in which a tenant transfers only part of its interests to the third party and retains residual rights and liabilities vis-à-vis the landlord; or
• An assignment in which a tenant transfers all of its interests to the third party, which then stands in the tenant’s shoes in terms of liability to the landlord.  

Here’s a quiz illustrating the how these seemingly subtle and arcane legal nuances can translate into tens and hundreds of thousands and even millions of dollars in the real world.  

SITUATION

A grocery store tenant subleases 25,740 square feet of premises consisting of 26,713 square feet to a subtenant with the landlord’s consent. The subtenant agrees to be bound by the terms of the tenant’s original lease with the landlord, which thus remains in place with the tenant continuing to pay full rent by remitting portions of the rent it receives from the subtenant to the landlord. The subtenant then occupies the space for the eight years left on the lease.

When the lease ends, the landlord does a walk-through inspection and discovers abandoned duct work and machinery, damaged plumbing pipes, concrete curbs that must be removed, and a corroded and nonfunctioning grease trap. The landlord considers the damages significant enough to warrant refusing to accept the premises and treat the tenancy as a holdover. The landlord then sues the tenant and subtenant for repair costs, unpaid rent, and other costs and damages.   

The tenant claims that the landlord released it from liability for any violations committed by the subtenant, citing the sublease/assignment clause (Section 15.1) of the original lease:

A tenant shall not be relieved of any liability for obligations under the Lease in the event of any sublet or assignment, unless the assignee (i) has a tangible net worth of at least $50,000,000, or (ii) has a tangible net worth between $20,000,000 and $50,000,000 and operates in the Premises for two years following such assignment, and in the case of either (i) or (ii), is then an operator of, or owned by an entity operating, a chain of at least 10 retail stores and has a retail operating history of at least 5 years, in which case Tenant shall be released from liability under this Lease from the date of such assignment in the case of (i) or two years from such assignment in the case of (ii) above. Such release shall be operative without the need for any further documentation; however, the parties agree to cooperate with each other and to sign such documentation as may be required or reasonably requested to evidence such release. (emphasis added)

Assume that the subtenant caused all of the damages and that those damages did, in fact, violate the lease.

QUESTION

Is the tenant liable to the landlord for the damages caused by the subtenant?

A.            Yes, because the arrangement between the tenant and subtenant was a sublease rather than an assignment

B.            No, because Section 15.1 relieves the tenant of liability for the subtenant’s violations

C.            Yes, because the landlord’s clear intent was to keep the tenant on the hook for lease violations committed after a sublease or assignment

D.            No, because the damages were done by the subtenant rather than the tenant

ANSWER

A. The tenant is on the hook for the subtenant’s violations because the arrangement was a sublease and the Section 15.1 liability limitation applies only to an assignment.

EXPLANATION

This scenario, which is based on a recent Arizona case, shows what can happen to a landlord or tenant that doesn’t recognize the legal differences between a sublease and an assignment. The lease language in this case, Section 15.1, largely tracked the common law rules leaving the tenant liable for lease obligations under a sublease but carving out liability in the event of certain assignments.

The terms “sublet” and “assignment,” as used in Section 15.1, are basically interchangeable, the tenant argued. The court disagreed, citing six other parts of the lease that refer to the terms separately and assign each one a separate meaning. “It is well established that a particular clause in a contract cannot be interpreted as if it stood by itself, but the court must take into consideration the entire contract” [Shoppes At Mirador Square LLC v. Wild Oats Markets Inc., 2023 U.S. Dist. LEXIS 45421].

Bottom Line: Since the arrangement was a sublease rather than an assignment, the tenant remained liable to the landlord and A. is the correct answer.

WHY WRONG ANSWERS ARE WRONG

B is wrong because the Section 15.1 liability limitations applied only to assignments and the court concluded that the arrangement in this case was clearly a sublease:

• The tenant transferred only 25,740 of the 26,713 square feet it leased to the subtenant;
• The tenant received rent from the subtenant and remitted it to the landlord; and
• The subtenant paid less than full rent under the lease, with the tenant paying the differential.

C is wrong because courts will consider the intentions of the parties in forming the contract only when the written agreement is ambiguous and subject to more than one reasonable interpretation. Since the tenant was unable to show that Section 15.1 was ambiguous, the question of intent was irrelevant in this case, the court concluded.

D is wrong because Section 15.1 specifically stated that the tenant wasn’t “relieved of any liability for obligations under the Lease in the event of any sublet or [particular kinds of] assignment” and the arrangement in this case was a sublease. So, the fact that the subtenant caused the damage in violation of the lease doesn’t affect the tenant’s liability to the landlord for the consequences of that violation.