According to the Bureau of Labor Statistics, 20% of small businesses fail in their first year, 30% fail in their second year, 50% fail after five years, and 70% of small business owners fail in their 10th year in business. Yikes! Despite these grim statistics, commercial leases are generally a minimum of 5 years and contain severe, default penalties. In some cases, landlords will require the tenant to personally guarantee the lease, effectively using the tenant’s personal assets, i.e. home, as collateral to secure the lease.
Most tenants understand the implications of defaulting on their lease and enter into the agreement, eyes-open, and with every intention of abiding by the terms and conditions. The road to hell (and default) are paved with good intentions. Economic downturns, lost contracts/clients, sequestration, etc. can disrupt even the best laid plans; leaving tenants struggling or unable to meet their monetary obligations under their lease. In such cases, tenants’ most powerful tool/strategy to avoid default is to sublease or assign their lease.
Most, if not all, commercial leases contain Assignment and Sublease provisions and while the specific language and conditions can vary there are general, shared principles. Subletting and assigning are similar in that they both involve a transfer of the tenant’s right or interest in the lease that allow another (3rd) party to occupy the leased premises. Under the terms of most lease agreements the original tenant will remain responsible for the terms of the lease in the case of either a sublease or an assignment. This means that the landlord can proceed against the tenant in the case of a default by the subtenant or assignee; including but not limited to, rental payments, damage to the leased premises, etc. As a result, it is in both the tenant and landlord’s interest to carefully vet the proposed subtenant or assignee.
If subleases and assignments are similar in that they essentially allow the tenant to “rent out” their space to a 3rd party, what’s the difference?
Under a sublease, the tenant is either (sub)leasing a portion of the leased premises for the remainder of the lease term, all of the leased premises for a portion of the lease term, or a portion of the leased premises for a portion of the lease term. Subleases do not necessarily indicate financial hardship on behalf of the tenant or a likelihood of default. In fact, in some cases, companies may choose to lease more space than needed upon the lease commencement date in order to reserve the space for future growth. This is more common with large companies, i.e. Google, that can afford the lease payments but may seek to reduce expenses by subleasing the unused space. Another situation in which a tenant may request to sublease their space is in the case of a downsizing, consolidation, etc. where the they no longer need their entire space but do not want to move and can offset their rental obligations by renting the unused portion to another party.
Under a lease assignment, the tenant transfers all of its rights and responsibilities under the lease to the assignee along with its right to occupy the entire leased premises for the remainder of the lease term. A lease assignment is a much more serious request on behalf of the tenant than a request to sublease the space. While not always the case, a request to assign the lease may indicate that the tenant is unable or unwilling to continue to make lease payments and is likely to default on its lease then or at some point in the future. As stated earlier, most leases require the original tenant to remain liable for the lease (payments, responsibilities, etc.); however, with lease assignments the landlord may release the tenant and enter into a direct relationship with the assignee. The landlord’s decision will be based on a number of factors, most notably the financial strength of the assignee and the difference between the contract rent and market rents. Assignments are not necessarily indicative of financial trouble and can simply be the result of tenants relocating or consolidating; resulting in them no longer needing the leased premises.