ASSIGNMENT AND SUBLETTING
- General Business Concerns. When a tenant executes a lease, the tenant is liable for the tenant’s obligations under the lease for the term of the lease. The tenant’s obligations will continue even though the tenant’s circumstances change, such as the death of an individual, a downturn in tenant’s business, a change in the retail tenant’s concept or a merger or consolidation of a corporate tenant resulting in the space becoming unnecessary. When circumstances change, the tenant wants the flexibility to find other users to occupy all or a portion of the space and assume some or all of the tenant’s remaining obligations under the lease. In order to have this flexibility, the lease must allow the tenant to assign the lease or sublet all or a portion of the tenant’s interest in the premises. In addition, the other provisions of the lease (such as the lease’s use clause and its restrictions on alterations) must be flexible.
A landlord, on the other hand, wants to be able to control who occupies the landlord’s building or project and for what uses. The occupants must be creditworthy, not adversely affect the reputation of the building, not increase the landlord’s ownership risks or adversely affect other tenants of the building or project. To the extent a landlord allows a tenant to assign the tenant’s interest in the lease or sublet the premises, a landlord will require the assignee or subtenant, as the case may be, to be responsible for all of the tenant’s obligations under the lease in order to ensure that the landlord has a remedy directly against the assignee or subtenant.
- Distinction Between Assignment and Sublease.
- Assignment. An assignment is a transfer of a tenant’s entire interest in a lease to an assignee. The assignee will deal directly with the landlord and will be directly liable to the landlord for the payment of rent. Unless specifically released from liability under the lease by the landlord, the assignor will remain liable for the tenant’s obligations under the lease. If the landlord makes a claim on the assignor, the assignor will then have a claim against the assignee, but only the landlord (and not the assignor) will be able to evict the non-paying or non-performing assignee. Thus, because the landlord can wield the eviction stick, the landlord is in a better position to compel the assignee’s performance than the assignor.
- Sublease. In a sublease, the tenant retains its interest in the lease and merely transfers the right to occupy all or a portion of the premises subject to the tenant’s rights under the lease. In this instance, the tenant retains the direct contractual relationship with the landlord. The subtenant will pay rent to, and deal directly with, the tenant. Typically, a tenant will seek to sublease a premises where the tenant wants to continue to retain a portion of the premises for the tenant’s own use or where the tenant desires to re-enter the sublet premises prior to the termination of the lease.
- Restrictions on Assignments and Subleases. A landlord can restrict the ability of the tenant to assign the tenant’s interest in the lease or sublease the premises. The limitation in the lease on the tenant’s ability to assign the lease or sublet the premises may be: (i) absolute (the landlord may approve or disapprove of a proposed sublease or assignment in the landlord’s sole and absolute discretion), (ii) conditional (the landlord may withhold the landlord’s consent to a proposed sublease or assignment only if the landlord has a reasonable basis for withholding such consent), or (iii) unqualified (the lease provides that “the tenant may not assign the lease or sublet the premises” and does not specify any standard governing the landlord’s determination of whether or not to withhold the landlord’s consent to such proposed assignment or sublease).
Many states allow a landlord to absolutely prohibit assignments and subleases. In some states such as California, the basis is statutory. See California Civil Code Section 1995.230. In Oregon, the Oregon Supreme Court in Pacific First Bank v. New Morgan Park Corp. upheld the ability of a landlord to absolutely withhold the landlord’s consent to a proposed assignment or sublease.
If the lease is silent as to whether the landlord’s right to withhold the landlord’s consent to a proposed assignment or sublease is absolute or conditional, the landlord’s implied covenant of good faith will prohibit the landlord from unreasonably withholding the landlord’s consent in most states. See Pacific First Bank v. New Morgan Park Corp. (Oregon Supreme Court). California reaches the same result by way of California Civil Code Section 1995.260. However, under a recent Court of Appeals case in Washington, a landlord has no implied duty to act in good faith in deciding whether to approve an assignment of a lease when the lease simply provides that an assignment requires the landlord’s consent. See Johnson v. Yousoofian.
Where a landlord agrees not to unreasonably withhold the landlord’s consent to a proposed assignment or sublease, the landlord will often include in the lease a number of circumstances in which it is reasonable for the landlord to withhold the landlord’s consent. These circumstances include:
- the transferee’s financial condition is inadequate;
- the transferee’s proposed use is different than the tenant’s use;
- the nature of the proposed use may result in: (i) an increase in insurance premiums, (ii) an increased risk with respect to the use or release of hazardous materials in the building or project, (iii) increased likelihood of damage or destruction, (iv) increased density or pedestrian traffic through the building or project, or (v) the installation of new tenant improvements which are incompatible with existing building system components;
- the transferee has a bad reputation;
- the expected percentage rent for the transferee’s business is less than that of the tenant;
- the transferee’s proposed use may violate or create a potential violation of an applicable law;
- the transferee’s proposed use may create traffic congestion or burden existing parking;
- the transferee is a labor union, foreign or domestic governmental entity, public utility or tax-exempt organization;
- the transferee is an existing occupant of the building or project, or a person or entity the landlord has dealt with previously with respect to leasing space in the building or project;
- in the case of a sublease, the monthly rental and other economic concessions result in the effective rent being less than the monthly rent landlord is asking for similar space in the building or project;
- any ground lessor or lender whose consent is required fails to consent;
- the tenant is in default at the time of the sublease or assignment request;
- in the case of a sublease, the proposed subletting would result in more than a specified number of subleases of portions of the premises being in effect at any one time or more than a specified number of subleases during the term of the lease.
- Tenant’s Remedies for Withholding Consent. Since a landlord’s decision to withhold consent is a subjective one, many landlords prohibit a tenant from obtaining damages based upon any assertion that the landlord unreasonably withheld or delayed its consent to a proposed assignment or sublease, thus limiting the tenant’s remedy to injunctive relief.
Unless injunctive relief can be obtained immediately, the tenant may be in an unfortunate position even if it prevails in court. This is because the proposed assignee or subtenant will not put its relocation on hold while waiting to see how the controversy between the landlord and tenant is resolved. Therefore, some tenants seek to include a clause requiring an expedited arbitration where a dispute arises as to the reasonableness of a landlord’s decision to withhold consent to an assignment or sublease.
- Landlord Recapture Rights. Because the control of one’s building or project is very important to the landlord, the landlord will often include a “recapture” clause in the lease. If a tenant seeks the landlord’s consent to an assignment or sublease under a recapture clause, the landlord has the option to “recapture” the space, terminating the lease. By recapturing the space, the landlord will release the tenant from any further liability under the lease. The landlord will presumably exercise this option (and forego having the tenant remain liable on the lease) if the landlord wants control of the space or if the landlord can relet the space at a higher rent.
The “standard” recapture option allows the landlord to recapture the space after the tenant has found a prospective subtenant or assignee and has reached agreement as to the business terms of the sublease or assignment. This puts the tenant in a difficult position of having to market the space subject to the landlord’s ability to kill the deal at the last minute. The tenant can minimize this problem by requiring the landlord to decide whether to exercise the landlord’s recapture option earlier in the process.
When drafting a recapture provision, landlords and tenants should consider including the following types of clauses in the lease:
- Landlord’s Concerns.
(i) The landlord will want to make it clear that the landlord may choose, in its sole discretion, either: (a) to recapture the space, or (b) not to recapture the space (in which event landlord retains the right to decide whether or not to accept the proposed sublease or assignment).
(ii) The landlord will want to make it clear that if the landlord recaptures the space, the landlord may lease the space to tenant’s proposed transferee or any other party.
- Tenant’s Concerns.
(i) The tenant will want the lease to have a clear (and short) time period within which the landlord must exercise its recapture option.
(ii) The tenant will want the ability to withdraw its request to assign or sublet if the landlord notifies the tenant that the landlord intends to terminate the lease.
(iii) The tenant will want to recover the costs of its unamortized tenant improvements if the landlord terminates the lease.
(iv) The tenant will want the lease to specify that in the case of a proposed sublease, the landlord’s recapture right only applies to the sublet space and the lease will be amended to reflect the reduced size of the leased premises, with the rental rate and tenant’s share of taxes and insurance adjusted accordingly.
- Exceptions from Restrictions on Assignment or Subletting. Restrictions on assignments and subleases are usually so broadly drafted as to cover any direct or indirect transfer of the tenant’s interest in the lease. However, there are certain types of transfers which should be allowed to occur without the tenant first obtaining the landlord’s consent. These include:
- Transfers by an individual tenant to an entity controlled by the tenant;
- Transfers by a tenant to an affiliated entity;
- Transfers by way of merger, consolidation or the acquisition of assets or capital stock (however, if the lease is a retail lease, the landlord will want to condition the approval of such transfer on, among other things, the proposed transferee having sufficient retail experience and there being no change in the use of the premises).
- Bonus Rent. A landlord will often require a tenant to share the profits the tenant receives from subletting space or assigning the lease. A “bonus” rent clause entitles the landlord to receive some or all of the rent or other consideration payable by a transferee as a result of the lease transfer to the extent the new rent exceeds the existing rent. This additional rent may be in the form of a lump sum payment in the case of a lease assignment or higher subrent in the case of a sublease. Landlords justify their “right” to bonus rent on the theory that they, not the tenant, are in the real estate business, and only the landlord is entitled to increases in rents due to increases in the value of the real estate.
- Continuing Liability of Tenant. Where a tenant assigns its interest in the lease, the tenant will remain liable for all of the obligations of the lessee under the lease unless the landlord specifically releases the tenant from the tenant’s obligations under the lease. Landlords are reluctant to agree to release the tenant and typically only do so, if at all, where the assignee has a sufficiently large net worth.
- Subtenant Concerns. A subtenant will have a number of concerns which need to be addressed when negotiating a sublease.
- Landlord Consent. The subtenant must determine if the landlord’s consent is required under the prime lease. If so, the effectiveness of the sublease should be conditioned upon the tenant obtaining the prime landlord’s consent to the sublease (and the landlord’s consent to all other relevant matters such as the subtenant’s proposed alterations and any changes in the use of the premises) within a specified period. If such consent is not granted within such specified period, the sublease will automatically terminate.
- Incorporation by Reference. If the majority of the terms of the sublease are “incorporated by reference” from the prime lease, the subtenant must carefully study the prime lease to be sure that there are no unanticipated pass throughs. In addition, there may be some provisions which should not be incorporated by reference, such as the initial construction provisions (especially any improvement allowances the landlord agreed to pay the tenant), further option rights of the tenant, and the rights of the parties upon condemnation or casualty. In addition, the tenant will want the subtenant’s default and cure periods under the sublease to be shorter than the tenant’s default and cure periods under the prime lease to ensure that the tenant will have an opportunity to cure defaults under the prime lease if the subtenant fails to cure such defaults under the sublease.
- Notices. The subtenant must be sure that it gets copies of all notices under the prime lease, whether sent by tenant or landlord. The subtenant should consider copying the landlord on notices sent under the sublease.
- Non-Disturbance. If the prime lease terminates, the sublease terminates as a matter of law unless the landlord specifically agrees not to disturb the subtenant’s possession of the space upon a termination of the prime lease. This is often difficult to negotiate, especially if the subrent is less than the rent under the prime lease or if the subtenant is leasing only a portion of the premises leased under the prime lease.
- Subtenant Repairs. While the landlord will, as a practical matter, provide basic building services and be responsible for maintenance and repairs of structural elements and building systems, the subtenant is not privity with the landlord and cannot directly enforce such obligations against landlord. To address this problem, the subtenant will want the ability to: (i) terminate the sublease if a breach is material, and (ii) have the ability to require the tenant to enforce its remedies against the landlord, or if the tenant fails to do so within a specified time period, enforce the tenant’s remedies against the landlord directly as the tenant’s agent.
- Pass Through of Special Tenant Rights. The subtenant may be able to obtain the benefit under the sublease of any special rights the tenant received under the prime lease. An example of this would be the ability to make any repairs the landlord fails to timely perform and deduct the cost of such repairs from subrent.
- Landlord Consent. The landlord will condition the landlord’s consent to an assignment or sublease upon the execution of the landlord’s form of consent. The form will, among other things: (i) require the tenant and the assignee or subtenant to acknowledge that the landlord is not in default of the lease, (ii) require the assignee to assume the lessee’s obligations under the lease, in the case of an assignment, or, in the case of a sublease, require the subtenant to abide by the terms of the prime lease, (iii) make clear that the landlord’s consent to the sublease or assignment in no way modifies the terms and provisions of the lease or in any way expands or enlarges the landlord’s obligations under the lease, (iv) reaffirm the ongoing liability of the tenant under the lease (unless the assignment specifically releases the tenant from liability), and (v) reserve the landlord’s right to approve all future assignments or subleases. If the tenant’s obligations under the lease were guaranteed, the landlord will also require a reaffirmation of that guaranty as a condition to consenting to such assignment or sublease.
The use clause of a lease is the provision which defines the types of activities which may be conducted within the premises. For an office space, the issue is straightforward; the tenant can occupy the space only for office uses. However, careful attention should be paid to the use clause in the context of flex/warehouse/industrial space and in the context of retail space.
- Flex/Warehouse/Industrial Space. For flex/warehouse/industrial space, the landlord should avoid the mistake of allowing the tenant to use the space for any lawful use. While the tenant’s expected use of the premises may not pose any special risks to the real estate, it is always possible a change in use may occur which poses: (i) unacceptable environmental risks (a change in use of flex space from office use to a biotech laboratory), or (ii) unacceptable safety risks (a change in use of industrial space from light manufacturing to heavy manufacturing).
- Retail Space. For shopping center space, the landlord wants to control the tenant mix to attract the largest possible volume of shoppers to maximize sales for all tenants of the shopping center. The three types of clauses which directly affect a retail tenant’s use of its premises relate to: (i) permitted uses, (ii) prohibited uses, and (iii) exclusive uses. The tenant’s use of the space may also be indirectly affected by the lease’s alterations clauses, its sign restrictions, and its assignment and subletting provisions.
- Permitted Uses. The permitted use is the specific activity the tenant is allowed to perform in the premises. The landlord should define the permitted use as narrowly as possible to ensure that the tenant’s use of its premises does not “evolve” over time. In addition, the landlord should avoid allowing the tenant to engage in “ancillary uses related thereto” or clauses of similar import.
The tenant, on the other hand, would like the use clause defined as broadly as possible. Where the tenant is selling items which are constantly changing due to advances in technology (such as computers, records and compact discs), the tenant should be sure that the use clause allows the tenant to sell technological evolutions of the products currently being sold by the tenant.
- Exclusive Uses. Tenants often request the exclusive right to sell a particular item in the shopping center. Landlords try to resist granting such exclusive rights since the granting of such rights limits the landlord’s flexibility. To the extent the landlord does grant such rights, the landlord should: (i) narrowly define the exclusive use, and (ii) exclude from the “exclusion” prior leases, renewals of prior leases, new leases with existing tenants of the shopping center, “anchor” tenants, and sales of the restricted item in small amounts by other tenants of the shopping center. In addition, tenant’s exclusive rights should automatically terminate upon the occurrence of: (a) a default under the lease, (b) an assignment or sublease, or (c) the tenant ceases to use the premises primarily for the sale of the exclusive use item. Finally, the exclusive right should not apply to any property acquired by the landlord after the date of the lease.
- Prohibited Uses. Where the tenant has sufficient strength to sign a lease with a very broad permitted use, the landlord can constrain the tenant by including a list of prohibited uses. This list often includes: (i) uses which pose environmental risks (for example, auto or boat repair, dry cleaner and lumber yards), (ii) uses which tend to hog parking spaces (for example, movie theaters, meeting halls, and other entertainment centers), (iii) office uses, and (iv) uses which may degrade the center’s reputation (pornographic sales, bars, bingo halls, pool halls, message parlors and dance halls). However, the “standard” list of prohibited uses may be changing as more and more shopping centers add entertainment center components as part of their tenant mix.
A co-tenancy clause is one in which certain of tenant’s obligations under the lease are contingent upon the landlord satisfying specific requirements with respect to the occupancy of the other portions of the project. A tenant would like to obtain a co-tenancy clause to enable it to limit its exposure if the project is a failure. Obviously, the landlord would like to avoid granting co-tenancy rights. This is especially true where the landlord grants several tenants co-tenancy rights. This can lead to a domino effect resulting in numerous tenants ceasing operations. Thus, it is no surprise that the existence of co-tenancy rights will be extremely troublesome for lenders. Co-tenancy rights are typically found only in shopping center leases since the success of a shopping center tenant often depends upon the success of the shopping center as a whole.
Under a typical co-tenancy clause, a tenant will generally have the right to cease operations, cease paying rent and/or terminate the lease if less than a specified number of anchor tenants are not open for business and/or a specified percentage of the total gross leaseable area of the mall portion of the shopping center is not open for business.
When drafting a co-tenancy provision, the landlord will want to define as narrowly as possible the circumstances in which a tenant may exercise its co-tenancy remedies. Among other things, this means:
- The landlord should describe the anchor tenants as generically as possible as opposed to specifically naming anchor tenants.
- The landlord should have a “cure” period within which to obtain replacement tenants before the tenant can exercise its co-tenancy remedies (e.g., 12 months).
- The landlord should “stagger” the tenant’s co-tenancy remedies. This means that if the landlord fails to satisfy the co-tenancy requirement after the applicable cure period, the tenant will still be required to remain open and operate tenant’s business but that the tenant will be obligated only to pay percentage rent. The tenant’s termination right will kick in only if the landlord fails to satisfy the co-tenancy requirement for another 12 months. Under this “staggered” approach: (i) the landlord continues to receive some cash flow, (ii) the shopping center remains occupied, and (iii) the landlord avoids triggering another co-tenancy clause in a different lease.
- The co-tenancy clause should not be triggered if the tenant’s business is not materially adversely affected by the vacancies. The test frequently used is whether there is a material drop in the tenant’s net sales.
- The co-tenancy clause should not apply if a space is closed due to casualty, condemnation or renovation.
- If the tenant does terminate, the landlord can require the tenant to pay a termination fee and/or reimburse the landlord for the landlord’s unamortized costs attributable to the lease (tenant improvement costs, brokerage commissions and attorneys’ fees).
As with co-tenancy requirements, operating covenants are especially important in shopping center leases. If an office tenant “goes dark” but continues to pay rent, the landlord’s concerns will generally be limited. However, if a major tenant of a shopping center “goes dark,” the consequences to the shopping center could be disastrous even though the landlord continues to receive minimum rent because: (i) the landlord will not collect percentage rent, (ii) the shopping center will lose customers, (iii) the tenant may open a new store in a new, competitive location, and (iv) the shopping center will be more likely to be vandalized. All of this will not be lost on the landlord’s lender, who will not want to lend on property where the rental stream from the property and its value are subject to uncertainty.
The landlord’s solution to this problem is to obtain an operating covenant. Among other things, the covenant may include the following:
- Require the tenant to remain open for business.
- Require the tenant to continuously and actively use and occupy the entire space throughout the term of the lease for the permitted use.
- Specify the hours of operation and the holidays on which the shopping center will be closed.
- Depending on the location of the premises, require the installation of window displays and the time periods during which such displays must be lighted.
Strong tenants will resist executing leases with continuous operation clauses because they want to maximize their flexibility. If a tenant refuses to execute a lease with a continuous operations clause, the landlord should obtain the right to recapture the premises if the tenant: (i) goes dark, (ii) reduces the portion of the premises which is open for business below a specified number of square feet, (iii) reduces its hours of operation below a specified level, or (iv) assigns the lease to a person or entity which will engage in a different use of the premises. A landlord wants to exercise this recapture right immediately; the tenant will want a cure period, especially with respect to a closure for casualty, condemnation or renovations. Another issue that should be addressed is the cost, if any, to be paid by the landlord in connection with the recapture of the premises. This will be determined, in part, by the rent payable at the time of the recapture and who paid for the tenant improvements.
Even landlords of office space want the ability to recapture space when tenants go dark. First, the rent paid by the tenant going dark may be below market. Second, the landlord may feel the building is more valuable fully occupied. The tenant will often require, as a condition to allow the recapture, that the tenant be released from all further liability under the lease.
A related concern of a retail landlord is to prevent a tenant from relocating and competing with the landlord. The landlord can prevent this from occurring by including a “radius” clause in the lease which prohibits the tenant and its affiliates from doing business within a specified radius of the shopping center. The radius clause obligations should survive the termination of the lease and allow the landlord to seek injunctive relief and/or specify the amount of damages payable to the landlord upon a violation by the tenant.
EARLY TERMINATION AND RELOCATION RIGHTS
- Early Termination Rights. Tenants typically seek early termination rights in the event of damage, destruction or condemnation (discussed below). A tenant may also request early termination rights for a variety of other reasons. As mentioned above, landlords will resist granting early termination rights due to, among other things, the adverse affect an early termination right may have on the landlord’s ability to finance the project.
A landlord may also seek an early termination right. Perhaps the landlord, as an alternative to relocating a tenant, will want the ability to “buy” the tenant out of its lease. This flexibility might, among other things, enable the landlord to accommodate a larger tenant. Or, if the landlord contemplates selling the project to a user during the lease term, an early termination right will be essential. In the retail context, a landlord may want the ability to terminate a lease with a tenant not paying percentage rent. By giving the landlord (but not the tenant) the right to terminate a lease if the tenant’s net sales do not meet a pre-determined target, the landlord has the ability to remove the “dead wood” from its shopping center.
- Relocation Rights. In all types of multi-tenant leases, the landlord would like the ability to require a tenant to relocate to another space. By having the ability to force tenants to relocate, the landlord is able to optimize the use of the project. The relocation process often works as follows. The landlord provides the tenant with a relocation notice, specifying the proposed relocated premises. The tenant will then have a period within which to decide whether or not to accept the landlord’s relocation proposal. If the tenant rejects the relocation proposal, the landlord then has a period of time within which it can rescind its relocation proposal or terminate the tenant’s lease. If the tenant’s lease is terminated, the tenant may demand a termination fee (often equal to the unamortized cost of the tenant improvements paid for by tenant). If the tenant accepts the relocation proposal, the landlord will: (i) build out the new space for the tenant at the landlord’s cost, and (ii) reimburse the tenant for tenant’s actual reasonable relocation costs (for example, the cost of changing stationery, business cards and advertising). In multi-story office building leases, the tenant frequently has no ability to accept or reject the landlord’s proposed relocation space. Tenants protect themselves by specifying the criteria for acceptable relocation space (for example, the floor of the building, the side of the building and the square footage of the relocation space).
FIRE AND CASUALTY.
To protect cash flows, landlords want to avoid granting the tenant a termination right upon the occurrence of a casualty, irrespective of the time which may be required to rebuild the premises. Tenants, on the other hand, want the ability to terminate the lease if the time required to rebuild the premises or project exceeds a specified time period or if the casualty occurs during the last several years of the lease term (since the tenant does not want to look for temporary space while the premises is being rebuilt and then look for permanent space a year later when the lease term expires).
If a landlord must give the tenant a termination right to “do the deal,” the landlord should try to include a procedure in the lease which allows the landlord to notify the tenant early on in the restoration process of any unanticipated delays and require the tenant to elect whether or not tenant will exercise its termination right at that time. By forcing the tenant to exercise the tenant’s termination right early, the landlord will have the ability to obtain a replacement tenant if the tenant elects to terminate the lease. If the tenant waives its termination right, the tenant will be required to resume its obligations under the lease when the premises are completed, even if completed late.
OBLIGATION TO REPAIR — WHO IS RESPONSIBLE?
The obligation to repair damage to the premises as a result of a casualty will be the responsibility of the party required to maintain insurance covering the damaged item. In most instances, the cause of the damage (for example, tenant’s negligence) will be irrelevant because the landlord and tenant will obtain subrogation waivers with respect to their respective property insurance policies.
The primary issue negotiated between landlords and tenants with respect to the reconstruction of the premises is who is responsible for the reconstruction of the tenant’s tenant improvements. In any event, the party responsible for insuring such improvements should be required to pay for such improvements.
Probably the most common request of major tenants is the right to cure landlord defaults (self-help) and offset rent to pay for the cost of such cure. Landlords (and their lenders) try to resist granting such offset rights since the existence of such rights may adversely affect the project’s income stream. If a landlord grants self-help and offset rights, the landlord should: (i) require the tenant to provide the landlord written notice of the landlord’s default, and (ii) provide the landlord an opportunity to cure the default (or object to the tenant’s allegations of a default). A tenant may want any dispute regarding the existence of a default resolved by an expedited arbitration.
If the landlord fails to cure an acknowledged default, the landlord should limit the tenant’s self-help remedy to those defaults which interfere with the tenant’s use of the premises (for example, the failure to provide janitorial services). The landlord should not allow the tenant to repair or tamper with the building structure or building systems. The landlord should also limit the amount of rent a tenant may offset during: (i) any month, and (ii) any twelve month period to ensure a minimum amount of cash flow. Further, the tenant should be precluded from exercising offset rights if the tenant is in default.
IMPROVEMENTS — REMOVAL VS. LANDLORD’S PROPERTY
Landlords like to maximize their flexibility by having the ability, at the landlord’s sole election, to determine whether the tenant improvements should stay or be removed from the premises by the tenant at the tenant’s cost. Because the cost of removing tenant improvements can be significant, tenants try to require the landlord to determine whether or not the landlord will require the removal of a particular improvement at the time the landlord approves of the construction of such improvement. This way if the tenant makes an improvement request which the landlord approves conditional on the tenant’s removal of the improvement at the end of the lease, the tenant can then determine whether of not to proceed with the proposed improvement, taking into account the anticipated removal costs.
The tenant will retain title to, and be able to remove at the end of the lease, the tenant’s personal property, trade fixtures and other specified fixtures.
A landlord will frequently require a security deposit to secure a tenant’s obligation under a lease. The landlord is committing substantial (and often borrowed) capital to construct tenant improvements which may have substantially diminished value or no value to a replacement tenant if the original tenant defaults on its lease. In addition, the landlord will have few effective remedies against a failing business or a tenant in bankruptcy. To address this risk, it is reasonable for a landlord to demand the payment of cash security deposit or the posting of a letter of credit.
If the landlord’s financial condition is shaky, the tenant’s security deposit is at risk. In any event, the tenant should try to obtain the landlord’s agreement to reduce the amount of the security deposit in stages over a period of years so long as the tenant performs its obligations under the lease. The tenant may also be able to convince the landlord to retain the security deposit in a segregated interest bearing account, in which instance the landlord may insist that landlord retain a percentage of the interest earned (often one percent) to compensate the landlord for its time and trouble.