Lease Battle Line: The Fight for Assignment and Sublease Profits
If a profit can be made from assigning a lease or subletting the premises, who should keep the profits?
The landlord owns the property and believes it is entitled to receive all income and profits earned from the property.
The tenant realizes that if market rents fall during the lease term, it will remain obligated to pay the higher lease rental rate and will not receive rent concessions from the landlord. Since it bears the downside risk, the tenant believes it should retain any upside profits from an assignment or sublease.
The battle line is drawn: Who is entitled to keep the profits?
Whether a tenant has a right to some or all of the profits is a matter to be resolved by negotiations, but a landlord should never seek 100% of the profits. If the landlord retains 100% of the profits, a rational tenant will limit its losses by assigning the lease or subletting the premises at a rental rate equal to or less than the lease rental rate. A tenant will not fight for profits if there is no motivation to do so. If Landlord hopes to profit from an assignment or sublease, it must share a percentage of the profits with the tenant.
What are profits? (It’s all in the definition)
Landlords like to broadly define assignment and sublease profits as any income derived by the tenant from the property in excess of the rent paid under the lease. Tenants desire a more nuanced definition that excludes the tenant’s expenses from the calculation of profits. Tenant’s expenses might include (i) brokerage commissions and marketing expenses, (ii) concessions provided to the assignee/sublessee, including any improvement allowance, (iii) rent paid to the landlord from the date tenant vacated the premises until it derived income from an assignment or subletting, (iv) the unamortized cost of the improvements to the premises made and paid for by tenant; (v) the value of furniture, trade fixtures and equipment included in the deal, and (vi) attorneys’ fees. What, if any, expense items are allowed will vary based upon the outcome of negotiations.
Another issue for the parties to resolve is whether the tenant’s expenses (i) will be reimbursed to the tenant in full before profits are deemed to exist, or (ii) will be amortized over the term of the assignment or sublease (the latter being better for the landlord since profits will be distributed from the get-go).
This article is part of our commercial lease “battle line” series. There are hundreds of battle lines drawn for the skirmishes fought between a landlord and tenant when negotiating a lease. Behind each battle line is the prospect for economic gain or loss that places the landlord and tenant at odds. Understanding the motivations and economic concerns of both the landlord and the tenant facilitates compromise and helps the parties get the deal done.
If you have any questions or comments, email Rick.