What to Consider When Subleasing Office Space

Ray Triana of Manatt, Phelps & Phillips, who specializes in legal advisement on finance, development and leasing, examines the risks and considerations that must be taken into account by involved parties before entering into a sublease.
Author Ray Triana of Manatt, Phelps & Phillips
Author Ray Triana of Manatt, Phelps & Phillips

In many markets, large blocks of office space are scarce. A company may decide to lease more space than needed in order to reserve space for future growth. When this strategy is executed, the cost can be mitigated by subleasing. Prospective subtenants, on the other hand, may want to sublease for a short term at a discount from market rents, and/or may not be interested in a permanent office location. However, subleasing presents a number of unique risks to both the tenant as sublandlord and the subtenant. In this article, “landlord” will refer to the primary landlord under the direct lease, “tenant” will refer to the primary tenant and “subtenant” will refer to the subtenant.

Most leases contain provisions that require the tenant to pay a portion of sublease rent to the landlord after deducting the rent payable under the lease and costs of subleasing. These provisions should be analyzed carefully with legal counsel. The lease may also provide that the tenant will lose certain rights, such as expansion rights or renewal rights, if the tenant subleases, or the tenant may lose sign rights on the building. The tenant and its advisors should confirm that the tenant will not forfeit a valuable right by subleasing. Many leases require that the consent of the landlord to any subleasing must be obtained, and a process for obtaining such consent including a time in which the landlord must respond to any request must be defined.

From the perspective of the subtenant, if the sublease is only for a portion of the space, the subtenant bears the risk that the primary tenant may go into default under the lease by failing to comply with the lease terms. The subtenant may want to request a non-disturbance agreement, which gives the ability to remain in the premises on the same terms as the sublease, if the tenant defaults under the lease. If the sublease is only for a portion of the space covered by the lease, the landlord may be reluctant to agree to non-disturbance. The subtenant may also want to request a non-disturbance agreement from the landlord’s lender, to cover the risk of a foreclosure wiping out the sublease.

The subtenant must also carefully review the prime lease with its counsel. There will be various provisions that typically should not apply to the sublease, such as the tenant’s liability to pay rent on the whole space. The remaining term of the lease must be the same as the proposed term of the sublease. If an extension option is required to be exercised to provide the subtenant with the full term, the sublease should obligate the tenant to exercise the option.

From the tenant’s standpoint, the tenant does not control the delivery of services to the subleased premises. Therefore, the sublease should provide that such matters are the responsibility of the landlord, not the tenant. The subtenant may want to negotiate to either require the tenant enforce the lease against the landlord on the subtenant’s behalf, or have the landlord give consent to provide the subtenant with a direct enforcement right if, for example, services are interrupted.

There are many other issues to consider beyond those noted above. For example, what happens upon a casualty? Who benefits from abatement and who can terminate? Which insurance and indemnities will be required, and must they run directly to both the tenant and the landlord?

Any party seeking to enter into sublease, whether as a tenant or subtenant, will need to carefully evaluate these and other matters.


 

Ray Triana is located in the San Francisco office of Manatt, Phelps & Phillips. Triana’s practice specializes in finance, development and leasing. He regularly advises banks, insurance companies, developers, landlords, tenants and other owners of real estate on issues related to the ownership, leasing, development and disposition of real property. He can be reached at rtriana@manatt.com