Commercial Lease Assignments and Subleases: Negotiation Strategies - - PowerPoint PPT Presentation

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Commercial Lease Assignments and Subleases: Negotiation Strategies in a Troubled Market

presents

Negotiation Strategies in a Troubled Market

Best Practices for Landlords, Tenants, Subtenants and Assignees to Avoid Legal Pitfalls

A Li 90 Mi t T l f /W bi ith I t ti Q&A

Today's panel features: Dorothea W. Dickerman, Partner, McGuireWoods, McLean, Va. Ruth A. Schoenmeyer, Of Counsel, Jenner & Block, Chicago

A Live 90-Minute Teleconference/Webinar with Interactive Q&A

y , , , g Elizabeth K. Cooper, Esq., Managing Director – Brokerage, Jones Lang LaSalle, Washington, D.C.

Thursday, March 25, 2010 The conference begins at: The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 P ifi 10 am Pacific

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Commercial Lease Assignments and Subleases: Negotiation Strategies in a Troubled

Market – Best Practices for Landlords, Tenants, Subtenants and Assignees to Avoid Legal Pitfalls Subtenants and Assignees to Avoid Legal Pitfalls

Presented by: Elizabeth K. Cooper, International Director Jones Lang LaSalle, Inc. Dorothea Dickerman, Partner McGuireWoods LLP Ruth Schoenmeyer, Of Counsel Jenner & Block LLP M h 2 2010

1

March 25, 2010

• I. Current Market Trends

Elizabeth Cooper Jones Lang LaSalle, Inc.

2

• A. Supply vs. Demand

3

Q4 2009 office clock – several markets beginning to stabilize to stabilize

Charlotte, Orlando, Tampa Atlanta, Detroit, Miami, Phoenix, West Palm Beach Chicago, Cleveland, Fairfield County, Hartford / New Haven, Los Angeles, New Jersey, Orange County, Philadelphia, Sacramento, Westchester County, Seattle Boston, Indianapolis, Jacksonville, New York, Oakland / East Bay, Richmond San Francisco Peninsula Silicon Valley St Louis

Peaking market Falling market

Richmond, San Francisco Peninsula, Silicon Valley, St. Louis Austin, Dallas, Denver, Fort Lauderdale, Houston, Memphis, San Diego, San Francisco Baltimore, Raleigh / Durham Minneapolis San Antonio

The Jones Lang LaSalle office clock shows where each market sits within its real estate cycle. Markets generally move clockwise around the clock with

Rising market Stabilizing market

Minneapolis, San Antonio Pittsburgh W hi t DC

move clockwise around the clock, with markets on the left side of the clock generally landlord favorable and markets on the right side of the clock generally tenant favorable.

Washington, DC

4

U.S. vacancy levels will continue to rise into 2010, but at slower levels at slower levels

18.3%

20% 16% 20% 8% 12% 4% 8% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009

5

Tenants more certain of future, pushing leasing activity higher for the second consecutive quarter

Quarterly percent change

higher for the second consecutive quarter

10% 0% 10%

• 10%

0%

9.8 percent annual decline

• 20%

decline

• 30%

Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009

6

Sublease space levels drop for the first time in two years as leasing activity grew on the discounted space

SF

years as leasing activity grew on the discounted space

Levels decreased by more than a half million square feet in Q4

120,000,000 140,000,000 60 000 000 80,000,000 100,000,000 20,000,000 40,000,000 60,000,000 , , Peak during last downturn Q2 2007 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009

7

'01 - '03

Marketed rents down more than 15.0 percent from peaks established in 2008

Quarterly percent change

peaks established in 2008

4% 6% 0% 2%

• 4%
• 2%
• 6%

4% Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Q2 2009 Q3 2009 Q4 2009

8

Net effective rents in primary markets starting to stabilize after such steep declines stabilize after such steep declines

0.0%

• 20.0%
• 10.0%
• 40.0%
• 30.0%
• 60.0%
• 50.0%

Overall net effective rent decline Largest percent decline in specific building

• 70.0%

NYC Boston Chicago San Francisco Los Angeles Washington, DC Dallas

9

Tenant-favorable conditions to persist in 2010

% change from peak of market (2007) to bottom (mid-2010) 12-month outlook

Employment Leasing activity

• 7.4 to 7.7 million jobs
• 63.0%

Sublease space Marketed rents + 37.0 MSF

• 20.0%

Effective rents Rent abatement

• 33.0%

+150.0% Tenant Improvement allowances New construction activity +30.0%

• 100.0%

10

• B. Lease Terms and Renewals

11

Today’s environment – reasons to sublease

• Reduction or mitigation of real estate costs
• Mergers and acquisitions
• Early relocation desired
• Excess space is not only costly but can lead to low morale in an office

12

Subleasing is difficult even in a healthy market

• Understand your sublease clause
• Set financial recovery expectations properly (use an expected and realistic range)
• Set timing expectations of when the task can be accomplished
• Understand your landlord’s motivations, and their other building/portfolio dynamics

Trust and take the advice of your real estate broker (or don’t hire them)

• Go ugly early – don’t just meet the market – beat it
• Go ugly early – don t just meet the market – beat it
• The best subtenant prospect for a decent financial recovery is always from

within the building, then from within the complex….and so on

• It’s far better to be “in-the-way” of a larger tenant needing additional space – rather

than being “good” at what you do

13

Structure your lease acquisition with all of this in mind.

• II. Distinctions Between Assignment and Sublease

Ruth Schoenmeyer Jenner & Block LLP

14

• A. Legal Differences

15

Reversionary Interest

• Number one difference: reversionary interest
• Assignment: Transferor does not retain a reversionary interest in lease
• Sublease: Transferor retains a reversionary interest in lease

Sublease term ends at least one day prior to the end of the term

• Sublease term ends at least one day prior to the end of the term
• Or, transferor retains options to terminate, expand or renew

16

Reversionary Interest

• How do courts determine whether an assignment or sublease has occurred?
• Reversionary interest, not intent
• Danger: Unintentional assignment pro tanto
• Issues for transferor
• Loses right to evict subtenant
• Loses control of renewal rights and other lease options

g p

• Liability remains
• Issues for transferee

Uncertainty as to rent

• Uncertainty as to rent
• Uncertainty as to rights upon transferor default

17

Relationship with Prime Landlord

• Transferee has direct relationship with prime landlord if assignment
• Transferee has indirect relationship with prime landlord if sublease
• Consent to transfers, alterations, etc.
• After hours services

18

Liability

• Not a distinction between an assignment and sublease
• Liability of the transferor continues under the original lease unless:
• Novation (i.e., full substitution of assignee for assignor)
• Prime landlord agrees transferor is off the hook in original lease or consent

19

• B. Drafting Differences

20

Drafting Assignments and Subleases

• Step one: Review prime lease to determine whether any particular language

must be included in assignment or sublease

• Prime lease often requires assignee to expressly assume all obligations under the

prime lease p

• Prime lease sometimes includes other magic language for any assignment or

sublease, e.g., if a pension trust owns the property, a transferee might be required to make certain representations regarding its relationship (or lack thereof) with to make certain representations regarding its relationship (or lack thereof) with prime landlord

21

Drafting Subleases

• Different approaches: stand-alone document or document that incorporates

all or some of the prime lease provisions by reference

• Regardless of which approach you use, transferor cannot give more than he

received under the prime lease received under the prime lease

• For example, if all alterations, without exception, require prime landlord’s

consent under the prime lease, transferor cannot agree that certain p , g cosmetic alterations will not require anyone’s consent

22

Stand-alone Sublease

• Start with normal lease document
• Certain provisions are simply between transferor and transferee: term, rent,

security deposit, condition of premises, etc.

• Other provisions will need to be adjusted to account for prime landlord

responsibilities or consent rights: maintenance and services, alterations, restoration obligations upon casualty or condemnation, etc. g p y ,

• Finally, add provision regarding prime lease: neither party will cause a

default thereunder, transferor will not amend the prime lease without t f ’ t t transferee’s consent, etc.

23

Sublease Incorporating Prime Lease by Reference

• In many ways, it looks similar to a stand-alone sublease: it will include the

provisions that are simply between transferor and transferee (e.g., term, rent, security deposit, etc.)

• However, instead of systematically going through the prime lease and addressing

, y y g g g p g each prime lease provision in the sublease, the sublease includes a general provision regarding the sublease that says something like:

Tenant, as if it were the tenant under the Prime Lease, hereby assumes and agrees to perform faithfully and on time, and be bound by, with respect to the Premises, and in addition to all of Tenant’s other obligations set forth in this Sublease, all of Landlord’s obligations, covenants, agreements and liabilities under the Prime Lease and all terms, conditions, provisions and restrictions contained in the Prime Lease (which terms are hereby incorporated herein by this reference to the extent that such terms contain obligations of "Tenant" under the Prime Lease which shall become obligations of Tenant under this Sublease) except: [review Prime Lease to determine which provisions should not be incorporated; transferee wants the list of exclusions to be long, while transferor wants the list to be relatively short].

24

Drafting Assignments

• Provisions to include
• Assignment and assumption: Be careful of when assignment and assumption
• ccurs; transferee should assume only those obligations and liabilities arising

after the date of transfer

• Indemnity: Same issue regarding date of indemnity
• Condition of premises: If transferor must remove certain personal property or

perform certain work, date of transfer should not occur until such conditions are satisfied satisfied

• Bill of sale: Include conveyance language if ownership of furniture or other items

is being transferred to the transferee. If sales tax returns must be filed, assign a value to the items being transferred value to the items being transferred

• Plans and warranties: Require delivery of “as built” plans, if any, and copies of any

warranties, as well as an assignment of the warranties themselves

25

Drafting Assignments

• More provisions to include:
• Surrender: Requirement that transferor surrender possession
• Security deposit: If cash posted, transferor should be reimbursed; if letter of credit,

transferee should post replacement letter of credit transferee should post replacement letter of credit

• Brokerage representation: Any brokers involved, and if so, who pays
• Rent: Adjustment of base rent and other amounts between the parties of as of the

ff ti d t f i t effective date of assignment

• Prime landlord consent: Condition effective date upon obtaining prime landlord

consent and an estoppel certificate from prime landlord

• Representations by transferor: Complete copy of prime lease delivered; prime

lease in full force and effect; no defaults; etc.

26

• C. Pros and Cons of Each Option

27

Pros and Cons of Subleases and Assignments

• Transferors usually prefer subleases
• They are more costly and time-consuming to draft, but transferor maintains control
• If subtenant defaults, transferor can evict

Transferor must consent to alterations

• Transferor must consent to alterations
• Transferor must consent to further transfers
• Control is important because liability of transferor continues
• Transferees usually prefer assignments
• No risk of termination if transferor defaults or files for bankruptcy
• No middleman to contend with if want to make alterations, perform a transfer,
• btain building services, enforce prime landlord’s obligations, etc.

28

• III. Key Considerations/Best Practices When

Negotiating Assignments and Subleases

Dorothea Dickerman McGuireWoods LLP

29

• A. Landlord Perspective

30

Landlord Perspective

• How do you feel about your tenants subleasing or assigning your space?
• What are your overall goals (before you sign the lease with your tenants) –

particularly, as concerning:

– profits from subleasing – type of subtenant that is ok (and not) type of subtenant that is ok (and not) – time to for you to review subtenant and give your sublease approval (goes hand in hand with financial recovery) how divisible is the space – how divisible is the space – how much term remaining – number of subtenants – demising issues and cost to remove partitions if necessary – restoration requirements – credit of assignee t i ht

31

– recapture rights – pass through of landlord’s legal fees to review a sublease or assignment

Why does the landlord want control over a tenant’s subletting?

• It’s the landlords building
• “You’re not in the real estate business – we are”
• Landlord does have to manage all the moving pieces – however
• It’s all about the money and…
• It’s about the landlord satisfying their other tenants – which is valid but…
• it normally doesn’t help the tenant at all financially and…
• it is a one-way street
• it is a one-way street
• When SHOULD the relative parity in this relationship be established?
• Very early on in the negotiation
• Because when negotiating to acquire its space a tenant has the most leverage -

later - the leverage shifts, never to be recovered

32

• B. Tenant Perspective

33

First things first… You have excess office space and think you want to sublet it – some threshold questions to ponder want to sublet it – some threshold questions to ponder…

• For the entire term or an interim period?
• Are you willing to demise the space if necessary?
• Will you offer any cash concessions to induce a subtenant to lease the space?
• Will you permit alterations to the space?
• Have you thought about restoration obligations?
• What net income can be garnered from subleasing (over and above the costs of doing so)?
• What are the specific restrictions to subletting/assigning set forth in your lease?

p g g g y

• What rights does the prime landlord have -- recapture right, profit sharing, reasons to withhold

consent?

• What are the required notices?
• Can you assign the lease – if so, do you remain primarily liable?
• Can you freely transfer to an affiliate, subsidiary or new firm?

34

Cost of subleasing

• Market concessions, (e.g., tenant improvement allowances, free rent

periods, cash)

• Brokerage fees (listing and procuring)
• Demising/code costs
• Not atypical to recapture only 50% of a tenant’s remaining lease obligation

in a sublease in a sublease

• Restoration

35

Pitfalls

• Landlord recapture/consent rights
• Quality of building, length of remaining term, etc.
• Anti-competitive lease language
• Credit of subtenants/assignees

36

How to carve up profit sharing

• Must haves… if one must carve it up at all…

–Deduct tenant’s “normal & customary” costs to sublet –TI’s Transaction fees –Transaction fees –Abatement –Marketing costs Marketing costs –Legal fees –Any other inducements

37

Restoration

• Few subleases are done entirely “as-is” – subtenants will likely do some

work— a tenant should be careful or it may inherit a restoration obligation

• If the use of the tenant’s in-place FF&E is being offered as an inducement,

be very careful please be very careful, please…

• do an exacting FF&E exhibit as a first step (again, you will be glad you did)
• be painfully specific about what conveys & what does not
• is it to be merely “used” or “conveyed” at the end of the term?
• who insures?

i d t di b d!

• misunderstandings abound!

38

Dealing with the prime landlord

• A tenant will need the landlord’s cooperation and consent (get the consent

document negotiated with the sublease)

• A tenant will want the landlord to do things much faster than required under

the lease the lease

• A tenant will likely need latitude beyond what its lease states (signage,

renewal rights, parking) g , p g)

• Size up the landlord and its point(s) of influence
• Use broker relationships – they mean more than the tenant’s in this instance

Moral – unless the language states clearly that the landlord has virtually no rights

p y (e.g., repeat business influence)

39

– be very nice – you’ll be glad you were

• C. Subtenant/Assignee Perspective

40

Subtenant’s Perspective

• It is not “just” a sublease. It is not “simpler” than a lease. It may or may not be “cheap”

from a legal fees point of view.

• Read the sublease and the lease (and any over leases)
• Read the sublease and the lease (and any over leases).
• Subletting & assignment restrictions

A l i j it ill l t t i l h i fi t d ft

• A new lease in a major city will almost certainly show up in first draft

form with subletting restrictions relating to:

• existing tenants in the building, the landlord’s portfolio, and/or people they’ve litigated against
• prospective, direct tenants they are “talking” to (whatever that means)
• price
• term

term

• credit
• sole discretion language

further sub subletting

41

• further sub-subletting
• number of total subtenants (or per floor)

Subtenant’s Perspective

• Use restriction
• Landlord’s right to approve
• Sole and absolute discretion (ie: arbitrary or “no reason”)
• Reasonable discretion
• Conditioned
• Conditioned
• Time to review
• How much time (15 days? 30 days? A reasonable time? No limit?)

( y y )

• What to review
• What does landlord get to review about a subtenant? An assignee?

42

Subtenant’s Perspective

• Financial condition of the Sublessor/Tenant
• Bargain price on the rental rate can distract from a hidden problem

A bankrupt sublessor/tenant has two assets in its bankruptcy: lease between itself

• A bankrupt sublessor/tenant has two assets in its bankruptcy: lease between itself

and landlord and sublease between tenant and sublessee

• The tenant needs to be your advocate with the landlord and enter a three-way

ti l th bt t t th th i ti f th t t t d l conversation, unless the subtenant gets the authorization from the tenant to deal directly with the landlord on everything but cost items.

• Get a non disturbance and attornment agreement with the landlord in the event of

f tenant default.

43

Recapture

• “Chilling” effect on a subletting or assignment
• Prospective sublessees should ask for a non-redacted copy of this clause to

assess the likely position of the landlord when being given notice of intent to sublease by its tenant y

• “Mechanics” of Recapture
• Before the subtenant start the effort or…
• After the subtenant spend a year marketing, touring, negotiating, running

numbers, proposing, dealing with outside agents, etc.?

• Under what negotiated conditions should the landlord be entitled to
• Under what negotiated conditions should the landlord be entitled to

recapture?

• e.g., if subtenant is subletting all of the space for all of the remaining term?

44

Why tenants prefer direct leases to subleases

• Most lease rights are personal and are contractually prohibited from being

transferred without the landlord’s consent

• No direct contractual relationship with the landlord exists under a sublease
• Rightful concern over sublessor credit throughout the term
• Sub-subletting challenges – more hoops (and approvals) to jump through
• Subtenants have to live with tenant’s existing lease (with no changes)

45

Landlord Bankruptcy/Tenant Bankruptcy/Subtenant Bankruptcy

• Just a word: in all 3 scenarios the lease becomes the asset of the estate of

the bankruptcy entity and will have repercussions with you and your rights under your lease or sublease; under your lease or sublease;

• While the landlord is insulated from the subtenant’s bankruptcy by the

tenant, a tenant’s bankruptcy affects both the landlord and the subtenant; , p y ;

• And the bankruptcy of the landlord will affect both tenant and subtenant, and

not much subtenant can do about it.

46

Elizabeth K Cooper Dorothea Dickerman Ruth Schoenmeyer Elizabeth K. Cooper International Director Jones Lang LaSalle

1801 K Street NW, 10th Floor Washington, DC 20006

Dorothea Dickerman Partner McGuireWoods LLP

1750 Tysons Blvd, Ste. 1800 McLean, VA 22102

Ruth Schoenmeyer Of Counsel Jenner & Block LLP

353 North Clark St. Chicago, IL 60654 g ,

direct: 202.719.6195 elizabeth.cooper@am.jll.com www.us.joneslanglasalle.com

McLean, VA 22102

direct: 703.712.5387

ddickerman@mcguirewoods.com

www.mcguirewoods.com

Chicago, IL 60654

direct: 312.840.8651

rschoenmeyer@jenner.com

www.jenner.com

47