Clean Hand-Off or Costly Fumble? Nuances and Risks of Assignment Clauses in Commercial Leases
Most of the time, the relationship between a commercial landlord and tenant is a two-party affair. Both the lessor and lessee conduct their due diligence on each other before the start of the tenancy and, if all goes well, develop trust, predictability, and familiarity over the course of the lease term. But when a tenant wants to introduce a third party into the dynamic through an assignment of their lease, it can create tension and conflict if handled incorrectly or if the parties don’t see eye-to-eye about the tenant’s rights or the proposed assignee.
Given the multitude of provisions in a commercial lease and the fact that assignment is often an afterthought in lease negotiations, it is unsurprising that assignment clauses are frequently the source of costly and disruptive disputes and litigation in commercial tenancies. Landlords and tenants alike should therefore give careful consideration to the language of assignment provisions, the way they operate in practice, and how the law approaches them.
Purposes of an Assignment Clause
An assignment clause governs whether, and under what conditions, a tenant may transfer its rights under a lease to a third party. A true assignment transfers the entire leasehold interest from the assignor to the assignee, with the latter stepping into the tenant’s shoes for the remainder of the term. An assignment is distinct from a sublease, which creates a new landlord/tenant relationship between the original tenant and subtenant. This is distinct from a sublease, where the original tenant retains a reversionary interest and remains in privity with the landlord.
Assignment clauses offer something valuable to each party. For commercial landlords, these provisions implicate their control over who occupies their space and the credit risk associated with the tenancy, but also offer the opportunity to maintain occupancy and cash flow if things go south for a tenant. For lessees, the right to assign their lease provides flexibility and options if conditions change. They may be acquired by another company, undergo a merger, or simply need to terminate the tenancy and mitigate their damages for doing so. These divergent interests can manifest in the language of the assignment provision and, more frequently, in how and when a landlord may reject a prospective assignee.
The Landlord’s Perspective
When a landlord underwrites a lease, it approves a specific tenant and that tenant’s finances, financial history, creditworthiness, reputation, and the industry or sector in which it does business. Giving that tenant unfettered assignment rights could place an unknown or financially weaker party in possession of the space. That is why commercial landlords always seek broad discretion to approve or reject assignments. And that discretion is often couched in terms of the landlord’s “reasonable consent” to a proposed assignment.
Many commercial leases in Michigan provide that the landlord’s consent to assignment “shall not be unreasonably withheld.” While this language appears landlord-friendly on its surface, in that the landlord gets the final word, Michigan courts have found landlords liable for wrongfully withholding consent when their stated reasons were pretextual or commercially unreasonable. Landlords should therefore document and share their objections, and base them on legitimate economic, legal, or practical factors, such as the proposed assignee’s creditworthiness, the nature of the proposed use, or conflicts with exclusive-use clauses granted to other tenants in the building.
Landlords will also seek to retain recapture rights in their lease’s assignment provisions, which allows them to essentially terminate a lease upon receiving an assignment request rather than permitting the desired transfer. This protects the landlord’s ability to re-lease at market rate if the current lease is significantly below market. Understandably, tenants are averse to such provisions, but for landlords, they offer a legitimate hedge against tenants monetizing below-market leases. Similarly, profit-sharing clauses allow landlords to capture a portion of any premium a tenant receives from an assignee above the base rent. These provisions are enforceable in Michigan and can meaningfully protect landlords in rising markets.
The Tenant’s Perspective
As noted, commercial tenants want as much flexibility as possible regarding their right to assign their leases. This can include carve-outs in the assignment clause for certain transfers related to mergers and acquisitions, or similar changes in the control or ownership of the lessee.
Standard assignment clauses, if drafted without such carve-outs, can inadvertently require landlord consent for an internal corporate reorganization or a sale of the business. Many landlords will agree that assignments to affiliates, parent companies, or subsidiaries, or in connection with the sale of all or substantially all of the tenant’s assets, do not require consent or require only notice.
Tenants should also carefully scrutinize the standard of consent. “Sole discretion” of the landlord is anathema to a tenant, as it gives the landlord virtually unfettered veto power to refuse an assignment. “Reasonable discretion,” for all its potential for ambiguity and dispute, is far preferable from a tenant’s perspective and is the minimum a tenant should accept. Requiring the landlord to respond within a defined period, such as 30 days, or deeming silence as approval are additional protections that tenants can bargain for.
While an assignment may mean the end of the original tenant’s occupancy of the leased premises, it does not mean the end of its obligations and liability under the lease. Absent an express release, the original tenant remains on the hook even after an assignment. A tenant that assigns its lease and then watches the assignee default may face the landlord’s claims for back rent, damages, and attorneys’ fees. Tenants should always negotiate for an express release upon assignment to a creditworthy assignee.
Far from boilerplate, assignment clauses in commercial leases can profoundly impact landlords and tenants alike. When not thoughtfully considered, strategically negotiated, and carefully crafted, these provisions may become fertile ground for protracted litigation, with a landlord seeking to avoid an unwanted or unreliable tenant, or a lessee looking to escape from a lease that has become an albatross.
If you are a landlord drafting a commercial lease or a business tenant about to sign one, you should work with a Michigan commercial real estate attorney before you finalize the assignment provisions. If you have questions or concerns about commercial lease assignments, please contact Michael Hamblin at Maddin Hauser.