How many times have tenants wanted a "quick fix" for a landlord form lease that seems to make assignment to anyone except a Fortune 100 company impossible? The following deals with a clause that gives the tenant certain basic rights of assignment. The clause that follows is fairly flexible--it could be used with an office lease, an industrial lease or a retail lease. It can be used a rider to a landlord oriented form lease, or added as an additional provision. It is assumed that this provision is added to a lease with a pro-landlord assignment clause which restricts assignments in a comprehensive way.
Section 49.1 provides that the landlord will not unreasonably withhold its consent to lease transfers that are regulated under other language appearing in the lease, i.e., the assumed pro- landlord assignment clause. Section 49.2 is really where the action is--it gives the tenant the right to transfer the lease in certain circumstances without any requirement to obtain (or even ask for) the landlord's consent for such transfers. Section 49.2 (A) gives the tenant the right to assign to an affiliate. A broadly drafted pro-landlord assignment clause would require the tenant to obtain the landlord's consent for such a transfer. This provision does away with that requirement.
Section 49.2 (B) allows mergers and consolidations so long as the surviving entity has a net worth at least as great as that of the tenant when the lease was originally executed. Presumably, the rationale for this net worth requirement is that the landlord should be no worse off (from a credit strength standpoint) than when it executed the lease with the original tenant. Many landlords would not be happy with that test, and would prefer to have some objective measure of net worth following the merger, often by reference to a specific fixed amount, e.g., a net worth of not less that $10 million immediately following the merger.
Still other landlords may prefer to fix the net worth of the surviving entity by using some multiple of the rentals remaining under the term of the lease. For instance, if the rent for the remaining term equals $500,000, the landlord may require a net worth for the surviving corporation to be, say, $5 million, or ten times the amount of the remaining rental under the lease. Such an approach does not provide any real assurance that the rental with be paid by the surviving entity, rather it merely provides some measure of the landlord's business risk of allowing such transfers to take place without its approval.
Section 49.2 (C) allows the tenant to transfer the lease to the buyer of all of its business operations. Although the clause states the buyer must have a present intention to continue business operations, this requirement really offers no great protection for the landlord since an ongoing business may default on the lease just as easily as one that discontinues business operations. This section also contains the net worth test of "...at least as great as that of the Tenant as of the execution of the lease..." discussed above. Section 49.2 (D) allows the tenant to assign or sublease all or any portion of the premises to a franchisee or licensee of the tenant, a right somewhat more useful to a retail tenant since franchising is far more prevalent with retailers than with office tenants.
Section 49.3 provides that the tenant is free to sell its corporate shares, and that such a sale does not constitute an assignment which requires the landlord's approval under the assignment clause. Many landlords insert percentages for the amount of stock which may be transferred without requiring the tenant to obtain its consent for the transaction. Still others allow corporate stock transfers to occur so long as there is no change of control of the tenant as a result; such landlords want the right to approve stock sales which change control of the tenant or which exceed a certain percentage.
Section 49.4 releases the tenant from responsibility for performance and rentals following the effective date of transfers that are made within the scope of Section 49.2. Most sophisticated landlords will not agree to release the original tenant following a transfer, even if the transferee has substantial credit strength. These landlords refuse to release the tenant on principle, and point out that the lease is being transferred for the benefit of the tenant, and if the landlord's credit position is enhanced as a result, so much the better. Absent an express release provision, the tenant would continue to be liable for performance even though the lease is assigned to a third party.
Article 49. Tenant's Rights of Assignment.
Notwithstanding anything to the contrary contained in the lease, Tenant shall have the following rights with respect to assignment, transfer or sublease (referred to hereinafter as a "Transfer") of the demised premises:
49.1 Landlord agrees that it will not unreasonably withhold its approval to any Transfer of the demised premises or any part thereof, provided such Transfer shall be subject to all of the terms and conditions of the lease.
49.2 Tenant shall have the right to perform any of the following acts without the necessity to request or obtain Landlord's approval therefor:
(A) Transfer the demised premises or any portion thereof to any "affiliate company." An "affiliate company" shall mean, for purposes of this Article 49, any corporation, partnership or other business entity under common control and ownership with the Tenant, or with the parent or any subsidiary of the Tenant.
(B) Merge into or consolidate with any corporation, provided that following such merger or consolidation, the resulting surviving entity shall have a net worth at least as great as that of the original Tenant executing the lease at the commencement hereof.
(C) Transfer the demised premises, or any portion thereof, to any buyer of all or substantially all of the business operations of Tenant, provided that, as of the effective date of such Transfer, (i) such buyer intends to continue the operation of such business as a going concern, and (ii) such buyer has a net worth at least as great as that of Tenant as of the execution hereof.
(D) Transfer the leased premises to any franchisee or licensee of the Tenant, provided however, such transferee shall be subject to all of the terms and conditions of the lease.
49.3 No sale of all or any of the shares of Tenant shall be considered as a transfer or assignment of this lease which shall require the approval of Landlord.
49.4 If Tenant shall make any Transfer pursuant to Section 49.2, Tenant shall be liable and responsible for the full and complete performance of this lease and for all payments arising prior to the effective date of such Transfer, but Tenant shall be relieved of any responsibility for any obligation, payment or performance falling due or arising after the effective date of such Transfer.
Return to List Of Free Sample Lease Clauses and Lease Advisories
What is the scope of a non-assignability provision in a commercial lease? How specific must the non-assignability language be to cover collateral assignments for security as well as absolute present assignments of possession and use? If the lease clause expressly states only that the tenant will not assign or sublease its interest in the lease without prior notice to and approval of the landlord, this may not be sufficient to prevent the tenant, without complying with such notice and consent requirements, from assigning, mortgaging, or pledging its leasehold interest as collateral to a third party who provides financing to the tenant. This article will discuss this issue and analyze the case law -- which is not extensive -- on this topic, as well as change in ownership or control of a tenant entity as a violation of the non-assignment clause.
The Stone v. Simmons Case
In Stone v. Simmons, No. 91-CH-125 (2nd Dist.1999), disposition aff’d, 301 Ill. App. 3d 1103 (1999), the Illinois appellate court issued an opinion upholding the trial court’s ruling that the tenant’s collateral assignment of its interest in the lease to Continental Bank (“Continental”), as security for a loan of $6 million did not constitute a violation of the clause in the lease prohibiting assignment without the landlord’s prior consent. The plaintiff alleged that the collateral assignment of the lease to Continental breached the anti-assignment clause in the lease stating that “Tenant shall not assign this Lease without prior notice or written consent of Lessor.”
While acknowledging that this was a case of first impression in Illinois, the appellate court affirmed the holding of the trial court that Continental’s security interest in the lease was in fact a collateral assignment, and that the assignment did not provide Continental with possession of the property unless and until a default occurred under the loan. The appellate court also noted that the language in the non-assignability provision of the lease did not specifically prohibit collateral assignments without the landlord’s written permission, concluding that collateral assignments are “different in kind” from present assignments. The court further noted that the plaintiff could have prevented the disputed collateral assignment of the lease by drafting the assignment-of-lease provision to specifically cover such an event.
Change in Ownership or Control of Tenant Entity
With the advent of securitized and conduit financing and the use of bankruptcy-remote borrowing entities, it has become more common for non-assignment clauses in leases to contain a “change of ownership or control” provision, i.e., a prohibition against certain “direct or indirect” changes in the equity ownership, control or management structure of the tenant (usually a limited partnership or limited liability company). This language usually provides that if certain principal individuals or entities at any time own less than a specified percentage of the management, ownership, membership, general partnership, or voting interests of the tenant entity, or if the tenant entity sells, conveys, or assigns more than a specified percentage of such interests, a default will have occurred under the lease. The parties of course generally heavily negotiate such assignment restrictions.
Anti-assignment lease provisions that prohibit or limit the change in ownership or control of the tenant have been enforced by the courts, including a sale of stock, subsequent equity mergers, and transfers by operation of law. For example, in In re Washington Capital Aviation & Leasing, 156 B.R. 167 (Bankr. E.D. Va. 1993), the Virginia bankruptcy court held that language in the lease requiring the lessee-debtor’s principal to control the lessee-debtor prevented a sale of stock in the debtor-lessee as a method of transferring its interest in the lease. See also Parks v. CAI Wireless Systems, Inc., 85 F. Supp. 2d 549, 555 (D. Md. 2000) (stating that “under appropriate circumstances a corporate merger can result in the violation of an anti-assignment provision contained in a contract”); The Citizens Bank & Trust Co. of Maryland v. The Barlow Corp., 295 Md. 472, 485 (1983) (holding that merger of corporate tenant under commercial lease into another corporation violated non-assignment clause that expressly excluded assignments by operation of law); PPG Indus., Inc. v. Guardian Indus. Corp., 597 F.2d 1090, 1095 (6th Cir.1979) (“If the parties had intended an exception in the event of a merger, it would have been a simple matter to have so provided in the agreement”); Nicolas M. Salgo Assocs. v. Continental Ill. Properties, 532 F.Supp. 279, 283 (D.D.C.1981) (holding that “A transfer is no less a transfer because it takes place by operation of law rather than by a particular act of the parties” (citation and internal quotation marks omitted)).
Lessons for Landlords (and Lenders)
The holding of the appellate court in Stone v. Simmons, supra, should not be seen as shocking or misguided. The law (although certainly not extensive) in other jurisdictions, and in scholarly journals and treatises, generally supports the court’s analysis and ruling. For example, in Friedman on Leases, § 7.3.3 (Express Restrictions—Construction of Express Restrictions—General) (Updated July 2016), the author states that:
Restrictions against assignment, subletting, and mortgaging are restraints on alienation and for this reason are construed against the restriction. A covenant against one form of alienation does not preclude another form. A covenant against assignment does not prevent subletting. Nor does it prevent pledging or mortgaging the lease, though the enforcement of the pledge or mortgage may vest title to the lease in a third person with the same effect as if it had been assigned.
Currently almost all forms of commercial leases--which generally are prepared by and for landlords—forbid the tenant to assign, sublet, mortgage, or otherwise encumber the lease. The following is a sample lease provision that prohibits assignments (including collateral assignments) by the tenant without the landlord’s consent:
____. Prohibitions. Tenant for itself, its successors and assigns, expressly covenants that it shall not by operation of law or otherwise assign, sublet, hypothecate, pledge, encumber or mortgage this Lease, or any part thereof, or permit the Premises to be used by others without the prior written consent of Landlord in each instance. For purposes of this Article _____, “assignment” shall be considered to include a change in the majority ownership or control of Tenant if Tenant is a partnership, limited liability company, or privately held corporation. Any attempt by Tenant to assign, sublet, hypothecate, pledge, encumber or mortgage this Lease shall be null and void. The consent by Landlord to any assignment, subletting, hypothecation, pledge, encumbrance, mortgage, or use of the Premises by others, shall not constitute a waiver of Landlord’s right to withhold its consent to any other or further assignment, subletting, hypothecation, pledge, encumbrance, mortgage, or use of the Premises by others. Without the prior written consent of Landlord, this Lease and the interest therein of any assignee of Tenant herein shall not pass by operation of law or otherwise, and shall not be subject to garnishment of sale under execution in any suit or proceeding which may be brought against or by Tenant or any assignee of Tenant. The absolute and unconditional prohibitions contained in this Article _____ and Tenant’s agreement thereto are material inducements to Landlord to enter into this Lease with Tenant.
The best approach is to address these issues during the negotiation of a commercial lease, and carefully draft the non-assignability provision to specifically cover a collateral assignment of the lease, as well as certain changes in ownership or control, and exempt only specifically negotiated and specified matters such as estate-planning transfers and certain “one-time only” transfers. In addition, the provision should expressly provide that any purported violation of the provision will automatically be void and invalid.