Sublease Considerations for Sublandlords and Subtenants Amid COVID-19

Amid Covid-19, businesses of all sizes are re-evaluating their real estate needs. Whether it be for office, retail, or showroom space, the current environment will likely see a reduced footprint for many companies. As such, we are issuing this advice to sublandlords and subtenants as a reminder of issues to consider during this time. We will address issues that both a prospective sublandlord and prospective subtenant should contemplate in a sublease agreement.

Concerns for the Sublandlord

Preparation for the Sublease:

When preparing to sublease a space, a sublandlord should review their lease (the “Overlease”) to consider the approval timeline from the overlandlord, any tenants with whom the subtenant cannot negotiate, and the costs imposed by the overlandlord in respect of the sublease. In order to avoid any issues with delivery of possession of the premises, the sublandlord should also verify the current move-in policies for the building, as well as how these policies could change.

Maintaining the Overlease:

From the sublandlord’s perspective, adhering to their lease obligations is of primary importance, especially during this time of uncertainty. A default by the subtenant could cause a substantial liability for the sublandlord who will likely have a very difficult time re-renting the premises. In this regard, cash is not always king especially when it comes to a sublandlord’s security deposit. A Letter of Credit is not an obligation of the tenant but rather the obligation of a third party bank to pay the owner a certain amount upon the breach of a lease. This is relevant if there is a risk of bankruptcy for the subtenant because, as a result of the bankruptcy of a subtenant, a sublandlord may not be able to retain a cash security deposit, so our recommendation is to have a Letter of Credit as security for the sublease.

The behavior of a subtenant can also jeopardize the sublandlord’s lease. A well-crafted sublease takes into account the interest and penalties payable by the sublandlord under the Overlease and creates an accelerated schedule of those interest and penalties for the subtenant, making certain that the amounts and interest rate payable by subtenant are equal to or higher than those payable by the sublandlord. Additionally, not all lease defaults are monetary so the sublandlord should have the right to cure the subtenant’s defaults under the lease and charge the subtenant for doing so.

End of the Sublease Term:

Especially during these times, there should be a heightened focus on the performance obligations of the subtenant. One obligation which has heightened import is assuring vacation of the premises upon expiration of the sublease and in this regard the penalties for the subtenant’s failing to timely vacate must be accounted for in the sublease. In addition, the sublandlord should also contemplate in what condition the premises will be delivered because it is likely that the subtenant will rearrange the layout of the space.

Concerns for the Subtenant

Akin to the sublandlord, the subtenant also shares a concern for a default under the lease. In the event the sublandlord defaults by failing to pay rent or declaring bankruptcy, the subtenant can lose its right to the premises prior to the expiration of the term. To combat eviction in the face of a default by the sublandlord, the subtenant should look to have the sublease recognized by the overlandlord. Since we can anticipate lower sublease rents amid COVID-19, it is preferable that the recognition of the sublease be in the form of a Subordination and Non-Disturbance Agreement (SNDA) so that the subtenant pays the rent stated in the sublease. In the alternative, however, the subtenant should have the right to cure a default by the sublandlord under the Overlease and set off the cost of same against the rest payable to the sublandlord because paying an increased rent could be less costly and disruptive than moving.

The subtenant should also understand what services are to be provided under the Overlease. Generally, the sublandlord is only obligated to request that the overlandlord provide services under the Overlease.  However, there may be certain services which, if not provided, the subtenant would want to perform and offset against rental payments. We can also anticipate higher operating expenses for buildings as a result of COVID-19 (i.e. cleaning, HVAC maintenance, etc.) and the manner in which these are passed through to the subtenant should be noted.

Finally, as discussed in the sublandlord concerns, the subtenant should clarify its right to make alterations to the premises as well as the requirements for removing same since it is more likely that the existing configuration may not be appropriate for the subtenant’s current needs.