Given the impact of remote work and the current economic downturn, companies are downsizing and putting lots of sublease space onto the market. While sublease rents are usually significantly lower than rents for direct space, subleases come with their own unique issues. Here are some of the more important sublease issues to consider:

Reliance on the Sublandlord

The rights of a subtenant are subject and subordinate to the primary lease between the property owner (called the master landlord) and the tenant (who is also the sublandlord). So a subtenant is relying on the sublandlord to pay all of the rent and perform all of the other obligations under the primary lease; otherwise, the master landlord could terminate the primary lease and thus also terminate the sublease.

A subtenant can try and eliminate this risk by seeking a non-disturbance agreement from the master landlord, where the master landlord agrees that it will continue to recognize the rights of the subtenant if the primary lease is terminated due to a default by the sublandlord. Master landlords rarely give non-disturbance to subtenants, however, because they want to control the space if the primary lease terminates. In particular, they may not want to be locked into a sublease where the amount of the sublease rent is likely well below the amount of the rent under the primary lease.

A subtenant should evaluate the creditworthiness and business prospects of the sublandlord in order to determine if the sublandlord is likely to stay in business and continue paying rent for the entire sublease term. Also, the sublease should prohibit the sublandlord from voluntarily terminating the primary lease prior to the end of the sublease. You don’t want the sublandlord negotiating an early buyout of its primary lease, which would result in a termination of the sublease.

A subtenant should also have the sublandlord confirm that there are no current defaults or disputes under the primary lease and that the sublandlord has given the subtenant a true and complete copy of the primary lease and all amendments, since the subtenant will generally be bound by the terms of those documents. If your client doesn’t need to make major tenant improvements in its sublease space and can pack up and move relatively easily if the primary lease terminates, then the risk of an unanticipated termination of the primary lease may be worth it given the rent savings in a sublease as compared to a direct lease.

Performance by Master Landlord

A sublease generally does not create any legal relationship between the master landlord and the subtenant. So if the roof leaks or there is a problem with the main electrical panel for the building, the subtenant can’t force the master landlord to make repairs because it is not in contract with the master landlord. To address this risk, the sublease should contain language that requires the sublandlord to enforce the sublandlord’s rights (as the tenant under the primary lease) if the master landlord fails to perform required maintenance or repairs.

A subtenant may also want to be able to require the sublandlord to assign its enforcement rights under the primary lease to the subtenant. The sublandlord may not be motivated to spend its time and money to enforce a default by the master landlord, so an assignment of these enforcement rights will allow the

subtenant to take steps directly against the master landlord if the master landlord fails to perform needed repairs or maintenance.

Primary Lease Issues

Since a sublease is subject to the terms of the primary lease, a subtenant needs to carefully review the primary lease to ensure that it can live with those terms. As a threshold matter, the assignment and subletting clause of the primary lease may allow the master landlord to recapture the proposed sublease space rather than consent to the sublease, so if the primary lease contains such a clause then this recapture risk should be pointed out to a potential subtenant.

Is the subtenant’s use permitted under the primary lease? This is generally not an issue in an office or warehouse lease, but use issues can be very complicated under a retail lease. The master landlord is often bound by pre-existing exclusive use and prohibited use restrictions that have been given to existing retail tenants and that must be parsed through by the subtenant to ensure that its use will not trigger any conflicts.

A subtenant should also pay particular attention to primary lease clauses relating to common area services and charges, insurance and indemnity, alterations, and surrender and restoration, since those clauses will also apply to the subtenant.

Sharing Space

If the sublease is for only a portion of the space under the primary lease, the subtenant needs to thoroughly evaluate how it will partition the sublease space from the balance of the premises and make the sublease space operational. Consider the location and configuration of entrances, exits and pathways to the sublease space and whether utility, HVAC and data/telecom systems have to be submetered, re-routed, or reconfigured. The subtenant needs to have its architect and engineers work with the sublandlord and the master landlord in order to address these issues.

In office subleases, the subtenant may need to coordinate the use of shared spaces such as conference rooms, copy rooms, kitchens, restrooms, server rooms and telecommunications closets. Office subtenants may also need to coordinate shared services such as janitorial and mail delivery services. Finally, the subtenant should consider how to allocate costs with respect to these shared spaces and shared services.

Surrender and Holdover

If a subtenant plans to make alterations to its sublet space, it should first confirm with the sublandlord and the master landlord if those alterations have to be removed at the end of the sublease term and the amount of restoration work that has to be performed. The subtenant should ensure that its removal and restoration obligations are limited to the alterations that it made, and not to any alterations that were made by the sublandlord.

If a subtenant only occupies a part of the total space under the primary lease, any holdover by it in the sublease space may result in holdover exposure to the sublandlord as to the entire space because the sublandlord is unable to return the entire space back to the master landlord. A subtenant should make sure that it surrenders possession of the sublet space on time unless it has cleared the terms of the holdover with the sublandlord and the master landlord or otherwise understands the costs and exposure arising out of a holdover.

Conclusion

While subleases provide an opportunity to save money on rent, they also come with their own unique set of issues. Subtenants should evaluate the legal, business and operational issues associated with subleases and try and build in protections in the sublease in order to lessen their exposure to these issues.

For more information, please contact Leon Tuan.