At least three substantial risks exist for companies that occupy subleased real estate, especially in the current economic environment. Those risks include:
1. Sublandlord Default:
The sublandlord defaults on its lease and the building's landlord terminates that lease
2. Landlord Mortgage Default:
The building's landlord defaults on its mortgage and the lender forecloses on the building, or the landlord gives the building to its lender in lieu of foreclosure
3. Landlord Tax Default:
The building's landlord defaults in the payment of real estate taxes, and the local municipality takes the building and sells it at a sheriff's sale
Under any of the above scenarios, there's a pretty good chance that your company will be in trouble. No matter what happens, when buildings begin to experience financial difficulties, tenants often suffer because its is usually a long, slow slide until financial challenges get resolved...one way or the other. Consider the following:
Sublandlord Default
As a subtenant, your company's business relationship is with the original tenant, also know as the sublandlord. Your company is responsible to pay rent to the tenant / sublandlord in an amount that likely has no bearing on the rent that the tenant / sublandlord pays to the building's landlord. Your company could be paying a higher or lower rent than the tenant / sublandlord pays. In the current economy, your company is likely paying a lower rent, and the difference is being paid by the tenant / sublandlord.
Should the financial burden of subsidizing your company's rent become too much to bear for the tenant / sublandlord, or if the tenant / sublandlord should default on its lease and not cure that default to the building landlord's reasonable satisfaction, where would your company stand? The answer may be "Nowhere!" or "Out in the cold!" Unless your sublease agreement provides for a direct relationship between your company and the building's landlord, one that by-passes the tenant / sublandlord, whether that relationship existed at the outset of the transaction or may be triggered at your company's option or by the building's landlord, if the tenant / sublandlord defaults on its lease, your company may have no control over its space and may be forced to vacate the premises.
Furthermore, if your company invested dollars into the space it subleases, you can expect to receive no remuneration when the building's landlord terminates the lease. And, if the tenant / sublandlord pledged an interest in its furniture to the landlord, the furniture it agreed to permit you to use, you may be required to leave the furniture in place, restore it, or reimburse the landlord for changes or damage you may have affected to it. To make matters worse, you may only first learn of the termination of the lease and your company's sublease after the tenant fails to resolve its default. You may only learn that your company must vacate the premises at the last minute. In extreme cases, the building's landlord may pad-lock the doors and let no one in. How's that great low-cost deal looking now?
Landlord Mortgage Default
If the building's lender ends up with ownership of the building where your company occupies real estate under a sublease, whether through a foreclosure or because the building's landlord turned over the building in-lieu of foreclosure, as a subtenant there is one very important point to remember: Your company's lease may be terminated!
That's right! Lease agreements are between a building's landlord and its tenant. Subleases are between a tenant / sublandlord and its subtenant. Sublease agreements are always subject to the terms of the tenant's lease, unless otherwise agreed to in writing by the building's landlord. Depending on the mechanics of how a lender takes over a building, that lender most often will have the right to terminate leases in that building. The lender may elect to terminate all, some, or one of the leases. Your next question should be: "Why would a lender terminate leases with tenants that are paying rent?"
There are a host of reasons why a lender that takes over a building may terminate leases, including:
- As a tactic designed to drive tenants to renegotiate leases to achieve higher rents, more favorable landlord terms, and more
- The building could have a greater sale value if it were partially or completely vacant
- The current mix, quantity, or quality of tenants may negatively affect the building's value
- The lender may wish to make room for a large, important, or desireable tenant from within or from outside the building
- The lender plans to make substantial renovations to the building, plans to modify it or even demolish it for some alternative use
- Others
No matter what the reason, a lender that has taken ownership of the building may terminate tenant leases. And, that means that subtenant leases will be canceled at the same time.
If your tenant / sublandlord's lease contains a non-disturbance clause or non-disturbance agreement, then the lender may not be able to cancel your tenant / sublandlord's lease, and your sublease agreement may be safe. A non-disturbance agreement is between lender and landlord or lender and tenant, and provides an agreement from the lender not to distrub or cancel the lease to which that agreement pertains.
A non-disturbance agreement for one lease does not apply to any other lease unless the agreement says so. Moreover, a poorly written non-disturbance agreement may contain loopholes that a lender could exploit to its benefit. Absent a solid non-disturbance agreement in the lease of your company's tenant / sublandlord, if a lender takes over your building, your company may need to call a mover.
Landlord Tax Default
If a building's landlord defaults on the payment of real estate taxes, the local taxing authority may use it governmental powers to take over the building. Since local governments tend not to be in the building management business, buildings they most often sell at auction those buildings that they take over. The local authority may have the right to cancel all leases contained in a building they take over. Since non-disturbance agreements are between a building's landlord and its tenant or between tenant and lender, they usually have no standing when a local taxing authority takes over a building.
How Can You Protect Your Company?
If your company already occupies real estate as a subtenant, all you can do now is to keep your eyes peeled for signs of trouble and have a contingency plan in place. Read 32 Signs That The Building Your Company Leases May Be In Serious Financial Trouble. If your company is considering occupying a sublease, do your homework to ensure that your occupancy will be stable. How? Hire superb real estate and legal advisors to research that the building you select and to ensure that your company's occupancy will be safe.
