It is unquestionable that the COVID-19 pandemic has had far reaching, traumatic, and world-changing impacts. It is frankly challenging to think of any situation in our lives not touched in some way by the pandemic.
Lawyers were sent scrambling almost from the first days of the pandemic, responding to the typical emergencies that arise when something as unexpected and wide-reaching impacted their clients. As our society has begun to adapt to life with COVID, our clients are also adapting and changing the way they do business.
Demand for Less Space
One such change that is rippling across many businesses is how they use their facilities.
Joseph M. Mella, U.W. 1991, is a shareholder with Ruder Ware in Wausau,, where he has practiced with the firm’s business and transactions practice group for over 30 years.
By some estimates, nearly half of all businesses employ staff who have the option of performing their duties from a location other than the primary business location (office or otherwise) at least partially, and in some cases, on a full-time basis.
These types of remote work options have upended the standard real estate usage marketplace. Researchers estimated at the beginning of 2021 that upward of a quarter of office-based business owners would be reducing their facility footprint because their employees would be working remotely. More recent reports show that office occupancy rates have increased, but are still below pre-pandemic levels.
The bottom line is that certain types of business owners are demanding less space for their operations. This trend is expected to continue.
An Increasing Trend: Subleasing Commercial Space
Business owners who are tenants are now, of course, trying to reduce their future occupancy costs. As tenants, they are seeking cost containment through lease modification, termination, or subleasing.
In some cases they are finding that their landlords will not allow them to get out of their leases, but are willing to allow subleasing. Subleasing allows the landlord to keep the original tenant on the hook for the lease obligations, regardless of who is paying the rent.
As a result, business owners who seek additional space have more options today than ever, to sublease space from existing tenants (instead of from the property owners).
It is the potential subtenant group and the risk allocation strategies they should consider that this note focuses on today.
How We Counsel Subtenants
Subleasing presents a unique arrangement for the subtenant. They are taking rights of occupancy and use from the existing tenant, whose rights of occupancy and use are subject to the terms of the prime lease.
Before subleasing, every subtenant should be cautioned to familiarize themselves with the terms and conditions of the prime lease. Some of these conditions will seem obvious and other less so. In some cases, it may be important to expressly address terms or conditions of a prime lease that will not be applicable to a subtenant.
One of the most important of these conditions to consider is the right usually reserved to the landlord to consent to any subletting of the property subject to the lease. Landlords can, in many cases, have unrestricted rights to disapprove of a subtenant or sublease. In other cases, these rights may be more limited by allowing the landlord to reject a subtenant or sublease only if such rejection has some reasonable basis.
Often we counsel potential subtenants to make their sublease effectiveness contingent upon receipt of the landlord’s express written consent. They should expect to provide information about themselves to the landlord, to allow the landlord to evaluate the potential subtenant.
Another set of conditions that should be the focus of potential subtenant scrutiny is whether there are any current monetary or other performance obligations of the tenant that have not been complied with. These obligations can include upkeep and maintenance obligations, utility payments, repairs, or incomplete improvements.
During this pandemic period, many of these would-be sub-landlords have not been occupying the space they are attempting to sublet, and have failed to undertake these obligations. We typically advise our clients to seek assurance from both the landlord and tenant (the would-be sub-landlord) that there are no unperformed obligations of the tenant at the time the sublease becomes effective. The usual methodology employed is some form of estoppel certificate or language built into the landlord’s consent agreement.
An additional set of risk factors that must be considered is the remaining direct obligation of the tenant to the landlord. In many cases, the tenant is completely removed from the leased space. With the original tenant so detached from the relationship, it presents the risk that this tenant may somehow fail to perform its lease obligations, which default will jeopardize the sublease in the event of a default and lease termination.
We advise our clients to consider making arrangements to perform directly with the landlord whatever obligations can reasonably be established, such as rent payments and the like.
We also suggest attempting to arrange for advance notice from the landlord if there is a default, with the right to cure the default, if necessary (with corresponding rights to recover against the tenant/sub-landlord).
One must be careful to not provide too many ways for the subtenant to step into the shoes of the tenant, as it creates an incentive for the subtenant to use these arrangements to extricate itself from a lease it clearly wanted out of to begin with. Regardless, it is typically not a bad course of action to provide for the subtenant to enter into a direct lease with the landlord in the event the landlord would otherwise choose to exercise a right to terminate the prime lease.
Good due diligence prior to entering into a sublease is always a good idea, be it physical examination or legal review. Physical inspections are always recommended. This is further emphasized today when additional factors such as viral spread, ease of cleaning, or physical accommodation of employees (e.g., spacing or separation) need to be considered.
Moving into the Future
The world of commercial leasing continues to be fluid, and changes in use and demand brought on by the pandemic will continue to force landlords and tenants to consider and address risks they may not have thought important in the past. Careful attention to these matters is warranted.
This article was originally published on the State Bar of Wisconsin’s Business Law Blog. Visit the State Bar sections or the Business Law Section webpages to learn more about the benefits of section membership.
