Permitted Transferees: What a Commercial Tenant Needs to Know When Negotiating the Assignment Clause

February 27, 2020

Are you a business owner or franchisee?

Will you be negotiating a lease in the foreseeable future?

Can you see your business model evolving during the lease term?

If the answer to these questions is “yes”, here is what you need to know when negotiating the transfer provisions in your next commercial lease.

What is the Assignment Clause and When is it Triggered?

Every commercial lease contains an assignment provision that lays out the landlord’s and the tenant’s rights and obligations in the event that the tenant seeks to “assign” the lease.

An “assignment” can occur in two scenarios:

Assignment of Lease: The first, and most common to lay people, occurs when the original tenant transfers and grants all of its rights and obligations under the lease to a third party, and the new tenant explicitly accepts these rights and obligations as its own and occupies the leased space.

Transfer of Ownership Interests in Tenant Entity: The second occurs when the tenant entity transfers its stock, membership or partnership interests (depending on whether the tenant entity is a corporation, limited liability company or partnership) to a third party entity, resulting in a change in ownership. In this scenario, the tenant under the lease remains the same — the transfer occurs internally within the tenant’s corporate structure.

Although the transfer that takes place in the second scenario does not seem like a traditional “assignment” (because the existing tenant remains in the space), most leases treat changes in control of the tenant entity as such. What constitutes a “change in control” that triggers an assignment, however, is negotiable. Typically, a transfer of a majority (51% or more) of the tenant’s stock, membership or partnership interests will suffice.

What do Landlords Typically Require to Effectuate an “Assignment”?

What a landlord requires to effectuate an “assignment” varies depending on how tough the landlord is and how much bargaining power it has. Below are several concepts you will typically encounter in a landlord’s form of lease.

Landlord Notice: Almost every commercial landlord will require a tenant to give it notice of any assignment of the lease. Landlords want to stay informed, which is not unreasonable.

Landlord Consent: In addition to notice, the landlord will often condition the assignment on its prior written consent. The key here is the standard of discretion imposed on the landlord — that is, whether the landlord must be “reasonable” in granting its consent, or whether it has “sole discretion” to do so. A tenant should push for the “reasonable” standard so that the landlord does not have the liberty to deny the tenant’s request for any or no reason at all, and should also negotiate to receive the Landlord’s decision promptly.

In determining whether to grant consent to an assignment, a landlord’s goal is to ensure that the proposed assignee will be able to satisfy the tenant’s obligations under the lease. As such, a landlord typically requires the submission of (1) a statement indicating the name and address of the proposed assignee, the nature of its business and the proposed uses of the leased space, (2) the proposed assignee’s most recent financial statements, and (3) an assignment and assumption agreement, stating that (a) the proposed assignee takes on all of the current tenant’s obligations under the lease and (b) the current tenant agrees to remain fully liable for the performance of all of the assignee’s obligations thereunder.

A more aggressive landlord will expressly condition its consent on the presence or absence of certain circumstances, such as: (1) the tenant not being in default under the lease, (2) the tenant not publicly advertising the space for a rental rate lower than the rent then being paid by the tenant, (3) the proposed assignee being financially responsible to the extent required for payment of rent and for successfully operating the business, (4) the proposed assignee having a net worth equal to or greater than that of the tenant, (5) the proposed assignee having a minimum amount of years of successful experience in the field of business to be conducted by it in the leased space, (6) the proposed assignee not being an entity with whom the landlord is then or has recently been negotiating to lease space, and (7) the proposed assignment being made in connection with the tenant’s sale to the proposed assignee of its business then being conducted in the leased space.

Payment of Monies: Also common are provisions requiring the tenant to reimburse the landlord for all of the reasonable costs incurred by it in connection with an assignment, including attorneys’ fees. If a tenant asks its landlord to engage an attorney to review assignment documents, it is only fair that the tenant pays for such costs. However, the tenant should negotiate a cap on these costs.

Sometimes the landlord will also require the proposed assignee to put up additional security, but this provision only passes muster when the proposed assignee is a risky one, making the additional security requirement reasonable.

Less common are instances in which the landlord requires the tenant to pay it a certain percentage of the entire gross consideration that the tenant receives from the proposed assignee (if any) in connection with the assignment, whether it be the monies received in selling the business or those received in a stock transfer.

Right of Termination / Space Recapture: Occasionally, a tenant will encounter a provision stating that upon receipt of the tenant’s request to assign, the landlord will have a right to terminate the lease and recapture the space. In other words, merely giving notice of the intent to assign triggers a landlord’s termination/recapture right. This is worst-case scenario and the tenant should negotiate its way out of such a provision.

What Should a Tenant Push For When Negotiating the Transfer Provisions?

Given the many conditions typically imposed by a landlord to effectuate an “assignment”, a tenant should push to incorporate the “permitted transferee” concept into its lease. A “permitted transferee” is an entity to which the tenant is permitted to carry out a transfer without the landlord’s prior written consent.

Transfers to a “permitted transferee” are not deemed “assignments” under the lease. Therefore, the onerous assignment requirements outlined above are not triggered, allowing the tenant to proceed with a transfer to certain pre-approved entities without having to fulfill any obligations under the lease (other than providing the standard notice to the landlord).

Commonly used examples of “permitted transferees” include: (1) the tenant’s parent, or any of its subsidiaries or affiliates, (2) an entity into which or with which the tenant is merged, consolidated or reorganized, (3) an entity to which all or substantially all of the tenant’s assets, stock or other equity interests are transferred, and (4) the tenant’s franchisor or another franchisee.

Can you see your business model evolving during the term of your next lease? If the answer is “yes”, you should negotiate with your landlord to incorporate the “permitted transferee” concept into your lease. The carve-out will work to save you much time and resources in operating your business.