This article presents the standards and conditions for a landlord’s consent and compensation under lease alienation provisions restricting leasehold assignments and subletting by tenants.
Consent conditioned on exactions
A landlord and tenant enter into a nonresidential lease. The lease contains an assignment and subletting provision, called a restriction-on-transfer or a restraint-on-alienation provision.
The provision does not prohibit transfers, but requires the tenant to obtain the landlord’s consent prior to assigning the lease or subletting (or further encumbering) the tenant’s leasehold interest. The provision either:
states the landlord’s consent will not be unreasonably withheld; or
fails to state any standards for objecting and withholding consent.
The lease also contains a cancellation provision allowing the landlord to cancel the lease agreement on the landlord’s receipt of the tenant’s written request seeking consent under the assignment or subletting provision.
The tenant vacates the premises and relocates his operations to another property with no intention of returning to the leased premises. The tenant finds a user who will pay rent at current market rates for the space, an amount which exceeds the rent owed the landlord on the lease, called overriding rent.
The tenant makes a request for the landlord’s consent to sublease to the user. The landlord responds by cancelling the lease agreement under the cancellation provision.
The landlord, having terminated the tenant’s leasehold by cancellation of the lease agreement, negotiates directly with the user. The landlord enters into a lease of the premises with the user at current rental rates.
The tenant makes a demand on the landlord for the overriding rent he lost due to the landlord’s refusal to consent to the sublease, claiming the landlord’s consent was unreasonably withheld since no conditions for the consent were agreed to which would entitle the landlord to the overriding rent.
The landlord claims his cancellation of the lease is valid, even though cancellation is an absolute restraint on the proposed transfer of the tenant’s leasehold interest, since the tenant and landlord freely bargained for the cancellation provision which the landlord exercised when the provision was triggered by the tenant’s request for the landlord’s consent to an assignment.
May the landlord cancel the lease agreement even though the landlord agreed not to unreasonably withhold his consent or condition consent on the exaction of the excess rents?
Yes! The two provisions in the lease, the consent-to-assignment provision and the cancellation provision, are mutually exclusive alternatives authorizing the landlord to take either of two completely separate courses of action when confronted with a request for consent to an assignment.
On receipt of the tenant’s request for consent, the landlord exercised the cancellation provision, relieving the tenant of any further obligation under the lease – as well as his tenancy in the premises and any potential profit from the property’s appreciated rental value.
Thus, the issue as to whether the landlord refused his consent never arises. The landlord cancelled the lease as agreed, thus nullifying any need to consider the request for consent.
However, should the landlord choose not to cancel the tenant’s leasehold interest on the tenant’s request for consent to an assignment, the landlord is then left to analyze whether or not to consent. As a result, he is required to be reasonable about any objection he may have to the assignment since no other standard was set in the lease.
Also, the cancellation provision in the lease is bargained for and not the unconscionable result of an advantage held by the landlord. The prospective tenant did not have to enter into this lease or lease this premises.
Thus, the landlord did not unreasonably interfere with the tenant’s right to assign or sublet by cancelling the lease agreement since the tenant’s real estate interest in obtaining higher rent had been contracted away by inclusion of the cancellation provision. [Carma Developers, Inc. v. Marathon Development California, Inc. (1992) 2 C4th 342]
Transfer of any interest
An assignment or subletting provision in a lease typically calls for the tenant to acquire consent from the landlord before the tenant may transfer any interest in the leasehold. [Calif. Civil Code §1995.250]
A transfer by the tenant includes an assignment, sublease or further encumbrance of the leasehold. [CC §1995.020(e)]
An assignment of the lease transfers the original tenant’s entire interest in the lease to a successor tenant, leaving no interest held by the original tenant. However, the original tenant named on the lease agreement remains liable for the successor tenant’s performance on the lease, even though the landlord consents to the assignment and the successor tenant assumes (i.e., becomes primarily responsible for) the lease obligations.
For the original tenant to be released of his liability under the lease on an assignment, a novation must be negotiated and entered into by the landlord and both tenants, sometimes called a substitution of liability. [Samuels v. Ottinger (1915) 169 C 209]
On the other hand, when entering into a sublease with a subtenant, the original (master) tenant transfers to the subtenant less than all of the master tenant’s interest in the property. Also, possession reverts back to the master tenant on expiration of the sublease.
The master tenant granting the sublease remains solely obligated to perform on the master lease. The subtenant does not assume liability of the master lease. However, the subtenant may do no acts which would constitute a breach of the master lease, a copy of which is attached to the sublease.
The further encumbrance of a tenant’s leasehold interest occurs when the tenant places a lien on his leasehold to secure a loan, such as a trust deed or the delivery of a collateral assignment.
Editor’s note — For simplicity’s sake, the following discussion will only refer to an assignment of a lease. However, the discussion fully applies to any sublease or further encumbrance transaction.
Various alienation provisions
Leases include various types of assignment provisions, also called alienation clauses, which may:
entirely prohibit any assignment of the lease [CC §1995.230];
require the landlord’s consent prior to an assignment without containing approved standards or place any monetary conditions for the withholding of the landlord’s consent [CC §1995.260];
require the landlord’s consent prior to an assignment, stating consent will not be unreasonably withheld [CC §1995.250(a)];
require the landlord’s consent, subject to conditions first being met by the tenant, e.g., payment to the landlord of all or part of the tenant’s gains on the assignment, a higher rental rate and an assignment fee, and an assumption by the tenant of maintenance and utility expenses [CC §1995.250(b)]; or
contain conditions for a valid assignment without requiring any consent at all, such as the landlord is entitled to all or part of the consideration the tenant receives for the assignment in excess of rent due on the lease. [CC §1995.240]
Standards lay out the analytical process imposed on the landlord which he must apply when making a judgment whether or not to withhold consent.
Conditions are sums of money or leasing terms that must be met by the tenant as a requisite to consent should the landlord consent to the assignment.
No standards for withholding consent
Consider a lease with an assignment provision calling for the landlord’s consent prior to the tenant’s assignment, but devoid of any standard or condition for consent, such as consent “will not be unreasonably withheld” or fees must be paid.
Thus, the assignment provision does not set a standard for consent or exactions to be paid as a condition for granting or withholding consent. Here, for lack of agreement to the contrary, the standards and conditions for the landlord’s consent are set by law.
A lease entered into on or after September 23, 1983, with no standard agreed to for the landlord to consent to an assignment, requires the landlord to have a commercially reasonable basis for his denial should he choose to withhold consent. The landlord cannot deny consent arbitrarily.
Also, no conditions for an exaction can be attached to granting the consent, such as a higher rental rate, unless bargained for as a condition for consent and included in the lease agreement. [Kendall v. Ernest Pestana, Inc. (1985) 40 C3d 488]
Commercial reasonability standard
Commercial reasonability standards relate to the landlord’s ability to:
protect his ownership interest from property waste and financial deterioration due to the successor tenants’ propensity to care for and make suitable use of the property under the use-maintenance provisions in the lease; and
ensure the future performance of the lease by an assignment to a creditworthy tenant.
Commercially reasonable objections for withholding consent to an assignment include:
the successor tenant’s financial responsibility (net worth), prior operating history and creditworthiness;
the successor tenant’s intended use, care and maintenance of the property;
the suitability of the successor tenant’s use, product marketing and management style for the property; and
the need for tenant alterations to the premises. [Kendall, supra]
For example, a lease use provision gives a tenant the right to operate a service business in a shopping center in which the landlord operates a retail business outlet. The lease restricts the tenant’s use to “office use related to the business” of the tenant.
The lease alienation provision in the lease agreement requires the tenant to obtain the landlord’s prior consent to an assignment of the lease. The alienation provision sets no standard for withholding consent and provides for no conditions to be met (paid) by the tenant for the consent if it is granted.
Later, the tenant seeks to transfer the lease to a successor who will operate a retail business from the premises. The successor tenant’s retail business will be in direct competition with the landlord’s retail outlet.
The landlord refuses to consent to the assignment since it calls for a change in use of the premises.
The tenant claims the landlord’s refusal is commercially unreasonable since it amounts to economic protectionism unrelated to the landlord’s ownership and operation of the rental property.
Here, the landlord’s refusal is a commercially reasonable application of the use restriction in the lease. He sought only to retain the use originally intended by the lease. The refusal is not due to improper economic protectionism in the management and operation of the real estate since the landlord did not seek an increase in rent or other economic benefits to enhance himself as a condition for his consent to the assignment of the lease. [Pay ‘N Pak Stores, Inc. v. Superior Court of Santa Clara County (1989) 210 CA3d 1404]
Also, the landlord can reasonably refuse his consent to a trust deed lien the tenant seeks to place on the leasehold interest when the proceeds of the loan are not used to improve the property. [Airport Plaza, Inc. v. Blanchard (1987) 188 CA3d 1594]
Reasonable increases in rent
Consider a nonresidential tenant who agrees to pay rent in an amount equal to a percentage of the tenant’s gross sales, but not less than a base monthly amount, called a percentage lease.
An alienation provision in the lease requires the tenant to obtain the landlord’s consent before assigning the lease. The provision does not include standards or conditions for the landlord’s consent to an assignment.
The tenant enters into an agreement to sell his business and assign the lease to a new operator. The operator buying the lease (and the business) is to pay the tenant a monthly premium over the remaining life of the lease, called overriding rent.
The tenant requests consent from the landlord for the assignment of the lease. On investigation, the landlord determines the operator will manage the business in a manner which will not generate gross sales at the same level as the current tenant. Thus, under the percentage lease, the new operator will not become obligated to pay the amount of rent currently being paid by the tenant seeking consent.
However, the landlord agrees to consent to the assignment conditioned on the landlord receiving the overriding rent premium the tenant is to be paid for the assignment.
The tenant claims the landlord cannot condition consent on exacting the rent premium since no standards or conditions for consent exist in the lease and thus cannot now be imposed.
Here, the landlord can condition his consent to the tenant’s assignment of the lease on the landlord’s receipt of the monthly rent premium to be paid by the new tenant in spite of the fact he did not contract in the lease agreement for the premium.
The landlord’s conditional consent to the assignment is commercially reasonable. The landlord when granting consent is entitled to preserve the rental income he currently receives from the existing tenant. The landlord does not need to accept the certain risk of a lower monthly percentage rent from the assignee while the original tenant receives a monthly premium. [John Hogan Enterprises, Inc. v. Kellogg (1986) 187 CA3d 589]
Proceeds from assignment demanded
Now consider a nonresidential lease that contains an assignment provision authorizing the landlord to demand all the consideration the tenant will receive for an assignment of the lease as a condition for his consent to the assignment.
The landlord using the lease does not bargain for any other exaction, such as a portion of the purchase price the tenant will receive on a sale of the business that the tenant operates from the premises.
Later, the tenant agrees to assign the lease to a new operator as part of the sale of his business. The operator will pay the tenant a lump sum payment for the lease as part of the purchase price since rent due on the lease is below market rates.
The landlord demands the tenant pass on the price paid for the lease as a condition for his consent to the assignment, which the tenant rejects.
The tenant claims the landlord’s demand in exchange for consent is commercially unreasonable, and thus unenforceable, since the landlord has no lawful justification for the premium or additional rent they agreed to in the lease.
Here, the landlord may condition consent on his receipt of the payment made for the assignment of the lease.
Nonresidential leases granting the landlord the right to receive any consideration the tenant is to receive related (and limited) to the value of the lease to be assigned are enforceable. [CC §1995.240]
Absent unconscionable or discriminatory provisions, nonresidential landlords and tenants are free to place commercially reasonable restrictions limited to the value of the leasehold on any assignment of the lease. [Carma Developers, Inc., supra]
More than rental value demanded
Again, a nonresidential lease may provide for the landlord to receive all consideration the tenant receives for the assignment of the lease in exchange for his consent since these amounts are considered commercially reasonable. [CC §1995.240]
However, the consideration the landlord may receive for his consent to an assignment is limited to financial benefits directly related to the value of the lease assigned.
For example, a tenant occupies nonresidential property under a lease.
The lease includes a profit-shifting clause calling for the tenant to pay the landlord, in exchange for his consent to an assignment, 25% of the consideration the tenant receives for goodwill on the sale of the tenant’s business. Both agree it is the location of the leased property which will give the tenant’s business its goodwill value.
The tenant’s business is a success and the tenant locates a buyer for the business and the remaining term on the lease. The tenant seeks the landlord’s consent for an assignment of the lease.
As agreed, the landlord demands 25% of the consideration the tenant will receive for his business goodwill. The tenant refuses to meet the demand and the landlord refuses to consent to the assignment.
As a result, the sales transaction fails to close. The tenant makes a demand on the landlord for 100% of his lost profits on the sale.
The tenant claims the landlord’s demand for a share of the profits on the sale of the business as agreed to in the lease was a commercially unreasonable and unenforceable condition for granting consent to the assignment.
The landlord claims the profit-shifting provision is enforceable since all consideration received by the tenant on a transfer of the lease, even in excess of the value of the lease, can be agreed to and taken in exchange for consent.
Here, the landlord’s right to receive consideration the tenant receives for the sale of a business and an assignment of the lease is limited to consideration the tenant receives for the increased value of the lease – and even then the condition of payment for consent must be agreed to in the lease alienation provision to be enforceable. [Ilkhchooyi v. Best (1995) 37 CA4th 395]
Unconscionable advantage situations
Now consider a subtenant who must negotiate a new lease with the landlord or be evicted. The master tenant’s lease has been terminated by the landlord due to no fault of the subtenant.
The landlord submits a proposed lease to the subtenant which differs significantly in its terms and conditions from the wiped out sublease the subtenant held with the master tenant. When the subtenant attempts to negotiate a reasonable rent based on “comps” and eliminate unacceptable provisions, the landlord tells the subtenant to “take it or leave it.”
The subtenant is told he will be evicted if the proposed lease is not signed.
The proposed lease includes an alienation clause calling for a 200% increase in rent as a condition to be met before the landlord will consent to an assignment of the lease.
The subtenant signs the lease. Later, the subtenant seeks the landlord’s consent to an assignment of the lease on his sale of the business. The landlord demands a modification of the lease rent provision to reflect the 200% increase in monthly rent as agreed, which the subtenant’s buyer refuses to sign.
The landlord claims the alienation clause is enforceable since the clause was freely bargained for.
The tenant claims the provision was the result of an unconscionable advantage held by the landlord when they negotiated the terms of the lease since the tenant was in no position to bargain with the landlord. When the lease was negotiated, the tenant could not refuse to rent due to the goodwill he had built up for his business at this location through a heavy investment in advertising, and the landlord was unconscionable in his negotiation in light of his advantage.
Can the tenant avoid enforcement of the profit-shifting clause?
Yes! The alienation clause agreed to was the result of the landlord taking unconscionable advantage of the subtenant’s situation. The subtenant was in possession under a wiped out sublease without any power to freely bargain. He was already in possession and operating a business that had developed goodwill that would be lost if he vacated.
Collection of future rents so hugely excessive as to effectively shift profits from the sale of the business to the landlord for his consent to an assignment of a lease was overreaching on the landlord’s part. Thus, the profit-shifting assignment provision was unenforceable as the product of unconscionable demands resulting from the advantage held by the landlord over the subtenant. [Ilkhchooyi, supra]
Also, any consideration the landlord seeks which is beyond the value of the leasehold interest or the landlord’s interest in the real estate is not reasonable, whenever or however bargained for.
Proceeds from the sale of a business, or a rent amount so large in its increase as to reduce the goodwill value of the business occupying the premises, reach beyond the economics (rental value) of the lease.
Thus, the demands agreed to unlawfully shift profits that are unrelated to the value of the leasehold. The right to freely bargain is not intended to give the landlord the right to freely fleece a tenant in the name of freedom of contract. [Ilkhchooyi, supra]
When a nonresidential lease contains a tenant-mitigation provision and the tenant breaches the lease, the landlord may treat the lease as continuing and recover rent for the life of the lease. The provision shifts to the tenant the responsibility for leasing the property to mitigate losses when the tenant vacates and breaches the lease.
Under the tenant-mitigation provision, the landlord and tenant agree the tenant has a duty to find a replacement tenant, pay for any tenant improvements (TIs) and collect rent when the tenant breaches the lease and vacates the premises. [CC §1951.4]
Thus, on the tenant’s breach of a lease with a tenant-mitigation provision, the landlord does not have the duty to mitigate his rental losses by repossessing and reletting the space himself before enforcing collection of future rents due under the lease from the tenant.
However, if the lease also provides for the landlord’s prior consent to a transfer, the tenant-mitigation provision is enforceable only if the landlord’s consent to an assignment is not unreasonably withheld. [CC §1951.4(b)(3)]
A landlord who prohibits assignments or unreasonably withholds consent retains the duty to mitigate his loss of rents on the tenant’s breach.
Assignment (alienation) provisions restricting the transfer (assignment) of the leasehold interest held by a tenant become a concern of the bus-op or industrial broker when:
negotiating the assignment of a lease in a bus-op sale (or negotiating a sublease or a further encumbrance);
relocating a tenant whose current lease has not yet expired; or
negotiating the origination of any lease.
A broker handling a bus-op sale or relocation of a business or industrial tenant must determine the tenant’s ability and under what standards or conditions the tenant is allowed to assign the existing lease to a buyer of the business operation or other successor tenant.
The broker starts the analysis by ascertaining the type of assignment clause the landlord’s proposed lease contains. The broker can then determine the tenant’s assignment rights under the lease.
Now consider a leasing agent who is negotiating a lease on behalf of a prospective tenant. The tenant’s agent should limit the wording of an assignment provision to include:
the landlord’s consent “will not be unreasonably withheld”; and
any exaction to be paid for the consent is limited to any increased rental value of the premises received by the tenant.
Any prohibition against assignment should be eliminated by including the “with consent” provision.
Conversely, the landlord’s leasing agent who arranges a lease should review the assignment provision in the proposed lease and include any consideration the tenant is to pay the landlord as a condition for his consent to an assignment.
For example, as compensation for consent to an assignment, the landlord may want to:
adjust rents to current market rates;
receive fees and costs incurred to investigate the successor tenant’s credit and business conduct so he can analyze his risk of loss should he consent to the assignment;
receive any overriding rent or lump sum payment the tenant receives which is attributable to the value of the lease;
require the successor tenant to pay operating expenses as additional rent such as maintenance, utilities, insurance and taxes; or
alter the terms of the lease and any options to extend/renew the lease or buy the property.
However, any exactions the landlord may expect or later seek for his consent must be agreed to and set forth in the lease, and be related to the value of the lease to be enforceable.