Word-of-the-Week: Sublease

What is a sublease?

A sublease is a leasehold interest subject to the terms of a master lease.

Under a sublease, the original lessee retains an interest in the lease and is responsible for the rental payment to the landlord while the right of possession is given to another – the sublessee.

Thus, a sublease is less than a complete transfer of a leasehold interest subject to the terms of the master lease.

The original lessee, also known as the master tenant, retains certain obligations and acts in a capacity similar to the lessor in relation to the sublessee.

Editor’s note — If a sublease exists on a commercial property, the master tenant is the “landlord” of the subtenant.

How a sublease works

A sublease can be established as long as the original lease allows it. [See RPI Form 552 §9]

In practice, a commercial lease agreement entered into by a tenant contains an assignment and subletting provision, called a restriction-on-transfer provision or a restraint-on-alienation provision.

The restriction-on-transfer provision either prohibits the transfer of the tenant’s interests or requires the landlord’s consent prior to assigning, subletting or further encumbering the tenant’s leasehold interest. If the provision permits an assignment or subletting, it states the landlord’s consent will not be unreasonably withheld. [See RPI Form 552]

Further, the lease agreement signed by the tenant contains a cancellation provision. The cancellation provision allows the landlord to cancel the lease agreement and terminate the tenant’s occupancy on the landlord’s receipt of the tenant’s written request to sublet the premises.

After taking occupancy of a commercial property, consider a tenant who vacates the premises and relocates their operations to another property. The tenant has no intention of returning to the leased premises.

The tenant finds a new tenant who will pay rent at current market rates for the space. The current market rates exceed the rent owed under the lease agreement. The amount by which the current market rates exceed the rents under the lease is called overriding rent.

The tenant requests the landlord’s consent to sublease to the new tenant. The landlord responds by cancelling the lease agreement and terminating the tenant’s leasehold interest under the cancellation provision.

The landlord, having terminated the tenant’s leasehold by cancellation of the lease agreement, negotiates directly with the new tenant. The landlord enters into a lease of the premises with the new tenant at current (read: higher) rental rates.

The original tenant makes a demand on the landlord for the overriding rent they 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 that entitled the landlord to the overriding rent.

The landlord claims their cancellation of the lease is valid, even though cancellation is an absolute restraint on the proposed transfer of the tenant’s leasehold interest. The tenant and landlord bargained for the cancellation provision that was triggered by the tenant’s request for the landlord’s consent to a sublease.

May the landlord cancel the lease agreement on receipt of the tenant’s request for consent to an assignment even though they agreed not to unreasonably withhold their consent?

Yes! The two provisions in the lease, the consent-to-assignment provision and the cancellation provision, are mutually exclusive alternative remedies. They give the landlord a choice between two different and separate courses of action when confronted with a request for consent to a sublease.

Transfer of any interest

A restriction-on-transfer provision in a lease agreement typically calls for the tenant to acquire consent from the landlord before the tenant may transfer their leasehold interest. [See RPI Form 552-7; see RPI Form 552 §9.2]

A transfer by the tenant includes an assignment, sublease or further encumbrance of the leasehold.

An assignment of the lease agreement transfers the original tenant’s entire interest in the property 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 becomes primarily responsible for the lease obligations. The act of taking over a previous tenant’s lease agreement and right of possession is called an assumption.

For the original tenant to be released of their liability under the lease agreement on an assignment, a novation (also known as a substitution of liability) is negotiated and entered into by the landlord and both tenants. [See RPI Form 552-7]

On the other hand, when entering into a sublease with a subtenant, the original tenant (or 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 obligated to perform on the master lease agreement. The subtenant does not assume liability of the master lease. However, the subtenant may not act in any way that constitutes a breach of the master lease agreement. A copy of the master lease agreement is provided to the subtenant as an attachment to the sublease. [See RPI Form 552 §2.5]