Hemenway & Barnes AUTHORED LITERATURE

Is Subleasing Office Space a Savvy Move or Risky Business?
Boston Business Journal
February 28-March 6, 2003

Insider View - Thomas Guidi

After the second consecutive year of "negative absorption," there is an unusually large amount of unused office and industrial space in the greater Boston metropolitan area. Contributing greatly to this oversupply of space is space available for subleasing. Subleasing may be particularly attractive to a company that is relocating or otherwise needs new space, because tenants with surplus space are likely to be willing to undersell landlords who have vacant space on the market.

However, while the economics of subleasing may be very attractive, subleasing is fraught with risks that do not exist in a direct-lease situation.

First and foremost, no matter how favorable the terms of a sublease, under the law a sublease is subject to the terms of the tenant/sublessor's lease with its landlord (the prime lease). The prime lease may contain onerous terms and may even prohibit subleasing, although it is more likely that the tenant will have a right to sublease subject to the landlord's consent and other specified terms and conditions.

Accordingly, before entering into a sublease it is imperative to review the prime lease to confirm the tenant/sublessor's sublease rights and to understand all of the terms and conditions.

If the landlords consent is required, the subtenant should make sure that the tenant/sublandlord obtains such consent. To avoid any doubt, it is best to have the landlord's written consent appended to the sublease.

Most subleases provide that the tenant/sublandlord is not to be held responsible if the landlord fails to provide heat or other services required under the prime lease. As a result, if the landlord fails to provide necessary services to the subleased premises, the subtenant will not have a direct claim against either the landlord or the tenant/sublandlord, being forced to rely on the tenant/sublandlord to enforce the terms of the prime lease against the landlord. While the sublease will ordinarily require the tenant/sublandlord to pursue such claims diligently, other issues in the landlord-tenant relationship may cause the tenant/sublandlord not to push as hard as it should on the subtenant's behalf

Another significant risk to a subtenant is that the tenant/sublandlord could default under the prime lease, causing the landlord to withhold services or, even worse, terminate the subtenant's right to occupy the subleased premises. This may occur even if the subtenant has neither done anything to violate the prime lease nor defaulted under the sublease.

One way to prevent this from happening is for the subtenant to obtain a nondisturbance agreement from the landlord. Under such an agreement, if the tenant/sublandlord defaults under the prime lease, so long as the subtenant has not defaulted under the sublease, the landlord will honor the terms of the sublease and not disturb the tenancy of the subtenant.

Unfortunately, most subtenants, particularly if they are subleasing a modest amount of space, will be unable to obtain a nondisturbance agreement from the landlord. If the landlord is not willing to enter into a nondisturbance agreement with the subtenant, then the subtenant should attempt to obtain from the landlord the right to notice and an opportunity to cure any tenant default under the prime lease.

Another risk that is exacerbated by relatively high vacancy rates is that the landlord could default on its mortgage loan, resulting in the landlords mortgage lender foreclosing on the landlord's property and ousting the tenant and the subtenant.

A tenant protects itself against this risk by obtaining a subordination, nondisturbance and attornment agreement, or SNDA, from the landlord's lender. "Attornment" means if a new landlord takes over, potentially by foreclosure, the tenant will attorn, or look to the landlord as the landlord.

An SNDA will protect both the tenant/sublandlord and the subtenant. However, many tenants, particularly those leasing relatively small amounts of space, will not be able to obtain SNDAs. If the tenant/sublandlord does not have an SNDA, it is not likely that the subtenant will be able to obtain one.

If the subtenant or any of its employees or invitees causes any damage to the subleased premises or any other portion of the landlord's property, the subtenant may be liable even if the loss is covered by the landlords insurance.

Under the common-law principle subrogation, if the landlords insurance company pays a property damage claim, it has the right to seek reimbursement from the person who is legally responsible for the damage.

Most often commercial leases contain waivers of subrogation. However, even if there is a waiver of subrogation in the prime lease protecting the tenant/sublandlord, it probably will not extend to the subtenant.

Thus, in the worst-case scenario of a major fire caused by the negligence of one of the subtenant's employees or invitees, the landlord's insurer could sue the subtenant for the cost of repairing the damage. It is important for a subtenant to be insured against such claims.

Unfortunately, it may not be economical for a subtenant to obtain enough insurance coverage to protect itself fully in this situation. Despite its inherent risks, subleasing is often the most attractive alternative for a company seeking new space. While risks can be minimized by careful due diligence and negotiation, some cannot be eliminated.

THOMAS GUIDI is a partner in the Boston law firm of Hemenway & Barnes.

Reprinted with permission from Boston Business Journal. All Rights reserved.