In uncertain economic times, there is very often an increase in the number of subleases, as was clearly evident following the dot.com crash, and we are likely to see this again.
From an occupant’s perspective, subleases often represent good value. The existing tenant may be very eager to obtain any income from unused space and therefore a subtenant may be able to negotiate favourable terms. Sublease rents also generally reflect a reduction in the direct lease rents for the simple reason that there are associated risks in being a subtenant.
It should be noted, however, that some head leases prohibit sublease rents from being less than the face rent of the head lease, and that is one thing a subtenant should check out in carrying out its due diligence of the head lease terms.
Nature of the Risk
A sublease is dependent on the head lease under which it is made. If the head lease is terminated, then all rights, including any subleases, that are dependent on that head lease will also fall. As a result, a subtenant who is in good standing under its sublease could find itself unable to enter its premises due to the head tenant being “locked out” or otherwise terminated by the landlord for a default under the head lease.
Protecting the Sublease Interest
There are a number of things a prospective subtenant can do to try to protect its sublease interest, at least to some degree.
Accommodation from Landlord
The best protection that a subtenant can seek is to obtain the agreement of the head landlord that the subtenant can continue to stay on at the sublease terms, notwithstanding any termination of the head lease. A head landlord will rarely agree to this. Historically, most subleases are at a rental rate and on other terms more favourable than under the head lease, and there is no incentive for a head landlord to agree in advance to accept anything less than what it is entitled to under the head lease.
However, perhaps there is an accommodation that the head landlord might agree to if asked. For example, rather than facing an immediate eviction, the head landlord may agree to allow the subtenant to stay on the premises (say, for 90 days) following a termination of the head lease. The subtenant might have to agree to pay the head lease rent (or some other amount perhaps greater than the sublease rent) in order to have this right. But this would allow the subtenant to “buy some time” to find alternative premises.
Under the Commercial Tenancies Act of Ontario, subtenants are given certain statutory rights in certain circumstances.
Section 21 of the Commercial Tenancies Act allows a subtenant to apply to the courts for an order allowing it to retain the premises where the landlord has terminated the head lease. The courts are given discretion to set out the terms of the continuing tenancy, including rent, payment of costs to the head landlord, and the granting of security. The term may be no longer than the original term of the head lease.
In determining what terms to impose where a subtenant successfully brings an application under Section 21, the courts have generally been concerned with not unfairly prejudicing or adversely affecting the head landlord. As such, the terms of the head lease are generally imposed, save and except for the term, which will match the sublease. As a result, the rent savings that were part of the sublease arrangement would be lost.
It should also be noted that where the sublease is only for part of the premises leased under the head lease, the courts have felt that if the subtenant is to obtain relief, it will have to assume the lease for all of the premises. That may not be something of interest or feasible for the subtenant (but must be anticipated).
A somewhat similar right is given to subtenants under Section 39(2) of the Commercial Tenancies Act in the event that the head lease has been disclaimed or assigned by a trustee in bankruptcy. Under this section, the subtenant has a right to take over the head lease at a rent equal to the greater of the rent payable under the head lease and the rent payable under the sublease. Again, the financial terms may be changed and the length of the obligation may be extended, as the subtenant must pick up the entire head lease term (which may be longer than the sublease term).
The rights under Sections 21 and 39(2) of the Commercial Tenancies Act can be contracted out of and many landlord forms of consent require subtenants to give up those rights at the time the consent to the sublease is granted. That is something that subtenants may want to try to resist (though the head lease may contemplate such waiving of rights and therefore, it may not be possible to resist).
There are other actions a subtenant can take when it is initially negotiating the sublease and the head landlord’s consent to try to add some protection. For example, in the consent agreement usually required by a head landlord, the subtenant can ask that the head landlord agree to give written notice to the subtenant of any defaults by the tenant under the head lease, together with a right to cure. This would give the subtenant some early warning of trouble and the ability to at least make a decision as to whether or not it wants to cure any defaults and/or start negotiating with the head landlord for a new permanent or interim deal to take effect if the head lease is terminated.
The subtenant may also want to make arrangements with the tenant and head landlord to have the sublease rent paid directly to the head landlord. This would eliminate the risk that the subtenant’s funds are diverted and not passed on upstream to the head landlord.
Some Concluding Remarks
A potential subtenant needs to be aware of the risks inherent in a sublease arrangement. There are ways to deal with these risks, at least to some degree, but as with most things, it will depend upon the positions and negotiating strengths of the parties. Specifically, the head landlord may have little incentive to join in the negotiations and to give any comfort to the subtenant. However, one cannot be sure and, therefore, should inquire. Indeed, there is a possibility that having an active occupant in the premises is of some value to the head landlord (as opposed to risking the current tenant defaulting) and, as a result, the head landlord may be willing to accommodate at least to some extent.