Allowing Flexibility While Retaining Some Control: Considerations When Drafting Permitted Transfer Provisions in Retail Leases
One of the most heavily negotiated provisions in any retail lease is the transfer and assignment provision. This provision is important to both parties, and careful thought must be given when negotiating and drafting the parties’ agreements on transfer issues – particularly those in which the landlord’s approval is not required.
The ability to assign the lease, sublet the premises or otherwise transfer its interest in the lease or premises is critical to a tenant in any retail lease. Tenants usually want to build into their leases the right to “off-load” their lease obligations if business turns out not to be as good as expected. One mechanism to do this (short of default), is by assignment or other transfer of the lease. As a result, tenants attempt to negotiate broad transfer rights into their leases.
On the other hand, many retail landlords want the ability to tightly control the types of operators, uses, quality of merchandisers and mix of goods that occupy their centers. Furthermore, landlords often rely upon the creditworthiness of the original tenant in entering a lease and do not want to reduce the level of creditworthiness in connection with any transfer. Because of these concerns, landlords often attempt to negotiate limited transfer rights for tenants in retail leases.
The ultimate outcome of the negotiations regarding the transfer provision will largely depend on, among other things, the relative negotiating strengths of the parties, the creditworthiness of the tenant and the desirability of the premises and center to the tenant.
Many retail tenants try to include additional concepts in the transfer provisions of their leases which would allow them to assign, sublet or otherwise transfer the lease to a party without the landlord’s consent or approval. This is sometimes referred to in a lease as a “Permitted Transfer” or other similarly defined term.
Essentially, Permitted Transfers allow a tenant to transfer its lease to a subsidiary or division of itself (or sometimes its parent company), in connection with a merger or consolidation, or in connection with the acquisition by another party of all of, or a controlling interest in, the tenant’s stock, assets or a number of the tenant’s other stores. There are additional scenarios, but this Article will focus on the foregoing scenarios, since they appear regularly in most Permitted Transfer provisions.
A tenant’s reasoning for these types of transfers without the landlord’s approval is often sound. For example, a successful regional, national or multi-brand retail operator may begin operating numerous locations under a single tenant entity, even though it operates several different retail brands or concepts. That operator may later (in the future) grow to a point that, for independent business reasons, it would like to separate its different brands or concepts into different tenant subsidiaries or divisions. Often times, a landlord will understand this business rationale and attempt to accommodate the tenant by agreeing that the tenant can transfer to a “wholly-owned” subsidiary or division. It is important for the landlord to limit the tenant to transfers to subsidiaries or divisions that are basically owned and controlled by the tenant. Otherwise, it could be possible for a tenant to transfer (without the landlord’s consent) to a subsidiary or division of the tenant that is created as a subterfuge, by limiting the tenant’s involvement and interest to that of only an insignificant minority interest. Although the initial tenant or parent may remain liable (or “on the hook”) following such a transfer, it may have divested itself to a degree that it is no longer as creditworthy, or is defunct, and with the new tenant being entirely different than the original tenant and not as economically robust or sound as the original tenant.
Landlords also normally understand that a retail tenant may need to preserve the ability to merge, consolidate or sell all (or substantially all) of its stock, assets or stores to another party without the landlord’s approval. However, this is understandable only when the tenant has a significant number of other locations. If the tenant has only one (or a very few) location(s), then by agreeing to these provisions, the landlord could essentially be permitting a tenant to circumvent the entire transfer provision of the lease by simply selling its single business at the premises – an unintended result. Thinking of it another way, most landlords would agree that if a retail tenant had many other retail locations and the business at the premises was just one of those many locations that was part of the tenant’s proposed merger, consolidation or sale, then the landlord should not be compelled to disrupt the larger transaction by having an approval right. On the other hand, if the tenant had only one or two stores, then the landlord could quite possibly feel differently and want to evaluate the transfer. As a result, many landlords will condition such Permitted Transfers on the tenant having (and including as a part of such transfer) at least 10 to 25 of its retail locations. That way, the landlord is reasonably assured that circumvention of the transfer provisions is not the reason for the transaction. Another strategy, if the landlord knows the original tenant has multiple locations, is to limit the merger and sale provisions that are permitted without the landlord’s consent to the original tenant under the lease.
Landlords must also recognize that whatever provisions are ultimately negotiated, they will apply throughout the lease term, including with respect to potential second-generation and later tenants. Accordingly, even if a landlord is not concerned about the impact the Permitted Transfer provisions will have on the original tenant, the landlord should consider future eventualities with other parties. For instance, if the original tenant is a major regional or national tenant with over 500 stores, the landlord may not be concerned about limiting the ability to merge, consolidate or sell so long as such tenant owns at least a certain number of other stores. However, several years into the lease term, the tenant may transfer the lease (with the landlord’s consent) to a small operator, who then, at another future date seeks to exercise a Permitted Transfer. If the lease does not have proper limiting conditions, then the landlord may not be properly protected.
The transfer provisions of retail leases in which the landlord does not have consent or approval rights are complicated and critical to both parties. Significant thought must be given to how they are drafted and how parties are to be protected in the present and the future.
The information provided on this client alert does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this client alert are for general informational purposes only.