Sub-letting in commercial leases

In a previous blog we discussed the assignment of commercial leases. In this blog we discuss an alternative means of dealing with a tenant’s interest in a lease of commercial property: sub-letting (also known as underletting). A tenant may wish to sub-let if it is unable to assign part only of its property, as assignment of part is often prohibited by a lease whereas it is more common to see sub-letting of part permitted. A tenant may also wish to sub-let if it wishes to dispose of its property on a temporary basis but wants to be able to go back into occupation at a future date. Depending on the terms of the lease (see below), sub-letting may also be an alternative where the lease rent is higher than the current market rent, making it difficult to assign the lease. If the lease permits sub-letting at lower than the lease rent, the tenant will find it easier to sub-let (although it will of course have to make up the shortfall in the lease rent at its own cost).

In a lease of commercial property, whether a tenant can sub-let its property will depend on what the lease does or doesn’t say. As with assignments, if the lease contains no provisions dealing with alienation, the tenant will be free to deal with it as it wishes. However, this is rare and most leases will contain detailed provisions dealing with sub-letting.

Depending on the type of building and the extent of the property demised by the lease, the tenant may be permitted to underlet part only – for example, one floor in a block of offices. However, in a smaller property the lease is likely to prohibit an underletting of part only.

A lease may also prohibit underlettings completely, especially if the landlord wants to retain more control over the identity of its tenant, as ultimately the landlord may become the direct landlord of a sub-tenant if the lease falls awayin certain circumstances.

Where a lease permits underletting (whether of whole or part), it will usually state that consent will only be permitted with the Landlord’s prior written consent. If the landlord consents in principle, a formal licence to underlet will need to be entered into between the landlord, the tenant and the sub-tenant, together with any guarantor for the sub-tenant (see below). All the parties should always seek legal advice before entering into the licence, to check the terms and conditions of it.

If the lease simply states that the Landlord’s consent must be obtained but does not make this subject to a requirement that it must not be unreasonably withheld, then the landlord is free to withhold its consent whether reasonable or not (and will not be required to provide an explanation). However, as with assignments, landlords should always be aware that a too-tight alienation clause may have an adverse affect on the rent review (if any) under the lease.

It is more common for the lease to state that where the landlord’s consent is required, such consent must not be “unreasonably withheld”. As with assignments, what constitutes consent being “unreasonably withheld” is usually a question of the circumstances in each individual case, including the nature of the property, the identity of the proposed sub-tenant and the amount of the proposed sub-lease rent. If the landlord is required not to unreasonably withhold its consent but does not respond to a tenant’s formal application for consent within a reasonable time, that can be deemed to be an unreasonable withholding of consent.

The landlord can choose to grant consent subject to conditions, which again are usually subject to a reasonableness requirement (depending on what is stated in the lease). These may include:

(a) that the rent payable under the sub-lease must be not less than the passing rent under the lease. Alternatively, it may state that the rent must be not less than the open market rent payable at that time (which may be higher or lower, depending on the market conditions at that time);

(b) that the sub-lease must contain rent review provisions operable at the same times and on the same basis as in the lease (although this may not be applicable depending on the length of term of the sub-lease);

(c) that the sub-lease must not be granted in return for payment of a premium;

(d) that the sub-tenant must either not be granted a rent-free period, or not for more than as is then usual in the open market;

(e) that the sub-tenant must provide a guarantee and/or rent deposit;

(f) that the sub-tenant must covenant by deed with the landlord to comply with the covenants contained in the lease, so far as they apply to the sub-let premises;

(g) that the sub-lease must be excluded from the renewal provisions of the Landlord and Tenant Act 1954. This is particularly important for the landlord where the lease is excluded, as it will want to ensure that the sub-tenant does not acquire rights of security of tenure.

The provisions of the sub-lease must comply with any such landlord’s conditions but will of course also be a matter for negotiation between the tenant (as landlord under the sub-lease) and the sub-tenant, dependent upon the bargaining strength of the respective parties at the time.

For further information please contact Victoria Sandberg.

Please note the contents of this note are given for information only and must not be relied upon. Legal advice should always be sought in relation to specific circumstances.