Assignments and subleases are commonplace. The difference between the two is a product of common law. Without a thorough understanding of the differing rights among landlords, tenants and transferees resulting from assignments and subleases, parties may find themselves unpleasantly surprised. This article will outline the fundamental differences between assignments and subleases, how the common law arranges the on-going rights among the parties, and the advisability of certain express agreements that change the common law results.
II. DISTINGUISHING BETWEEN AN ASSIGNMENT AND A SUBLEASE.
The quantity of interest transferred distinguishes an assignment from a sublease. This distinction can be summarized as follows:
Assignment. When a tenant transfers its entire interest in a leasehold estate, the transfer is an assignment. To qualify as such, the transfer must include the tenant's entire estate for the duration of the lease.
Sublease. When a tenant transfers less than the remaining term or less than the tenant's entire estate, thus leaving the original tenant with a reversionary interest in the lease, the transfer is a sublease.
For these purposes "estate" is tantamount to term. Determination of whether a tenant has retained a portion of the estate does not depend on the whether the tenant receives less rent than it owes under the lease, or even on whether the tenant transferred the entire premises. An assignment can occur regardless. But, retention by the tenant of even the smallest right with respect to the term constitutes a "reversionary interest" and creates a sublease. For instance, courts have construed a transfer as a sublease where the original tenant retained an option to terminate, extend or renew the prime lease. In fact, the reversionary interest need not even be under the control of the original tenant to qualify the transaction as a sublease. At least one court has held that a tenant may have retained a reversionary interest where a third party to whom premises are conveyed has the option to terminate the conveyance.
Surprisingly, one factor that does not distinguish an assignment from a sublease is the portion of premises involved. As long as the tenant relinquishes its interest in the portion of the premises transferred for the entire term of the lease, an "assignment pro tanto" occurs. Such a transfer carries all the legal implications of any other assignment, except that the assignee has liability for only a portion of the rent proportionate to the interest it receives in the premises. Most people would think that a sublease has occurred, because less than the entire premises has been conveyed. However, such a transfer creates a form of assignment. This means that the assignee will have privity of estate with the landlord, and may have privity of contract as well.
Landlords and tenants may not find pro tanto assignments desirable. A landlord will be concerned about dealing with two separate tenant interests under one lease document. For instance, what if the original tenant defaults under the lease with respect to its space, but the assignee continues to meet its obligations under the lease for its portion of the premises? Would the landlord be forced to terminate the lease for only a portion of the premises? The landlord certainly did not intend this result when it entered into the lease. Although the landlord might be able to control this risk if the lease requires its consent for a transfer, what if the lease is silent? From the assignee's or tenant's perspective, what if it wants to terminate the lease? Can it do so without the consent of the other party? What if either the tenant or assignee bankrupts? If the trustee rejects the lease, does this terminate the assignment? No easy answers exist for these issues. Comprehensive transfer provisions in leases and assignment documents provide the only real solution.
III. WHAT'S AT STAKE: THE LEGAL IMPLICATIONS OF IDENTIFYING A TRANSFER.
A. Privity of Estate v. Privity of Contract. The classification of a leasehold transfer as an assignment or sublease carries differing legal implications regarding future liability arising under the prime lease. A party's liability under the terms of the prime lease ultimately depends upon the somewhat archaic term of "privity." The common law recognizes two general types of privity: (a) privity of estate and (b) privity of contract.
Privity of Estate. Privity of estate rests upon a landlord-tenant relationship. Acquisition of a leasehold interest by the new tenant, regardless of whether it is an assignment or sublease, establishes privity of estate.
Privity of Contract. Privity of contract rests upon the existence of an agreement, regardless of whether a landlord-tenant relationship exists. Privity of contract does not run with the land, unlike privity of estate. Accordingly, the original lease will not bind a new tenant under privity of contract unless the new tenant assumes the lease.
The original landlord and tenant under a lease have both privity of estate and privity of contract. When the original tenant transfers its interest in the lease to a third party, these relationships inevitably change. The manner and extent of the transfer determine what forms of privity will thereafter exist.
B. Assignment. If the original tenant assigns its interest in the lease, its privity of estate terminates, but its privity of contract remains intact. In other words, assignment of the lease ends its right to possession, but, absent an express release under the terms of the lease, its liability under the lease continues. When the assignee takes possession of the premises, the assignee obtains privity of estate. Privity of estate binds the landlord and assignee to the terms of any covenants running with the land, but only so long as the privity of estate continues. As a result, the assignee becomes liable to the landlord for the payment of rent and the breach of any other lease covenants running with the land. Likewise, the landlord becomes liable to the assignee for the covenant of quiet enjoyment. However, the assignee does not come into privity of contract with the landlord unless the assignee expressly assumes the tenant’s obligations under the lease. Without an assumption, the assignee would not be liable for contractual agreements that do not run with the land, such as an original tenant/assignor's undertaking to pay a note made in favor of the Landlord. Further, absent the assignee's assumption of the lease, a subsequent assignment will end the assignee's privity of estate, and with it, all of that party's obligations to the landlord. Thus, the absence of privity of contract between the landlord and assignee prevents the assignee from being liable for any breach committed by the original tenant or any prior or subsequent assignee.
As previously alluded, the tenant cannot relieve itself from liability under the lease merely by assigning the lease to a third party. Despite an assignment, the tenant remains secondarily liable for the obligations of the assignee under the lease. This means that if the landlord cannot recover from the assignee, it can thereafter pursue the tenant. From the landlord's perspective, it would prefer to pursue either or both of the tenant and assignee, at its election and without exhausting remedies against one or the other. To achieve this end, the lease must expressly provide that the original tenant remains primarily liable notwithstanding a transfer of its interest.
If the assignee assumes the obligations of the tenant under the lease through agreement with the assignor, both the tenant and the assignee have privity of contract, while only the assignee has privity of estate. The landlord can enforce the lease against the assignee as a third party beneficiary, regardless of whether the landlord was a party to the assignment/assumption agreement. However, some jurisdictions have held that in limited circumstances, when a landlord has accepted the assignee in place of the assigning tenant, either expressly or by implication, then the assigning tenant is released from liability arising under the terms of the lease.
Notwithstanding its initial liability under the lease following an assignment, the original tenant may later be released from liability, if the terms of the lease are amended by agreement between the landlord and the assignee. Thus, from the landlord's perspective, it is important for the lease to provide that the tenant remains liable, at least for the initial lease obligations, regardless of any later amendment of the lease terms.
C. Sublease. A sublease, unlike an assignment, does not establish privity of estate or privity of contract between the landlord and the subtenant. Instead, when a sublease occurs, the original tenant retains both privity of estate and privity of contract with the landlord. No legal relationship exists between landlord and subtenant. A sublease therefore does not transfer any of the original tenant's rights or obligations under the lease to the subtenant. Accordingly, the landlord cannot hold the subtenant liable for a breach of the lease, even if caused by the subtenant, nor can the subtenant enforce the terms of the lease against the landlord.
Despite the lack of privity between the landlord and subtenant, a sublease does establish a new leasehold estate between the tenant and subtenant, creating both privity of estate and privity of contract. Thus, the sublease document will control whether and to what extent the subtenant can hold the tenant liable for breaches of the lease by the landlord, and what happens if the subtenant's failure to perform under the sublease creates liability for the tenant under the lease. These agreements do not, however, disturb the privity of contract and estate existing between the landlord and tenant, despite the subtenant's possession of the premises. Thus, for either the landlord to have rights against the subtenant or vice versa, the landlord and subtenant must execute a separate document establishing them.
IV. CONSENT, WAIVER AND BREACH:
The law favors free transferability of rights. As such, a party may prohibit assignment or subletting only through the use of express prohibitions in the lease. Absent such prohibitions, tenants may sublease or assign their leasehold interests freely. However, simple restrictions on transfer in the lease may not be sufficient. Many courts perceive restrictions against assignment or sublease as restraints on alienation. As a result, courts often interpret restrictive language against the landlord. For instance, a prohibition only against assignments does not preclude subleases, and vice versa. Furthermore, under the majority rule, a simple covenant against subletting would not bar subletting only a portion of the premises.
Some states have enacted statutory limitations upon a tenant's right to transfer its leasehold interest. For instance, a Texas statute prohibits tenants from subleasing or assigning a leasehold interest without the consent of the landlord. Other states have adopted similar restrictions, but only as to short term leases.
Given the common law, and absent satisfactory statutory provisions that change the common law result, most leases contain language requiring landlord consent for transfers of the tenant's leasehold estate. Where a requirement for landlord consent exists, in most jurisdictions the tenant's failure to obtain such consent will enable the landlord to recover damages. However, in certain circumstances or where a statute or the language of a landlord consent requirement expressly provides, a landlord may be able to declare the assignment or sublease void, sue the tenant for breach of covenant or obtain an injunction. It is important to note, however, that the breach of covenant prohibiting assignment or sublease does not, in and of itself, terminate the lease. While an assignment in breach of the restriction may provide the basis for forfeiture, the assignee will still receive good title to the lease as a result of the assignment. As such, the landlord is still entitled to recover rent from the assignee despite the breach.
To ensure that the landlord can terminate the lease or void an unauthorized transfer regardless of jurisdiction, the lease should expressly provide such rights, at its election. A landlord may, however, waive the breach of a transfer restriction against or otherwise prevent itself from objecting. As such, although a lease may prohibit assignment or sublease without consent, the landlord may expressly, or by implication, be deemed to have waived a transfer in violation of the lease by acting in a manner that implies that the breach of this covenant has been waived. For instance, the landlord's knowing acceptance of rent from an assignee or subtenant may constitute such a waiver, and prevent the landlord from declaring a lease forfeiture.
Another pitfall arises after a landlord has either consented to a transfer or waived a breach of a non-assignment clause. Unless the lease expressly provides to the contrary, the restriction on transfer will terminate for future transfers.
V. PRACTICAL ASPECTS
An assignment can differ from a sublease in only the most nominal way – at the very limit a transfer for an hour less than the full term constitutes a sublease, while a transfer for one hour longer constitutes an assignment. In either case, the original tenant will remain liable to the landlord for the lease obligations. But the rights of the landlord and transferee will differ. In case of an assignment, the assignee will at least have privity of estate and therefore certain rights against the landlord and vice versa. In case of a sublease, the subtenant has no rights against the landlord, nor does the landlord have any rights against the subtenant.
Each party will have different goals. The landlord will want to enforce the lease against both the tenant and transferee to the maximum extent possible. It would therefore prefer an assignment where the tenant agrees to remain primarily liable under the lease. The transferee will want the freedom to enforce the essential lease obligations against the landlord with minimum liability. It would therefore prefer and assignment without assumption. The tenant would prefer either to have total absolution or total control. Thus, it may prefer an assignment with assumption by the assignee and release of the tenant. If the tenant cannot absolve itself of liability under the lease, it may opt for the other end of the spectrum, and create a sublease, retaining a nominal portion of the estate, in order to prevent the transferee from having direct dealings with the landlord.
Any of the foregoing results and infinite variations can arise. The trick comes in making the results intentional. A tightly crafted transfer clause in the lease provides the best solution. The following list comprises the key elements to include:
1. No transfer of all or any portion of the premises or the tenant's leasehold estate may occur without the landlord's consent.
2. Any transfer without the landlord's consent is voidable, at the landlord's option.
3. Any transfer without the landlord's consent may result in a forfeiture of the lease, at the landlord's option.
4. The acceptance of rent by the landlord from any transferee will not be deemed to be a waiver of the landlord's right to consent or declare the lease forfeited or the transfer void.
5. The landlord's consent to one transfer will not be deemed to be a waiver of the right to consent to any future transfer.
6. Following an assignment, the tenant will remain primarily liable under the lease. If the assignee defaults, the landlord may proceed directly against the tenant without the necessity of exhausting remedies against the assignee.
7. The landlord may consent to subsequent sublettings or assignments or amendments or modifications to the lease by transferees without notifying the tenant, and without obtaining the tenant's consent thereto. No such actions will relieve the tenant from primary liability under the lease.
Under the common law and some state statutes, assignment and subletting create specific sets of rights among the landlord, tenant and transferee. These pre-established results may be undesirable from the standpoint of the parties and the structure of a particular transaction. Thus, drafting a comprehensive transfer clause plays an essential role in ensuring results consistent with the expectations of the parties.
See Orchard Shopping Center, Inc. v. Campo, 485 N.E.2d 1248 (Ill. App. 5th Dist. 1985) (holding that where, as a term of a lease transfer, a Sublessee retains the right to terminate the sublease for any reason upon seven days notice, a reversion is retained by the transferor and, as a result, the transaction is a sublease). See also Indian Refining Co. v. Roberts, 181 N.E. 283 (Ind. App. 1932).
 Gateway Company v. DiNoia, 654 A.2d 342 (Conn. 1995) (fn. 8); Dolph v. White, 12 N.Y. 296 (1855).
See 185 Madison Associated v. Ryan, 174 A.D.2d 461 (N.Y.A.D. 1991) (stating "[i]t is well settled that in order to relieve the original tenant-assignor from its continuing liability after assignment, it must be expressly shown that the lessor not only consented to the assignment, but accepted the assignee in place of the tenant and such release of the tenant must either be express or implied from facts other than the lessor's mere consent to the assignment and its acceptance of rent from the assignee"). But see, De Hart v. Allen, 161 P.2d 453 (Cal. 1945) (maintaining that an assignor/lessee of lease remains as primary obligor under the lease).
See, e.g., Board of Commissioners v. Lions Del. County Fair, Inc., 580 N.E.2d 280 (Ind. App. 1991); Smith v. Hegg, 214 N.W.2d 789 (S.D. 1974); Gagne v. Hartmeier, 611 S.W.2d 194 (Ark. App. 1981); Rogers v. Hall, 42 S.E.2d 347 (NC 1947). See also, M. Friedman on leases, § 7.303.
See Drake v. Eggleston, 108 N.E.2d 67 (Ind. App. 1952). For minority view, see Minneapolis, St. Paul & Sault St. Marie R.R. v. Duvall, 67 N.W.2d 593 (N.D. 1954).
V.T.C.A. Property Code § 91.005 (1995), discussed in 718 Associates, Ltd. v. Sunwest N.O.P., Inc., 1 S.W.3d 355 (Tex. Civ. App. 1999); Lawther v. Super X Drugs of Texas, Inc., 671 S.W.2d 591 (Tex. Civ. App. 1984).
See M. Friedman on Leases, § 7.301 (citing Sooner Pipe & Iron Co. v. Bartholomew, 248 P.2d 225 (Okla. 1952)).
See generally, Shropshire v. Prahalis, 419 S.E.2d 829 (S.C. App. 1992) (allowing a forfeiture remedy where the lease contained a forfeiture clause); Clasen v. Moore Bros. Realty Corp., 413 S.W.2d 592 (Mo. App. 1967); Artesia Medical Development Co. v. Regency Association, Ltd., 214 Cal App. 3d 957 (Cal 2d Dist. 1989); Twelve Oaks Tower I, Ltd. v. Premier Allergy, Inc., 938 S.W.2d 102 (Tex. Civ. App. 1997) (providing that under a Texas statute, failure by a tenant to obtain consent to assignment renders the lease voidable at option of lessor, and is not terminated unless landlord undertakes to terminate it, declare forfeiture or reenter). See also M. Friedman on Leases § 7.304.
See Chessport Millworks, Inc. v. Solie, 522 P.2d 812 (N.M. 1974); Cities Serv. Oil Co. v. Taylor, 45 S.W.2d 1039 (Ky. 1932).
See Klee v. United States, 53 F.2d 58 (9th Cir. 1931); Fink v. Montgomery Elevator Co., 421 P.2d 735 (Colo. 1975).
We think today’s subject is quite interesting, though we know that its greatest appeal will be to law “wonks.” [A “wonk” is variously “a person preoccupied with arcane details or procedures in a specialized field” or “a student who spends much time studying and has little or no social life” or “one who studies an issue or topic thoroughly or excessively” (Various sources)].
Even readers with no need to see a definition of “assignment,” might be puzzled as to the words “pro tanto.” Even those who know what those words mean probably don’t realize that you can combine “assignment” with “pro tanto” and do serious harm to one party or the other to a lease.
Simply speaking, an assignment results in one party (the assignor) turning over all of its rights to another party (the assignee). The assignor (say, a tenant), absent some other agreement with the person or entity on the other side of an agreement (say, a landlord and a lease), retains obligations under that agreement (e.g., under the “lease”), but not any rights. [That’s not entirely accurate because there are ways to retain certain rights by way of agreement between the originally contracting parties, but that’s for another day. Today, we’re going to confuse readers enough with the “pro tanto” concept, such that we don’t need to go down a tangent at this point in the posting.] Basically, the effect of a tenant assigning its interest in a lease is that the tenant under the lease changes and the landlord now has to deal with a new tenant, the assignee.
By contrast, in a subletting, the identity of the tenant under the lease doesn’t change. Even though the named tenant may have given up its right to possession of the leased space to a “subtenant” (one who is “under” or “sub” to the lease’s actual tenant), the hallmark of a sublease is that, before the lease ends, the actual tenant gets back its “possession.” Commonly, this is done by making the sublease end before the “prime” lease ends, thus putting the actual tenant back in the space for as little as a day or less at the end of the lease’s term. Whether just giving possession of less than the entire leased premises absolutely, positively, certainly, incontestably, assuredly, unmistakably will be seen as a sublease (and not as an assignment) is one of the things today’s posting will explore. [Think: FedEx and whether any package showed up a day late.]
According to Wiktionary, the etymology of “pro tanto” is from pro (meaning “for”) + tanto the ablative singular masculine form of tantus (meaning “so great” or “so much”). [No, “tantus” is not a single (unmarried) aunt.] So, this Latin phrase can be translated as “For so much; for as much as one is able; as far as it can go.”
How does this help us? We’re afraid, not very much at this point, but it might yet make sense after we’ve Ruminated about what happens when “pro tanto” follows “assignment,” as in “assignment pro tanto.”
There is one more piece of background some readers will need, and it is that a real property lease is a hybrid agreement covering both property rights and contracts rights. It both “conveys” a right to use and occupy property and also covers a whole bunch of rights and duties very much like in a contract having nothing to do with real property. In the context of a lease, there is something called: “privity.” Merriam-Webster defines it as “a relationship between persons who successively have a legal interest in the same right or property.” Take note that this definition encompasses both a “right” and “property.” It doesn’t say, “the same right IN property.” So, a tenant may be either or both in “privity of estate (property)” with its landlord or in “privity of contract (right)” with its landlord.
When a tenant assigns its leasehold interest to an “assignee,” that assignee (assuming it has accepted the assignment) has privity of estate with its landlord, not necessarily “privity of contract” with its landlord. The landlord is “stuck” with the assignee when it comes to the “estate,” but, unless the assignee agrees with the landlord to accept the “contractual” obligations under the lease, it (the assignee) is not in privity of contract with the landlord. How that works is too complicated for today (and maybe for any day). So, we’re not going there.
The core of this “estate” thing is that the tenant, in return for paying rent, has the right of exclusive use and possession of the leased premises. That right comes from the landlord (usually being the property owner). Though we are far in time from the feudal times of Merry Old England, the distinction between estate and contract still has some serious effects, such as creating our subject today, an assignment pro tanto.
What is this creature, the “assignment pro tanto”? We’ll start with an example. Suppose you have a single lease for two adjacent stores or a single lease for two adjacent office suites and the lease term expires at the very end of December 31, 2023. Now suppose you sublet one of those stores (or offices) with a sublease term that expires at the very end of December 31, 2023. Unless a court finds that the sublandlord-tenant has reserved some possessory right to the “sublet” space or unless case law in a particular jurisdiction considers the two adjacent spaces inseparable such that the right for the sublandlord-tenant to possess the space it retained somehow gives it a possessory right to what it “sublet,” THE COURT WILL FIND that what seemed like a sublease was actually an assignment of part of the leased space. Yes, before the purported sublease, the landlord had one tenant for the two spaces. Afterwards, it has two separate tenants.
Now, we gave the example of two adjacent spaces. We didn’t have to do so. The sublandlord (inadvertently turned assignor) could simply have “sublet” a part of its space for the entire remaining term of its lease without retaining any right to get back into that space on the expiration date of the “sublease.” That could, absent some interfering factor, also turn out to be an assignment “for so much” (pro tanto) of the space that was “sublet.” Here it is, explained a little differently. Remember that a sublease has elements of a conveyance (transfer of some kind of “estate”) and elements of a contract. If a particular “sublease” gives away the sublandlord’s entire estate, the sublandlord has no estate left. It no longer has a connection to the “dirt.” It has ended its “estate” relationship with its (former) landlord. It no longer has “privity of estate” with that landlord. Yes, it still has a contractual relationship with that landlord, but its (leasehold) estate has been conveyed to what it called a subtenant. That’s why the result isn’t intuitive. In “real property terms,” a lease is just like a deed and if a deed gives the real property interest away such that it never comes back, the real property interest has been conveyed. A leasehold interest is a form of real property interest. That was good enough for King Arthur; it should be good enough for you.
Ruminations knows that many readers, in their heads, are taking the facts in those examples and twisting and turning them. Two adjacent spaces – not likely! Don’t be so quick. When a tenant ground leases land and turns it into a shopping center, the retailers there will all have subleases. That sets up a situation where, if the term of any of those subleases (each of which would only be for part of the ground tenant’s premises) ran right through the end of the ground lease’s term, they could very well turn out to be assignments. That would mean each of those particular retailers would be tenants of the ground owner, not of the shopping center developer. While their “contract” rights might come from the developer, their right of possession would actually come from the ground owner. That means the rent should be paid to the ground owner. This means that if such a “subtenant” pays its “sublandlord,” it can be forced to pay again, this time to the “real” landlord, the ground owner. It also means that only the ground owner can evict the retailer because “possession” comes from the ground owner.
[Here’s a note for those who want to argue that the way subleases are drafted, sublandlords never give up all of their rights. Check the case law in each jurisdiction where you want to make that argument. In many states, even a contingent “right of reentry” does not constitute a reservation of a right to possession though a “right of reentry” would seem to be a possessory right. This isn’t a law review article, so we’ll leave readers to look that up themselves.]
We didn’t want to do an exhaustive search of cases throughout the country to find one that illustrates our ground lease example. Instead, all we’ll do is direct readers to Middle Village Associates v. Pergament Home Centers, a New York case from the year 2000. You can find it by clicking: HERE. It will tell you about some of the case law and why this particular sublease was NOT an assignment pro tanto.
Does it matter that the parties intended a “sublease,” not some form of assignment? It appears not. “Intent” doesn’t seem to matter.
An assignment pro tanto is not limited to the inadvertent and unexpected “not really a” sublease situation. If a tenant were to assign the lease for only a portion of its space, that would create two tenants. In fact, there are times when this might be an intended result and could be used to effectuate a result that benefits the assigning tenant. For an example of how someone took advantage of an intentional assignment pro tanto, click HERE to see what the bankruptcy trustee did in the Brentano’s case. If you click there you’ll learn how this bankrupt tenant of two floors in a building designed a plan to assign its lease as it covered the fourth floor (and get money from that assignee) and then reject the pro tanto (third floor portion) of the space. Yes, create two tenants (effectively two leases) out of one tenant (and one lease), and then bail out on the third floor, leaving the landlord with a new tenant and only for the fourth floor.
Landlords, you might want to revisit your form leases and ban assignments of less than all of the tenant’s leasehold interest. You might want to ban subleases that do not end at least a day before the expiration date you’ll be inserting in the lease itself. You’ll want to review those requests for consent to an assignment or subletting a little more carefully in the future. After all, a few thousand people will have read today’s blog posted and they are now better armed to do mischief.
Now, Ruminations will return to “pro tanto,” but in a different context. Remember that it can be translated as ““For so much; for as much as one is able; as far as it can go.” Well, this is “pro tanto” for Ruminations but for the bonus that follows.
Here’s a bonus for those who reached this point and who were either wonks when they started or became one by reason of today’s posting. In the year 1578, English courts decided what is known as Dumpor’s Case. That case resulted in a “rule,” not surprisingly, the “Rule of Dumpor’s Case.” And, though intuitively wrong, it still applies, 437 years later, in many, though not all, states. It says that absent a specific provision to the contrary in a lease, once the landlord gives its consent to an assignment of the lease by its tenant (or if it acquiesces without formally consenting), a lease covenant saying that the tenant needs its landlord’s consent to an assignment is waived. Yes, even though a lease doesn’t say that the “tenant needs landlord’s consent” is for the “first” assignment only, that’s what the Rule of Dumpor’s Case says. The Rule doesn’t apply to sublettings. So, if you are a landlord and don’t like to be dumped upon, you’ll want even your shortest form of plain English lease to say that giving consent to any particular assignment or acquiescing to an assignment is not a waiver of Tenant’s obligation to seek consent to every other subsequent assignment.