Power centre leases: Assignment, subleasing and change of control

October 2009

Power centre leases: Assignment, subleasing and change of control

bouton-vers-francaisFredric L. Carsley
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For both landlords and tenants alike, the assignment, sub-let and change of control (collectively "Transfer") are primarily exit strategy driven and at times, re-organized. The plethora of US retailers re-organizing is self explanatory. For Secured Lenders, the preoccupation is simple, and best explained in the following provision from the standard Hypothèques CDPQ Inc. hypothec:
 
13.3 L'emprunteur s'oblige à ne consentir à aucune cession de bail qui aurait pour effet de libérer l'ancien locataire sans le consentement préalable écrit du prêteur.

Types of tenant transfers

Landlords

Sophisticated landlord leases address three kinds of transfers:

  • Assignment of the lease
  • Sublet of all or part of the premises
  • Change of control of the tenant, by a corporation, general partnership, limited partnership, trust or other legal structure

Note that change of control is not addressed in the CCQ. If the lease is silent on matters such as requiring the landlord's consent to such a transfer, the law would not assist the landlord here. So a tenant could sell its business by selling shares as opposed to assets, and avoid the landlords.
 
Sophisticated landlord leases also address involuntary Transfers, such as those resulting from insolvency, and transfers by operation of law, such as lease assumptions resulting from amalgamations and other re organization techniques.

Tenant concerns

Tenants seek as much flexibility as possible to:

  • exit as required
  • sell, either individually or in larger packaged transactions
  • re-organize for business and tax planning purposes

The consent requirements and process then come into play in each of these schemes

Consent matters

Absolute prohibitions

Prior to 1973, former Article 1638 of the CCLC gave the tenant the right to assign or sublet, unless the lease stipulated otherwise. It was felt that absolute prohibitions to assign or sublet were not illegal, but where the landlord's consent was required, it had to be exercised reasonably.
 
As part of the 1973 reform, Article 1619 CCLC was supposed to ensure that landlords acted reasonably in refusing consents. In fact, the provision was drafted in a manner that was somewhat restrictive from the tenant's perspective, by stating in the first paragraph:

"The lessee cannot sublet all or part of the thing or assign his lease without the consent of the lessor, who cannot refuse it without reasonable cause." (Emphasis added)

Article 1870 CCQ appears to create more of a right in favour of the tenant than a restriction, subject of course to obtaining the landlord's consent. Article 1870 CCQ states:

"The lessee may sublease all or part of the leased property or assign his lease. In either case, he is bound to give notice of his intention and the name and address of the intended sublessee or assignee to the lessor and to obtain his consent." (Emphasis added)

With this apparent change in the text and given the protectionist nature of the CCQ, one wonders if the courts would uphold an absolute prohibition against assignment or subletting. For example, in the case of Family Life Assurance Co. v. Crecco , the court held that where a lease contained a clause prohibiting assignments or subleases, the tenant was simply prohibited from doing so and the landlord was not required to give any reason for refusing its consent. The Crecco decision has been criticized in doctrinal writing as being contrary to the basic obligation to act reasonably . However, the principle was addressed by the Quebec Court of Appeal in the 2000 case of Malouin v. Ferme Guy Bonin enr. , where a lease clause prohibiting assignment or sublet "sans la permission préalable du locateur" required the landlord to act reasonably in refusing consent, although the clause did not expressly so state. As Justices Rousseau Houle and Biron pointed out in their majority opinion, if the landlord was not obliged to act reasonably in refusing consent, the clause would be a purely potestative condition. This of course would be null as a result of the application of Article 1500 CCQ.

Justice Beauregard, in dissent, made the following remark that is germane to absolute prohibitions:

"L'appelant concède que les articles 1870 et 1871 ne lui donneraient aucun droit si la clause du bail avait simplement stipulé que le locataire n'avait pas le droit de sous-louer les lieux."

This case was about sub let, but we can assume that the same reasoning would apply to assignment.

A serious reason

Article 1871 CCQ stipulates that the landlord may not refuse its consent without "a serious reason". The French text uses the phrase "un motif sérieux". Given the body of jurisprudence which exists that has interpreted the concept of "consent not to be unreasonably withheld" in assignment and subletting situations, it is surprising that the legislator did not use the "reasonable cause" test contained in the CCLC. However, it is submitted that for practical purposes, there should not be much, if any, difference between the two notions.

Justifying the refusal

The second paragraph of Article 1871 CCQ requires that the landlord motivate the grounds upon which he was refusing his content. It states:

"If he refuses, he is bound to inform the lessee of his reasons for refusing...". (Emphasis added) 

It is submitted that this is of public order and may serve to invalidate clauses which purport to give the landlord the right to act arbitrarily or in its sole and unreviewable discretion.

"Deemed reasonable"

A practice has developed in many form leases, whereby the landlord lists a series of reasons which the parties agree in advance will be deemed as reasonable cause to refuse consent. This practice, which was approved of in the case of Les Immeubles Bleury Dorchester Inc. v. Banque Nationale du Canada , should be continued and perhaps the matters listed should be re examined and expanded. However, unreasonable provisions may not be upheld by the courts, despite the fact that the lease purports to "deem" them to be reasonable.
 
Criteria common to all asset classes include financial and operational capability, or simply put, can the landlord be reasonably assured that the proposed transferee will be able to perform the tenant's obligations under the lease?
 
Others are unique to the asset class, such as tenant mix concerns in shopping centres.
 
One area which is becoming more and more prevalent is the so called "cross default" notion, whereby if a tenant is in default under one lease it will be deemed to be in default under another lease, usually either with the same landlord or with a company which manages the two properties in question. The "deemed reasonable" list has, in many cases been expanded to include defaults either by the assignor or assignee under a related or connected lease, and this practice should continue as well.

Delay to advise

Under the CCLC, unless the landlord responded within fifteen days of the receipt of the request to assign or sublet, the landlord was deemed to have consented to the request.
 
In the first reading of Bill 125 (which eventually developed into the CCQ), the delay was reduced to ten days. As a result of interventions made by the Bar of Quebec and other groups, the delay was re established at fifteen days.
 
For many landlords, fifteen days may not be long enough to determine if the assignee or subtenant is acceptable. In these cases, the delay should be extended contractually.

Release of assignor on assignment

Under the law existing prior to January 1, 1994, the assignor was not released from its obligations under the lease unless the landlord specifically agreed to the release. In fact, most leases stated that if the lease was assigned, then the assignor must remain jointly and severally liable for the obligations of the tenant under the lease. Most hypothecs on rents and leases used by real estate lenders provided, among other matters, that in the event of an assignment of the lease, the landlord is not permitted to release the assignor from its obligations without the lender's consent.
 
Article 1873 CCQ introduced a new concept into the law. It provides that an assignor is automatically released from its obligations under the lease, save that in the case of commercial leases, the lease may validly provide otherwise. Clearly it is crucial for landlords to contract out of the effects of Article 1873 CCQ in any lease, offer to lease or any other leasing agreement for commercial premises.
 
In many cases, while the leases themselves deal with the issue satisfactorily, the offers to lease are silent on the matters of Transfers. As occurs all too frequently in practice, the leases are not executed for a considerable length of time or may in fact never be executed and the parties are governed by the terms of the offer to lease. This could prove disastrous for a landlord, who, believing that it has contracted with an "asset company", finds that the tenant has assigned the lease to a no asset shell (whether it be related or unrelated to the tenant) and is left with little or no security for the payment of rent and the fulfillment of other obligations of the tenant under the lease. Landlords should ensure that their offers and other similar contracts contain assignment and subletting clauses that contract out of the release provided for in Article 1873 CCQ.
 
It should be noted that in the first draft of the Article 1873 of the CCQ (then Article 1861), the release would only apply in the circumstances where the assignor was obtaining the landlord's consent. Under Article 1873 CCQ as finally enacted, the release applies in any circumstances where an assignment is being made. This could apply even where assignments are permitted without the landlord's consent, such as assignments to related corporations, assignments to a purchaser of a larger business and other assignments which the landlord agrees to permit without having to obtain its consent.

Subleases

Basic legal notions of subleases

A sublease is a "lease within a lease" where the sublandlord/head tenant grants peaceable enjoyment to the subtenant on the terms and conditions of the sublease.
 
There is no contractual lien de droit between the head landlord and the subtenant, although Article 1638 CCLC extended the landlord's privilege to the moveable effects located on the premises that belonged to the subtenant to the extent that the subtenant was indebted to the head tenant.
 
This lack of lien de droit has traditionally left the subtenant in an extremely precarious position. As the courts have held on several occasions , if the head lease is cancelled, terminated or resiliated, the sublease no longer has any effect. The subtenant must relinquish its possession of the premises and the only recourse it may have is to claim damages against the head tenant/sublandlord. Not only is this unsatisfactory to the subtenant who wants to remain in the premises, but may even be illusory if the sublandlord proves to be insolvent.
 
Most of the examples in the jurisprudence deal with the landlord exercising a right to cancel the lease as a result of the head tenant's default. It has even been suggested that where the head landlord and the head tenant voluntarily agree to terminate the head lease, this would entail the effective termination of the sublease . From the subtenant's point of view, this clearly does not yield a very satisfactory result.

CCQ provisions

Articles 1874, 1875 and 1876 CCQ bring certain innovations to the law regarding subleases, but they may not resolve the fundamental problem of the subtenant who wants to remain in the rented premises.
 
Article 1874 CCQ appears to be a carry over of the rule contained in Article 1620 CCLC. Article 1874 CCQ provides that the subtenant cannot be required to pay amounts that are greater than what the subtenant is required to pay under the sublease. Suppose the sublease is either in good standing or alternatively, the subtenant pays all amounts owing to the head tenant, but in either case, the defaults under the head lease are not fully cured. If the landlord seeks to cancel the head lease, would the subtenant still retain any rights to remain in the rented premises or would the existing jurisprudential position based on no lien de droit continue to apply?
 
The legislator may have thought that it was creating some special right in favour of the subtenant, but if it was doing so, certainly Article 1874 CCQ (or for that matter the other articles) do not appear to come to the subtenant's rescue; to argue otherwise would mean that if the subrental is less than the head rental, the head landlord would effectively have to accept the lesser amount. This surely cannot be the intention of the legislator.
 
Doctrine and case law would appear to support this view. Professor Pierre Gabriel Jobin :

"Les rapports entre le locateur principal et le sous-locataire sont quelque peu complexes. Il faut d'abord rappeler qu'en règle générale suivant l'effet relatif des contrats, il n'existe aucun lien contractuel entre eux."

Justice John Bishop of the Quebec Superior Court, in the case of Fairview Pointe Claire Leaseholds Inc. v. Café Suprême et P. Ltée agreed with Professor Jobin, in ruling that Article 1876 CCQ does not give the sub tenant the right to resiliate the head lease or to seek a rental reduction. Rather, Article 1876 CCQ permits the sub tenant to "exercise the rights and remedies of the lessee to have them performed", referring of course to the landlord's obligations under the head lease. This is a legislative exception to the general rules flowing from the principal of relativity of contracts and would not be required had the CCQ chosen to create a lien de droit between the principal landlord and the sub tenant.
 
Cancellation may not necessarily be in the landlord's best interest, particularly in weak markets where tenants are difficult to find. To maintain cash flow, landlord's leases should provide that a sublease cannot be at rentals which are less than the rentals payable under the head lease. To avoid the situation where the subtenant pays the head tenant but the head tenant does not pay the head landlord, provide in the lease that the subrentals are assigned to the head landlord and that the subtenant pays directly to the head landlord.
 
Articles 1875 and 1876 CCQ appear to give the head landlord and the subtenant certain rights against one another, despite the fact that there may be no contractual lien de droit. Article 1875 CCQ entitles the head landlord to resiliate the sublease where the subtenant is in default and the default is causing the landlord or other lessees or occupants serious prejudice. Article 1876 CCQ permits the subtenant to exercise remedies normally belonging to the tenant where the landlord is not fulfilling its obligations under the head lease. For example, if the landlord is supposed to clear the snow from the parking lot and it is not being done, the subtenant does not have to rely on the head tenant to force the landlord to do so, but would be entitled to force the head landlord to do so directly.
 
These latter two articles (Articles 1875 and 1876 CCQ) probably would not have been necessary if the law intended to create a direct lien de droit between the head landlord and the subtenant, thus further substantiating the argument that the subtenant is still at risk.
 
The subtenant should protect itself by obtaining an attornment agreement from the landlord entitling the subtenant to continue the lease if the head tenant defaults.
 
This may create negotiating problems. At the head landlord level, the sublease terms may be less favourable to the head landlord than are the terms of the head lease. At the level of the head tenant and the subtenant such as in franchise and affiliation situations, the head tenant may have a particular interest in what is known as "controlling the real estate" and may not wish to confer an advantage upon the subtenant.
 
At the operating level, it is impractical to avoid the sub tenant, even though contractually there is no lien de droit. Many retail chains operate through franchise, affiliation or other arrangements where the operator is not merely the store manager. While the chain's interests are more widespread, the operator's interests are singular to this specific location. Landlords must understand that relationships with real estate people aside, the chain operator must satisfy its franchisee with whom it has a contractual relationship.
 
The chain tenant might say that it is not in default if the franchisee causes the default. The landlord response should be that it is up to the chain to control the franchisee.

Tenant issues

Consent matters

As in other "tension areas" of landlord tenant relations, while landlords traditionally seek optimum control, tenants traditionally seek optimum flexibility to achieve their business objectives. Here is a non exhaustive list of concerns, some of which are obvious while others are not:

Consent

The tenant will not want the landlord to frustrate the sale of its business. Some instances:

  • refusal to grant consent
  • rights to terminate in lieu of granting or refusing consent
  • rental increases following the Transfer, such as increases of Minimum Rents in retail Leases to Effective Rent (Minimum and Percentage Rent aggregations) as the financial guarantees increase. Here the landlord is really seeking to improve its position, as had the Transfer not occurred, the Minimum Rent guarantee should not increase
  • payment of consideration for the Transfer to the landlord, which re directs the profit from the tenant, and brings into play a lengthy discussion as to who benefits from the incremental value: - is it the property itself, the efforts of the landlord, of the tenant, or any combination of the foregoing?

Solidary liability

Secured lenders will not permit the release of the tenant from any of its obligations. However, tenants should be wary of obligations they may not be able to control, such as continuous operation in retail leases. An interesting example is found in the case of Compagnie de Construction Belcourt Ltée v. Golden Griddle Pancakes House Ltd. , where a restaurant franchisor agreed to a continuous operation covenant and then assigned the lease to a franchisee who closed the restaurant. A mandatory injunction was awarded against the franchisor to re open, and operate the restaurant. Not easily negotiated, but a carve out of this obligation would have avoided the problem.
 
It is not surprising that many franchise operations are set up with the franchisee as the tenant and the franchisor securing an option to acquire the lease upon the franchisee's default. landlords should be careful here not to expose themselves to situations where third parties such as trustees in bankruptcy possess and exert rights over the lease. As the landlord cannot control this situation as readily, the franchisor's rights must be subordinated to and conditioned upon such third party rights.

Non arm's length transfers

Consent: Most landlords will not object to permitting non arm's length transfers without consent, provided there is continued solidary liability and continuity of control and management. Most criteria should be readily achievable. However, solidary liability creates issues in: 

  • Amalgamation, as two or more become one rendering solidary liability a legal impossibility
  • Certain tax driven re-organizations where the transferor must be wound up to effect the "re org", such as the Section 88 re-organization under the Income Tax Act (Canada)

Rental increases, cancellation rights and other special landlord rights should be carved out for non arm's length transfers.
 
Landlords should insert language in the lease requiring assurance that the net worth of the transferee will be no less than that of the tenant transferor.

Publicly traded tenants

Many standard leases carve this out from the change of control requirements, usually subject to management and operational criteria.

Rental increases / cancellation rights

As these practically only come into play in successful locations during "up markets", tenants should strive to limit these rights as much as possible. A few tips:

  • retail chains will want to limit the cancellation rights to isolated Transfers; landlords will want to set a minimum number of locations within a geographical area to allow the continuance of a chain in their properties
  • sub leases that are used for partial spaces; a tenant may wish to temporarily "lay off" some space but reserve the right to re¬claim it should it wish to expand in the future
  • for single lease operations, such as manufacturers, if a potential purchaser would want to acquire the plant, a cancellation right may significantly adversely affect the sale of the business

Use limitations

As discussed above, restrictive use clauses interplay with the consent process.

Alterations limitations

Particularly for larger spaces such as "big box" tenants, the ability to sub divide and sub lease at rentals that are considerably greater than the lease rentals can yield an attractive real estate play, particularly where the target possesses both performing and non performing assets. However, as Target stores are reported to have discovered when analyzing Zellers leases, the ability of landlords to control exterior alterations requiring landlord's consent proved discouraging to say the least. Take for example a 60,000 square foot Zellers store that could be physically sub divided into 3 units of 20,000 square feet each, to say Bureau en Gros, Future Shop and Winners. Each new retailer would require its own storefront, and an exterior entrance directly to the parking lot. Target Stores' assessment was in many situations there could only be one exterior entrance from which each would have a "mini mall", a circumstance that most leasing experts would conclude would severely limit the re tenanting process.

Assignment by landlord

Landlord-drafted leases usually release the landlord from future obligations to the tenant when the landlord assigns its rights. Landlords should ask for this in tenant drafted leases.
 
Tenants should agree to the concept provided that: 

Landlord-drafted leases usually release the landlord from future obligations to the tenant when the landlord assigns its rights. Landlords should ask for this in tenant drafted leases.   Tenants should agree to the concept provided that:

  • the assignee assumes the landlord's obligations
  • the release should not apply to landlord defaults existing at the time of the Transfer, to which landlords should add a "materiality" qualifier

Strong credit anchors may insist upon reasonably satisfactory evidence that the assignee has the financial and operational capacity to perform the landlord's obligation as a pre condition to the release.

Secured lender issues

Essentially, the Secured Lender has the same basic concerns as the landlord, and as indicated at the outset, will not permit the release of the tenant without the Secured Lender's consent.
 
When acting for a landlord, or reviewing leases for a purchaser or a Secured Lender, especially when the lease is on the tenant's form, pay particular attention to clauses that release the tenant on a Transfer. In principle, these are simply not financeable and should not be agreed to.
 
Secured Lenders sometimes wish to approve Transfers involving anchor tenants. This may not be practical in terms of normal operational requirements, and particularly in securitized lending with its lengthy and cumbersome approval process, not viable. Borrowers should try to either resist this or pre-clear the process with their anchors in the leases.
 
As a minimum, borrowers should negotiate a delay for the service to respond, failing which it will be deemed to have consented. This delay should reflect the delay the borrower as landlord has to respond to the tenant.
 
Substantively, the borrower must oblige the secured lender to refuse on grounds upon which the landlord would be reasonable in refusing the consent. Otherwise, the landlord could find itself squeezed between its obligation to the secured lender. Obtain the secured lender's consent, and its obligation to the tenant not to refuse consent unreasonably.
 
This series of articles addressing some of the more controversial and business-oriented concerns of developers, tenants, shadow anchors and secure lenders, will be completed in our next issue with the last article regarding the notions of use and change of use in the case of power centre leases.

 

 

 

 

 

 

 

 

 

 

 

 

This bulletin provides general comments on recent developments in the law. It does not constitute and should not be viewed as legal advice. No legal action should be taken on the basis of the information contained herein.

 

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