The Journal of The DuPage County Bar Association

Back Issues > Vol. 25 (2012-13)

Commercial Lease Assignments: A Litigation Perspective
By Brian M. Dougherty

Introduction. In a perfect world, all tenants would perform their obligations under a lease, especially commercial tenants.  However, there may be circumstances when an assignment or sublease would be beneficial to all of the parties involved.  It might seem rather simple for a landlord to decide on whether to accept an assignment,[1] but that is not always the case.  There are some pitfalls in the process that can and should be avoided by being attentive to some basic details.  In exploring lease assignments issues, the goal is minimizing litigation exposure and protecting one’s interests, whether of the landlord or the tenant.

Privities of Estate and Contract.  In real property, two privities exist: estate and contract.  Where there are express covenants in a lease that run with the land, such as paying rent, the lessee is bound under both privity of estate and contract.[2]  Privity of contract continues until the end of the lease term.[3]  These are the hallmarks to any lease.  When an assignment of a lease occurs, these same two privities become relevant once again.[4]  Under privity of estate, the assignee under an assignment assumes no greater liability under the lease than the assignor/tenant and is liable for only those covenants that run with the land, such as the payment of rent.[5]  Privity of contract can be created if the assignee assumes the obligations of the assignor/tenant under the lease.[6]  An assignment is interpreted the same way as any other contract:  “[t]he creation and existence of an assignment is determined according to the intention of the parties and that intention is a question of fact derived from the instruments executed as well as the surrounding circumstances.”[7]  For instance, many, if not all, commercial leases impose liability on the tenant for rent even if the tenant vacates the premises prior to the lease term expiring.  A “rent survival” clause would be a contractual obligation assumed by the assignee.  Thus, even if the assignee terminates possession under the lease, under privity of contract, it remains liable for all obligations under the lease.[8]  This may be academic in these times, since almost all commercial lease assignments require the assignee to assume the lease in toto.  However, an assignment does not necessarily create privity of contract in the absence of express language to the contrary.[9]  From a landlord’s perspective, the landlord wants privity of estate and contract created in an assignment because it creates two liable parties under the lease: the tenant and assignee.  An assignee would then have liability co-extensive with the assignor if the assignee defaults under the lease.  Certain circumstances may exist where an assignee may not want to assume the obligations under the lease (e.g. assignee takes over for an insolvent tenant).  An assignee needs to carefully craft language making this clear since most assignments, especially commercial ones, involve both privity of estate and contract.

Unreasonably Withholding Consent.  When drafting an assignment provision in a lease, two options exist.  The first option is setting forth in specific detail what criteria must be met in order for a landlord to even consider an assignment.  For example, if the tenant is a restaurant, a lease may require the assignee to have at least 5 years of restaurant ownership experience and $250,000 in unencumbered assets.  This gives the landlord some assurance that the assignee is not some “fly-by-night” establishment.  Withholding consent, based on objective grounds (such as experience and asset value), which are contained in a lease, are generally reasonable as a matter of law.[10]  Second, leases may generally provide that assignments must be approved in writing by the landlord and a landlord will not unreasonably withhold its consent.[11]  A condition precedent to the lessor’s duty to accept an assignee or subtenant is that the tenant must tender a suitable assignee.[12] Thus, before the landlord could be liable for a failure to consent, the tenant has the burden of proving at trial that it tendered a person who was “ready, willing and able” to take over the lease and met reasonable commercial standards.[13]  Reasonable commercial standards include the financial responsibility of the proposed tenant, the type of business to be conducted, and whether the proposed business competes with any other lessees (e.g. multi-unit shopping center).[14]  Financial responsibility is the most important characteristic.[15]  Where the proposed tenant is insolvent or of dubious financial responsibility, the landlord’s refusal would not be unreasonable.[16]

In Jack Frost Sales, Inc., the proposed tenant was a corporation that had never gone into business.[17]  Its stated capital was $1,000, but there was no evidence that the corporation had any money.[18]  One shareholder had some wealth, but was under no obligation to support the corporation other than having placed money in escrow.[19]  There was also no evidence that the landlord was ever given any documentation of financial responsibility.[20]  The only information given to the landlord related to two other individuals, but not the corporation.[21]  Even though one of the two individuals was financially responsible, there was no evidence that she would guaranty the lease.[22]  By way of comparison, in Vranas & Associates, a corporation was an assignee.[23]  But this time, the evidence showed it was financially responsible having been incorporated with $25,000 and a guaranteed $250,000.[24]  The landlord was also given a security interest in the fixtures and inventory.[25]   

In practice, a tenant would have to provide the landlord with adequate documentation showing that the assignee was commercially reasonable.  Such information may include references, personal or business financial statements, tax returns, and business plans.  If the tenant fails to provide this information to the landlord, it is in no position to assess the tenant’s request and it cannot be said that the landlord’s refusal to accept an assignment is unreasonable.  Only when the tenant provides the landlord with sufficient documentation and the landlord rejects the prospective tenant is there a factual issue for trial.  Landlords should provide a tenant with a written description of the required documentation needed for assignment consideration.  All communications on the topic should be properly documented as well, in case litigation arises from a failed assignment.      

Exclusivity clauses.  Another issue of concern to landlords, especially landlords in shopping centers, are lease provisions impacting other tenants.  Tenants in a shopping center generally do not want competitors in the same center for obvious reasons: competition cuts revenues.  Tenants may require an “exclusivity” clause in a lease.  An “exclusivity” clause would prevent the landlord from leasing to a competitor or a business that services substantially the same clientele.  Exclusivity clauses are generally enforceable covenants.[26]  For instance, Tenant A might be a Thai restaurant.  Tenant A may insert a clause in its lease preventing its landlord from leasing to a restaurant serving Southeast Asian cuisine.  Tenant B might be a Vietnamese restaurant looking to rent from landlord.  Tenant A’s lease clause would prevent landlord from renting to Tenant B.  Where a lease clause prohibits a business competitor from being a tenant, the lessor can reasonably exercise its power and withhold consent to an assignment regardless of how acceptable the assignee would be.[27]  Shopping center landlords should keep a master record of all leases that have exclusivity clauses that can easily consulted when assignments are being considered for other tenants.  This minimizes the risk of an oversight when negotiating a new lease.   

Non-default clauses.     Under Illinois law, a lease is an agreement subject to the law of contracts.[28]  Private parties are free to contact as they see fit subject to public policy restrictions.  Thus, a contract whose terms violate the Constitution, statutes or decisional law will be unenforceable.  Shrewd landlords may insert what is known as a “non-default” clause as a condition to approving an assignment.[29]  A “non-default” clause generally provides that in order for a landlord to consider an assignment, a tenant must not be in default under the terms of its lease (e.g. tenant must be current in rent).  Landlords do not want tenants to fall behind in rent and then come to the landlord seeking an assignment.  An assignee may be unwilling to assume contractual obligations that include a tenant’s past due rent.  Landlords would be hard pressed to get an assignee to agree to that.  One Illinois case addressed this issue in a different way.  In Golf Management Co., Inc., the landlord argued that the tenant could not allege that the landlord unreasonably withheld its consent because the tenant breached the lease first.[30]  Because of this, the tenant could not take advantage of the lease’s terms.  The court found otherwise because the landlord breached first.[31]  Notwithstanding, the doctrine of material breach prevents the breaching party from taking advantage of favorable lease terms.  This is but another way of preventing a tenant from claiming that landlord unreasonably withheld its consent. 

Mitigation of Damages and Assignments.  There is one Illinois statute that must be dealt with in virtually every breach of a lease case with an unexpired lease: 735 ILCS 5/9-213.1.  This statute provides that a landlord must use reasonable measures to mitigate its damages after a tenant vacates a leasehold.  This means that if a tenant goes out of business and vacates the space, the landlord cannot let the space remain vacant and collect rent from the tenant.  Commercial leases usually provide that even if a tenant abandons the leasehold, that the tenant will still remain liable for the financial obligations (e.g. rent) under the lease (e.g. “rent survival” clause).  Section 9-213.1 tempers this obligation by requiring the landlord to take affirmative steps to find a replacement tenant to take over the space and pay rent.  If the landlord fails to take such steps, it could be barred from collecting rent from the defaulting tenant during the period of time that the landlord failed to take reasonable measures.

Mitigation issues arise also arise when the tenant defaults, but tenders one or more suitable assignees for the lease.  The landlord refuses to review any of the assignees’ applications or financials citing the non-default clause in the lease.  Arguably, the landlord has breached its statutory duty under section 9-213.1 because it failed to review the proposed assignees’ financials or other relevant documents.  The tenant has proposed suitable replacement tenants that could have feasibly taken over the leasehold.  The statutory duty to mitigate, which is public policy in Illinois, would trump the landlord’s reliance on the non-default clause.  As applied to these facts, the non-default clause would offend public policy embodied in section 9-213.1.  Landlords that have non-default clauses must be careful when a tenant abandons a space.  If the tenant wants assist in locating potential replacement tenants, landlords should make sure that the tenant still follows the assignment criteria supplied by the landlord. 

Execution of Assignment Documents.  A lease assignment typically results in the tenant/assignor signing a “consent to assignment” document with the landlord and assignee.  If the assignment is going to be guaranteed by third-parties, a guaranty contract would be executed contemporaneously as part of the assignment.  In some instances, the landlord may require the officers of a corporate tenant, or other business entity agent(s), to sign the consent to assignment in their individual capacities.  The same individuals may also be guarantors, which might have granted them rights under the lease such that they can assert a tenant’s defenses if things go awry.  However, this issue has been addressed; in Lancaster v. Roberts,[32] Roberts and Lancaster entered into a sales contract.  The sales contract was signed by Roberts and Lancaster, as well by Jones and Ann Lancaster.  The sales contract, however, did not refer to Jones or Ann Lancaster in the body of the instrument, although it was signed by them.  The Illinois Supreme Court held that:

It would seem, however, upon reason and principle, that when a third person merely annexes his name to a contract which, in the body of it, does not mention him, and which is in itself a complete contract between other parties, who sign it and are mentioned in it, such third person does not thereby become a party to the efficient and operative parts of the contract. His signature, in such case, can only be regarded as an expression of his assent to the act of the parties in making the contract, and may perhaps operate as an estoppel against his assertion in the future of an adverse interest in the subject-matter of the agreement.[33]            

Other courts have been in accord.[34]  As long as the individuals who sign the consent to assignment are not named in the body of the document as having any rights, such as being a “tenant,” they acquire no rights under the lease.  It is as if they are signing the consent to assignment just to acknowledge the lease as being the operative document governing the landlord-assignee relationship.  Landlords should be careful when having non-tenants signing assignment documents.  Language should clearly provide that any signatories are not acquiring any rights and are merely signing as witnesses or acknowledging the lease as being the correct contract.    

Conclusion.  Handling lease assignments can bring a variety of issues to the table for the landlord.  Most leases will have general language preventing a landlord from unreasonably withholding consent to an assignment. The big picture issue for the landlord is making sure there are enough responsible parties in case the tenant’s business fails and there are major outstanding liabilities.  This leaves the landlord with as much recourse as possible.  Personal guaranties are a solid avenue for a landlord since guarantors typically would not acquire any rights under the lease and all defenses against the landlord would be waived. Landlords should also make sure that the assignee remains liable for contractual obligations if possession is surrendered prior to the lease’s expiration.  Painstaking attention to detail in the transactional phase will certainly result in less headaches if litigation ensues down the road.

[1] This article will focus mainly on assignments since that is the majority of cases on the subject.  Some of the rationale contained herein may be equally applicable to subleases. 

[2] Consolidated Coal Co. of St. Louis v. Peers, 1666 Ill. 361, 366-67 (1896)

[3]  Id

[4]   Kagan v. Gillett, 269 Ill. App. 311, 1933 WL 2462, at *6 (1st Dist. 1933) 

[5]   Cork-Oswalt, Inc. v. Hickory Hotel Company, Inc., 20 Ill. App. 2d 406, 410 (3rd Dist. 1959); Kewanee Boiler Corporation v. American Laundry Machinery Co., 289 Ill. App. 3d 482, 7 N.E.2d 461, 463 (1st Dist. 1937) 

[6]    Id, 7 N.E.2d at 463 

[7]   Service Adjustment Co., Inc. v. Underwriters at Lloyd's London, 205 Ill. App. 3d 329, 334 (1st Dist. 1990) 

[8]   Id

[9]   Id

[10] See Toys “R” Us, Inc. v. NBD Trust Company of Illinois, 1995 WL 591459, at *38 (N.D. Ill. October 4, 1995); B.M.B. Corporation v. McMahan’s Valley Stores, 869 F.2d 865, 868-69 (5th Cir. 1989) 

[11] Golf Management Co., Inc. v. Evening Tides Waterbeds, Inc., 213 Ill. App. 3d 355, 360 (1st Dist. 1991) 

[12] Jack Frost Sales, Inc. v. Harris Trust and Sav. Bank, 104 Ill. App. 3d 933, 944 (1st Dist 1982)

[13] Id

[14] Vranas & Associates, Inc. v. Family Pride Finer Foods, Inc., 147 Ill. App. 3d 995, 1003 (2nd Dist. 1986) 

[15] Jack Frost Sales, Inc., 104 Ill. App. 3d at 946

[16] Id

[17] Id at 947

[18] Id

[19] Id

[20] Id

[21] Id

[22] Id

[23] Vranas & Associates, 147 Ill. App. 3d at 1004

[24] Id

[25] Id

[26] Walgreen Co. v. Sara Creek Property Co., 775 F.Supp. 1192, 1196 (E.D. Wis. 1991), aff’d, 966 F.2d 273 (7th Cir. 1992) 

[27] See Arrington, 30 Ill. App. 3d at 641; see also Edelman v. F.W. Woolworth Co., 252 Ill. App. 242, 1929 WL 3172, at *2 (1st Dist. 1929) 

[28] American Apartment Management Co. v. Phillips, 274 Ill. App. 3d 556, 559 (1st Dist. 1995) 

[29] Gladitz, Inc. v. Castiron Court Corp., 677 N.Y.S.2d 662, 666 (N.Y. Sup. May 19, 1998) 

[30] Golf Management Co., Inc., 213 Ill. App. 3d at 363

[31] Id

[32] 144 Ill. 213 (1893)

[33] Id at 222-223

[34] Doyle v. Dunne, 144 Ill. App. 14, 1980 WL 2059 (1st Dist. 1908); Fuchs v. Block, 1910 WL 2139 (1st Dist. 1910); In re Wirth, 355 B.R. 60 (N.D. Ill. Bankr. 2005) 

Brian M. Dougherty is an associate in the litigation group at Goldstine, Skrodzki, Russian, Nemec and Hoff, Ltd. His practice area comprises commercial landlord-tenant matters, representing employees and employers in employment disputes arising under state and federal law and business torts. He is a member of the DCBA Bankruptcy Law, Business Law, and Labor and Employment Committees.

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