Canada: Lease Take-Overs: Key Issues and Concerns

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate, April 2010

A lease take-over is an arrangement whereby a landlord agrees to assume some or all of the prospective tenant's remaining obligations under its existing lease in order to induce the tenant to enter into a new lease for premises in the landlord's building. The landlord would typically assume these obligations under the tenant's existing lease from and after the commencement date of the new lease.

Such arrangements often arise in the context of the construction of new, large office buildings wherein the financing of the project may be dependant on lease agreements having been signed with tenants representing a certain percentage of the leasable square footage of the building. In such situations, the landlord is incentivized to induce one or two significant-sized "anchor" tenants into lease agreements in order to meet such financing thresholds. Sophisticated tenants, however, are conscious of the probability of delays inherent in any large construction endeavour and are wary of the risks that may result. The new building may take several months or even years to complete, and the planned completion date may be delayed by construction or other issues. As a result, a tenant may lack some degree of certainty as to when it will be able to occupy its new premises and, in the interim, how to deal with its existing premises and landlord. In particular, the tenant may lack the ability to overhold in its existing premises and be forced to face the very real possibility of having nowhere to go after the expiry of its existing lease if the new premises are not ready for occupancy at that time. Most tenants cannot bear the business interruption risk of office downtime between lease arrangements.

The lease take-over solves many of these problems. For the landlord, it allows it to sign up a lease in order to meet financing thresholds. For the tenant, the lease take-over provision in the tenant's new lease would provide for a period of lease overlap, thereby averting the business interruption risk. Additionally, lease take-overs may accommodate issues created by prior expansions of the tenant's existing premises where termination dates may vary or the leased premises may no longer be contiguous. The tenant may therefore wish to take advantage of the lease take-over arrangement as an opportunity to consolidate premises or termination dates.

While lease take-overs provide a useful response to a number of leasing issues in new office buildings, there are several key areas of concern of which both tenants and landlords should be aware. From the tenant's perspective, following commencement of the new lease, although no longer in physical possession or occupation of its old premises and notwithstanding that the new landlord may have agreed to assume the tenant's existing rent obligations, the tenant remains primarily liable to fulfil its obligations under the existing lease and is therefore responsible for any default of the new landlord in making such rental payments. Tenants should therefore seek to include provisions in the new lease to mitigate such risk by allowing them to set off any payments owing under the new lease against rent arrears under the existing lease. If the landlord (or in some cases, the landlord's lender) will not agree to the tenant's right to set off such amounts, as a fall-back position, the tenant should consider requesting a letter of credit to secure the landlord's obligation to make the rental payments under its existing lease. Additionally, the tenant may wish to include provisions entitling it to receive a portion of any consideration arising from the early surrender of the existing lease where negotiated between the new and existing landlords. Further, although the landlord is agreeing to assume certain of the tenant's remaining financial obligations under its existing lease, the tenant should consider requiring the new landlord to assume all of its lease obligations, as there may be restoration, repair, insurance or other obligations that the tenant will continue to be responsible for during and at the end of the term of the existing lease.

On the other hand, there are a number of issues that the new landlord should seek to address. The new landlord should ensure that the lease take-over provision is drafted so that its obligations are contingent on: (i) reviewing and approving the existing lease (in particular, the new landlord will want to confirm that the existing lease provisions on assignment or subletting are not unduly restrictive); and (ii) requiring the tenant to obtain an estoppel certificate from the existing landlord for the existing lease confirming that the existing lease is in good standing.

It goes without saying that the landlord will wish to recover as much of the cost of carrying the balance of the tenant's existing lease commitments as possible by trying to assign or sublet the premises to a third party or negotiating an early surrender agreement with the existing landlord. However, since the legal relationship under the existing lease is between the tenant and the existing landlord, the landlord has no legal standing under which to take any action with respect to the existing premises. As such, the lease take-over agreement should require the tenant to co-operate fully with the new landlord with respect to its efforts to assign the existing lease, sublet the existing premises, or to arrange a surrender of the existing lease or otherwise dispose of the existing premises. The tenant should also be required to seek all necessary consents or to provide any executed documents required in connection with such efforts by the landlord. The tenant should not be permitted to renew, extend or otherwise amend the existing lease without the new landlord's prior written consent. Additionally, the tenant should be contractually obliged to execute any consents or other documents within a reasonable or specific period of time, regardless of any alleged defaults or other outstanding issues existing between the tenant and the new landlord. From the new landlord's perspective, the lease take-over provision should explicitly provide that any rent, additional rent or other monies payable by any subtenant, assignee or occupant or by the existing landlord in connection with the existing premises shall be the property of the new landlord. Finally, the new landlord should ensure that the new lease requires the tenant to vacate the premises under the existing lease so that the landlord may undertake to assign or sublet the old space as expeditiously as possible.

Although lease take-overs can clearly offer both landlords and tenants flexibility in addressing certain leasing issues, they can also create additional risks to either party if key areas are not considered and addressed when drafting lease take-over provisions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.