Subleasing Warehouse Space: What Both Sides Should Check

In a sublease, the existing tenant becomes the sublandlord and rents all or part of its space to a subtenant. Smith, Gambrell & Russell explains the core concept: any right a subtenant has comes from the sublandlord's rights and is subject to the master lease. The sublease cannot run past the master lease's term, and the firm warns that subleases can actually be harder to draft than direct leases.

Womble Bond Dickinson adds a warning for subtenants: they often do not read the master lease, but they should, because it is generally incorporated into the sublease and, with few exceptions such as rent, must be observed. Read the amendments and any side letters too, not just the original document.

The two parties also have different interests. The sublandlord wants to reduce its cost without adding new risk, and it usually stays liable to the landlord for the whole lease. The subtenant wants space on a useful term without taking on someone else's problems. A good sublease tackles that tension directly.

Many leases require the master landlord's consent. Smith, Gambrell describes a consent to sublease as a three-party agreement among the master landlord, the sublandlord and the subtenant, and says changes from the master lease terms need the landlord's approval in that document. It should be read as closely as the sublease. Womble warns subtenants to make sure it does not have them acknowledging they are assuming the master lease, a different legal concept.

Before spending money on a sublease, both sides should check for these items in the master lease.

• The consent standard, the landlord's time to respond, and any fee you must pay.
• Any recapture right, which can let the landlord take back the space when the tenant proposes to sublease.
• Profit-sharing on any sublease rent above the master lease rent.
• Limits on the use, and whether the subtenant's operation falls inside them.
• Rights that are personal to the original tenant, such as renewal options, signage or parking.

Howard Rice, in a note published by Arnold & Porter, says a subtenant should demand the master landlord's consent to needed alterations, and to rights such as parking, as a condition of the sublease. For a warehouse, that list should cover racking, trailer parking and outdoor storage.

A subtenant's biggest risk is losing the space because of something it did not do. Smith, Gambrell says that if the sublandlord defaults under the master lease, the sublease is subject to being wiped out unless the subtenant has negotiated a recognition and attornment agreement with the master landlord. The firm adds that it is rare for a landlord to offer this absent economic incentives. Arnold & Porter's note suggests that a right to receive notice of defaults and cure them, deducting the cost from sublease rent, can be a fallback, though it may be impractical when the sublandlord's obligations are much greater.

• ✓Has the sublandlord given us the complete master lease and all amendments?
• ✓Is the sublandlord in good standing, and will the landlord confirm that there is no default?
• ✓Is the sublandlord financially able to keep paying the master rent?
• ✓Can the sublandlord terminate its own master lease or agree to a buyout without our consent?
• ✓Do we get the benefit of rent abatements the sublandlord receives, for example in a utility interruption?
• ✓Who provides the landlord-type services, repairs and building access that matter to us?
• ✓Does the sublandlord agree to pass along our requests and enforce the landlord's obligations?
• ✓Is our deposit at risk if the sublandlord fails? Would a letter of credit or a rent credit work better?
• ✓Are we taking on the sublandlord's end-of-term restoration obligations, and for which items?

Womble specifically flags a form sublease that lets the sublandlord end its master lease at any time. Arnold & Porter's note makes the deposit point, warning that a subtenant may lose a cash deposit if a financially weak sublandlord becomes insolvent. If you cannot get comfortable with a sublandlord's finances, price that risk or look elsewhere.

The sublandlord generally stays on the hook to its landlord, so a subtenant's mistakes can become its problem. Smith, Gambrell gives an example: if the sublease ends on the same day as the master lease and the subtenant does not return the space in the required condition, the sublandlord may be liable to its landlord. Ending the sublease early creates time to fix problems.

• Screen the subtenant's credit, operation and materials before asking for consent.
• Require the subtenant to comply with the master lease, and indemnify you for violations.
• Set a sublease expiration ahead of your own, with a joint walk-through.
• Limit your promises to what you can actually control, since the landlord controls the building.
• Make sure your remaining operation, if any, will not breach your own use, hazardous materials or fire protection obligations.
• Get your own legal review of insurance, indemnity and subrogation language.

An office sublease shares a reception desk. A warehouse sublease may share docks, truck courts, forklifts, power, restrooms and a fire protection permit. Partial-space deals need operating rules in writing, because a disagreement over a dock door during a peak shipping day is expensive.

1. Draw the premises and shared areas on a plan, and show the demising line, even if there is no wall.
2. Assign dock doors and yard positions or a scheduling method, including trailers and overnight parking.
3. Decide how electricity, heat and other shared utilities are measured and billed.
4. Settle who owns and maintains any racking, forklifts or equipment left for the subtenant's use, and confirm they are free of liens.
5. Agree on access, security and hours, and on who can enter which areas.
6. Share fire protection information before any storage moves in, and ask the fire official and insurer about the new arrangement.
7. Document the space's condition before the subtenant moves in, and agree on a return standard.

Fire protection needs particular attention. Seattle's fire department says that its high-piled storage permits are not transferable and that a change in use, occupancy, operation or ownership requires a new one. Rules vary by jurisdiction, so ask the local fire official. Also, a subtenant's goods may change the storage hazard for the whole building, so both parties should tell their insurers.

Ask both insurers to review the deal together. Arnold & Porter's note advises making sure the master lease's waiver of subrogation also covers the subtenant, or the subtenant may face exposure for building damage the landlord's policy covers.

Have your attorney read all three documents as one set. TAG represents occupiers on either side of a sublease, whether you are offloading surplus space or taking it, and we check the master lease early, so a seemingly attractive sublease does not fall apart at the consent stage.