Sub-letting A Commercial Lease

Last updated: 6 August 2019

Estimated reading time: 7 minutes

When is sub-letting right for a tenant or landlord? Businesses operating from commercial premises often occupy the premises under the terms of a lease, but things become a little more complicated when the lease in question is a sub-lease (often also referred to as an underlease). This article will explore just what a sub-lease is, the advantages and disadvantages of sub-leases and the consequences of breaching a sub-lease.

Jump to:

  1. The sub-letting process: what is a sub-lease and how does it work?
  2. Advantages and disadvantages of sub-letting
  3. When is it legal to sub-let a commercial lease?
  4. Can a sub-lease be granted without consent?
  5. What if the terms of a sub-lease are breached?

The sub-letting process: what is a sub-lease and how does it work?

To answer the question of what a sub-lease is, it must first be established what a lease is.

The basic concept of a lease is that an owner of a freehold property (the ‘Landlord’) grants another party (the ‘Tenant’) exclusive use of that property (or part of it) for a period of time and usually in exchange for a rent (although, contrary to popular belief, payment of rent in a lease is not essential).

For the arrangement to be a lease, it is essential that the Tenant has ‘exclusive use’ of the property. This means that the Tenant should be entitled to lock the Landlord out of the property. The Landlord is still entitled to inspect the property but upon prior notice to the Tenant.

What, then, is a sub-lease? A sub-lease is when a Tenant decides to grant a lease (a ‘sub-lease’) of the property to another party (the ‘Sub-Tenant’) out of their lease. The sub-lease must be granted for a period of time less than the lease out of which it is granted. For example, if the Tenant has a lease that runs until 1 January 2020, the sub-lease it grants must be for a term that expires before 1 January 2020.

Upon completion of the sub-lease, the Landlord remains the Tenant’s landlord (and the terms of their lease remain in place and must be complied with by the Tenant), but the Tenant becomes the Sub-Tenant’s landlord. A diagram is shown below to illustrate the structure.

The only restrictions on sub-letting are those that are set out in each respective lease. Therefore, if a sub-lease did not include restrictions on sub-letting, the Sub-Tenant could grant a further sub-lease (and this lease is often known as a sub-underlease). In theory, the process could be repeated meaning that there could be various layers of sub-leases but, in practice, this rarely happens as most leases contain restrictions on sub-letting for the reasons set out later in this article.

Advantages and disadvantages of sub-letting

The advantages and disadvantages of sub-letting differ for each party and will differ for each particular circumstance. However, set out below are some common advantages and disadvantages for each party.

Party Advantages Disadvantages
Landlord
  • A Tenant may be struggling to pay the rent and the rent they receive from a Sub-Tenant may help ensure that that they pay their rent.
  • A Tenant could be paying the rent but may not be physically occupying the property. If the Tenant sub-lets it could ensure that the property is re-occupied, which is a particular concern for a Landlord who may own neighbouring properties and needs to maintain high occupancy levels (such as an owner of a shopping centre).
  • An extra party is involved, which makes matters more complicated from a practical perspective.
  • The Sub-Tenant is not the Landlord’s immediate tenant. This means that if there are any breaches of the sub-lease, the Landlord will often need to first approach the Tenant to remedy the breach. Essentially, the Landlord may feel they have less control over the property.
Tenant
  • The Tenant retains its interest in the property rather than assigning (transferring) the lease to another party. This is a particular benefit if the Tenant has no immediate use for the property but wishes to use it in the future.
  • It may be an income stream. The Tenant may have paid a premium for their lease, which may have been granted for a long term, such as 125 years. The Tenant may then look to grant sub-leases and use the rent as an income stream.
  • As the Tenant retains its interest in the property, it is still liable to comply with the terms of its lease. However, it will no longer be in occupation of the part of the property occupied by the Sub-Tenant. If the Sub-Tenant does anything that breaches the Tenant’s lease, the Landlord could pursue the Tenant. The Tenant may then look to pursue the Sub-Tenant, but there is a risk of not being successful, or the Sub-Tenant not being able to pay, leaving the Tenant out of pocket.
  • The Tenant takes on the burden of collecting rent and ensuring the Sub-Tenant complies with the terms of the sub-lease.
Sub-Tenant
  • The sub-lease may be on favourable terms if the Tenant is in dire need of additional income.
  • The Sub-Tenant has no control over the lease above it, which means that the Tenant may breach their lease and, through no fault of the Sub-Tenant’s, the Landlord may begin forfeiture proceedings, which would also bring the sub-lease to an end.
  • There is an added layer of complexity – the Sub-Tenant is not just bound by the terms of its lease, but it is bound by the Tenant’s superior lease and it is likely to have to deal with both the Tenant and the Landlord.

When is it legal to sub-let a commercial lease?

If a Tenant’s lease includes no express provisions preventing them from sub-letting, then they are permitted to do so, and they do not need to consult with the Landlord.

Often, however, a commercial lease will either completely prohibit sub-letting, or will place restrictions on it.

If a lease prohibits sub-letting and a Tenant proceeds to grant a sub-lease, the Tenant has not committed a criminal offence. However, the sub-lease will not be binding on the Landlord and the Landlord could bring an action against the Tenant for breaching their lease. Commonly, a lease will completely prohibit sub-letting part of a property but will allow a Tenant to sub-let the whole of the property, providing that they have obtained the Landlord’s prior written consent. In this scenario the Landlord cannot unreasonably withhold or delay their consent.

When the landlord provides their consent to a sub-lease (known as a licence), it will commonly include covenants (obligations) from the Sub-Tenant made directly to the Landlord to comply with the terms of the sub-lease. This then means that the Landlord can go directly to the Sub-Tenant if it wishes to enforce any breaches of the sub-lease, rather than involving the Tenant. The licence will also often include obligations on the Tenant not to vary the sub-lease without obtaining the Landlord’s consent.

The lease can also set out some specific requirements and terms that the sub-lease must satisfy, such as, but not limited to: the level of rent; the frequency of rent reviews; and whether the sub-lease can benefit from security of tenure. One of the most common requirements is that the sub-lease must contain express provisions prohibiting the Sub-Tenant from granting further sub-leases. The purposes of this is to ensure that the property does not become subject to countless sub-leases, which would result in the Landlord having great difficulty in ensuring it knows who should be complying with what obligations, which would make enforcement of breaches difficult from a practical perspective.

Can a sub-lease be granted without consent?

As we’ve discussed above in When is it legal to sub-let a commercial lease?, if the Tenant’s lease does not include any provisions requiring the Tenant to obtain the Landlord’s consent to sub-letting, then the sub-lease can be granted without consent.

If, however, the Tenant’s lease does require consent, and it is not obtained, or consent is obtained but the terms of the sub-lease do not comply with any requirements set out in the Tenant’s lease, then the Tenant will be in breach of its lease. This means that the Landlord could bring an action against the Tenant for breach of its lease, which could include the Landlord seeking to forfeit the lease (which means bringing it to an end).

What if the terms of a sub-lease are breached?

If the terms of a sub-lease are breached, then the Tenant can look to enforce the breach against the Sub-Tenant. The Tenant can either look to ensure that the Sub-Tenant rectifies the breach, or it may look to forfeit the lease (bring it to an end). The problem with forfeiture is that the Sub-Tenant may ask the Court not to forfeit the lease and, even if the Tenant were successful, the sub-lease would come to an end and the Tenant would no longer receive any rent from the Sub-Tenant.

A Tenant must be very careful, though, when granting a sub-lease to ensure that, as an absolute minimum, the Sub-Tenant’s covenants (obligations) match the Tenant’s covenants contained in their lease. A well drafted sub-lease will include an obligation on the Sub-Tenant to comply not only with the terms in the sub-lease, but also to comply with the terms contained in the Tenant’s lease (often known as the ‘head lease’ or ‘superior lease’), with the exception to pay the Tenant’s rent.

If the obligations contained in the sub-lease do not match those in the Tenant’s lease then the Sub-Tenant may do something that they are not prohibited from doing in the sub-lease, but that may be in breach of the Tenant’s lease. This would then leave the Tenant in a difficult position as the Landlord may then bring an action against the Tenant for breaching the terms of their lease, but the Tenant could not bring any action against the Sub-Tenant as they would not be in breach of their lease. It is, therefore, essential that careful consideration is taken when drafting a sub-lease to ensure that there are no gaps or contradictory obligations that would leave the Tenant exposed.

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