Tenants may make a lot of money by subleasing all or part of their space or assigning their lease to a third party. That’s why commercial leases often require the tenant to pay all or a percentage of their sublease/assignment profits to the landlord. But cashing in on these profit-sharing provisions can be tricky, especially when tenants try to conceal their profits from the landlord. How can a landlord be sure that it’s getting its fair share of sublease/assignment profit with tenants that may be less than transparent? 

Here’s a strategy that a veteran New York City leasing attorney has used effectively with the landlord clients he represents, along with a Model Clause you can use to implement it. 

Landlord’s Need for Tenant Transparency

Landlords typically have the right to consent to any sublease/assignment a tenant proposes to make. Landlords need certain information about the proposed subtenant/assignee and terms of the deal so that they can perform due diligence and determine whether to grant or deny consent for the arrangement. Such information generally includes: 

• Detailed financial data about the proposed subtenant/assignee’s credit, assets, liabilities, liquidity, and net worth;
• Background information about the subtenant/assignee’s business and operational history; and
• A copy of the proposed sublease or assignment agreement.

Tenant Sublease/Assignment Profits May Be the Sticking Point

If a lease includes a profit-split clause, landlords also need to know the exact amount of profit, if any, the tenant expects to earn on the sublease/assignment so that they can properly calculate their share of the profit. The danger is that tenants will hide their true profits to circumvent their profit-split obligations. The good news is that there are three things you can do to neutralize this risk. The key is to take action when the tenant notifies you of and seeks your consent for the proposed arrangement. “The landlord is in the driver’s seat because the tenant needs its consent to consummate the sublease/assignment,” explains the NYC attorney.

Step 1. Demand Full Disclosure 

Demand whatever due diligence information you think you need to review the arrangement and its potential profitability to the tenant knowing that you can always withhold consent if that information isn’t provided.

Step 2. Have the “Sublease Police” Review the Deal 

Don’t stop there. The NYC attorney encourages his landlord clients to deploy an accounting executive within the landlord’s organization to serve as what he dubs “the Sublease Police” charged with performing due diligence on the proposed assignment or sublease transaction for the purpose of unearthing any profits that the tenant may be trying to conceal. 

Step 3. Add Profit Payment Obligations to Consent Agreement

If you decide to consent to the sublease/assignment, get extra protection in case you later discover that the tenant was, in fact, concealing profits. Strategy: Add special language to the Consent Agreement that the landlord, tenant, and assignee/subtenant must sign to execute the arrangement that clearly establishes your entitlement to a 100 percent share of any “shadow” profit that the tenant may earn surreptitiously and that you learn about later. Like the Model Clause below, the Consent Agreement provision should require:

• The tenant and its sublessee/assignee counterpart to jointly and severally warrant that the latter hasn’t paid and isn’t required to pay the tenant any consideration that the underlying lease requires the tenant to pay or report to the landlord; and
• The tenant to immediately report and pay to the landlord as additional rent 100 percent of any consideration it receives or becomes entitled to receive from the subtenant/assignee in connection with the sublease/assignment agreement. 

Simply seeing how tenants react to the clause may also help you smoke out any profit concealment that may be taking place, according to the NYC attorney. “A tenant that’s been fully honest and transparent with the landlord about whether the assignment or sublease is generating a profit shouldn’t have any problems with adding the clause to the Consent Agreement.” It’s the tenants that have something to hide that are most likely to object to the clause.