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Lease Strategies

Product Overview

This LARG contains the following items:

Thoughts on the Pro-Tenant Retail Key Money Agreement, Drafting the Pro-Tenant Consent to Sublease, and the Lease Clause Critique: Selected Clauses from the Pro-Tenant Sublease.

Number of Single Spaced Pages: 12





This LARG focuses upon aggressive subleasing techniques used by tenants and subtenants. The first section looks at key money agreements, and includes a brief sample agreement. The second feature focuses upon a pro-tenant Consent to Sublease, negotiated by a subtenant with considerable leverage. The Lease Clause Critique analyzes several clauses from a pro-tenant sublease which contains some unusual components.

Thoughts on the Pro-Tenant Retail Key Money Agreement

Suppose a high quality jeweler has been looking for retail space facing Union Square in San Francisco for several years. The retailer has eight other stores, all in top, downtown retail locations. Several prior negotiations for space in San Francisco have fallen out of bed because the retailer and prospective landlords couldn't agree on the rent, length of term, and the level of improvements for the premises. And the space offered in those deals was never the "110% location."

But something happens. The real estate executive for the jeweler arrives at his office one Monday morning to find three telephone messages from his retail real estate broker for the San Francisco area. They all say: "Urgent. Call ASAP. Have perfect Union Square location, but it'll take some key money." OK, the real estate executive thinks, how much key money?

Key Money Can Make It Happen

A key money agreement provides for the payment of cash by a prospective subtenant to the tenant currently occupying desirable premises. The payment induces the tenant to sublease the premises, and ensures that the tenant doesn't sublease the premises to somebody else. The reference to "key money" is made because, if the subtenant pays the cash, it gets the key to the premises. The key money agreement is negotiated along with the sublease and the document that confers the landlord's consent to the sublease.

Key money agreements usually provide that their terms are to be kept strictly confidential between the subtenant and the tenant, and that the subtenant in particular will not show the landlord or its representatives a copy of the agreement, or even acknowledge its existence. If the landlord knows of the payment to the tenant, that knowledge will undoubtedly affect its attitude toward the approval of the sublease.

Excess Subrentals as Additional Rent?

Most landlords take the position that any compensation paid to the tenant by a transferee in excess of the rent reserved in the lease should properly go to the landlord, since the landlord owns the property generating the revenue. As a result, sophisticated landlords often include express language in the assignment and sublease section of the lease which requires that all or a portion of such excess rentals be paid to the landlord as additional rental. In some cases, such clauses allow the tenant to keep excess rentals equal to the unamortized value of the leasehold improvements the tenant has made, and brokerage commissions and legal fees incurred by the tenant in connection with the sublease.

An example of such a pro-landlord excess rentals clause (without any allowance for improvements, brokerage commissions or legal fees) is:

Any sublease rentals or any other economic consideration ("Excess Rentals") received by Tenant as a result of subletting the premises, whether designated as rentals under a sublease or otherwise, which in the aggregate exceed the total amount which Tenant is obligated to pay Landlord under this Lease (computed on a square foot basis with respect to the area subject to the sublease) shall be payable as additional rent by Tenant to Landlord under the Lease. Such Excess Rentals shall be due and payable by Tenant to Landlord as soon as they are received by Tenant.

It's For The Fixtures

Whether or not the lease contains such excess rental provisions, almost all key money agreements are drafted to characterize the amounts paid as payments for the purchase of the tenant's leasehold improvements or fixtures by the subtenant. Of course, where the lease provides that all leasehold improvements belong to the landlord at the end of the term of the lease, one wonders how much such improvements could be worth. Perhaps the tenant's fixtures have some value, but one must take a careful look to determine if the amounts paid under the key money agreement are for fixtures or are, in fact, for the right to sublease the premises.

Tenant Representations

Since key money agreements are almost always kept secret from the landlord, the landlord might consider including representations by the tenant in its standard form Consent to Sublease stating that no payments or compensation of any kind were made (or will be made) to the tenant, except for those which were previously disclosed to the landlord. Such representations should help flush out the existence of any secret payments made to the tenant, unless the tenant simply chooses to defraud the landlord, thereby risking fraud litigation if the landlord ever finds out about the payments.

A sample key money agreement providing for two separate payments to the original tenant follows. Note that the subtenant is obligated not to disclose the terms of the agreement to the landlord or its representatives.


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