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 explain what a sub-lease is, the advantages and disadvantages of sub-leases and the consequences of breaching a sub-lease. Before entering into or granting a sub-lease, we recommend speaking to our commercial property solicitors. They'll help you understand the details and potential risks so you can make an informed decision.
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 payment of rent is not essential).
For the arrangement to be a lease, the Tenant must have ‘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 2030, the sub-lease it grants must be for a term that expires before 1 January 2030.
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
Set out below are some common advantages and disadvantages for each party.
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Can a sub-lease be granted without the Landlord’s consent?
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. The sub-lease can be granted without Landlord’s consent.
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, or consent is obtained but the terms of the sub-lease do not comply with any requirements set out in the Tenant’s lease, the sub-lease will not be binding on the Landlord and the Landlord could bring an action against the Tenant for breaching their lease. The Tenant will not have committed a criminal offence. 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. The Landlord usually 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 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.
A Tenant may want to consider granting a licence to occupy as an alternative option to sub-leasing. Licences to occupy are usually short-term arrangements and do not allow exclusive use of a premises.
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 sub-lease would come to an end and the Tenant would no longer receive any rent from the Sub-Tenant. The Sub-Tenant may ask the Court not to forfeit the lease.
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.