Successor In Interest Versus Assignment Of Lease

Author’s note, Nov. 22, 2014: For a much-improved update of this page, see the Common Draft general provisions article.

(For more real-world stories like the ones below, see my PDF e-book, Signing a Business Contract? A Quick Checklist for Greater Peace of Mind, a compendium of tips and true stories to help you steer clear of various possible minefields. Learn more ….)

Table of contents

Legal background: Contracts generally are freely assignable

When a party to a contract “assigns” the contract to someone else, it means that party, known as the assignor, has transferred its rights under the contract to someone else, known as the assignee, and also has delegated its obligations to the assignee. Under U.S. law, most contract rights are freely assignable, and most contract duties are freely delegable, absent some special character of the duty, unless the agreement says otherwise. In some situations, however, the parties will not want their opposite numbers to be able to assign the agreement freely; contracts often include language to this effect. Intellectual-property licenses are an exception to the general rule of assignability. Under U.S. law, an IP licensee may not assign its license rights, nor delegate its license obligations, without the licensor’s consent, even when the license agreement is silent. See, for example, In re XMH Corp., 647 F.3d 690 (7th Cir. 2011) (Posner, J; trademark licenses); Cincom Sys., Inc. v. Novelis Corp., 581 F.3d 431 (6th Cir. 2009) (copyright licenses); Rhone-Poulenc Agro, S.A. v. DeKalb Genetics Corp., 284 F.3d 1323 (Fed. Cir. 2002) (patent licenses). For additional information, see this article by John Paul, Brian Kacedon, and Douglas W. Meier of the Finnegan Henderson firm.

Assignment consent requirements

Model language

[Party name] may not assign this Agreement to any other person without the express prior written consent of the other party or its successor in interest, as applicable, except as expressly provided otherwise in this Agreement. A putative assignment made without such required consent will have no effect.

Optional: Nor may [Party name] assign any right or interest arising out of this Agreement, in whole or in part, without such consent.

Alternative: For the avoidance of doubt, consent is not required for an assignment (absolute, collateral, or other) or pledge of, nor for any grant of a security interest in, a right to payment under this Agreement.

Optional: An assignment of this Agreement by operation of law, as a result of a merger, consolidation, amalgamation, or other transaction or series of transactions, requires consent to the same extent as would an assignment to the same assignee outside of such a transaction or series of transactions.

Takeaways

• An assignment-consent requirement like this can give the non-assigning party a chokehold on a future merger or corporate reorganization by the assigning party — see the case illustrations below.

• A party being asked to agree to an assignment-consent requirement should consider trying to negotiate one of the carve-out provisions below, for example, when the assignment is connection with a sale of substantially all the assets of the assignor’s business {Link}.

Case illustrations

The Dubai port deal (NY Times story and story)

In 2006, a Dubai company that operated several U.S. ports agreed to sell those operations. (The agreement came about because of publicity and political pressure about the alleged national-security implications of having Middle-Eastern companies in charge of U.S. port operations.)

A complication arose in the case of the Port of Newark: The Dubai company’s lease agreement gave the Port Authority of New York and New Jersey the right to consent to any assignment of the agreement — and that agency initially demanded $84 million for its consent.

After harsh criticism from political leaders, the Port Authority backed down a bit: it gave consent in return for “only” a $10 million consent fee, plus $40 million investment commitment by the buyer.

Cincom Sys., Inc. v. Novelis Corp., No. 07-4142 (6th Cir. Sept. 25, 2009) (affirming summary judgment)

A customer of a software vendor did an internal reorganization. As a result, the vendor’s software ended up being used by a sister company of the original customer. The vendor demanded that the sister company buy a new license. The sister company refused.

The vendor sued, successfully, for copyright infringement, and received the price of a new license, more than $450,000 as its damages. The case is discussed in more detail in this blog posting.

The vendor’s behavior strikes me as extremely shortsighted, for a couple of reasons: First, I wouldn’t bet much on the likelihood the customer would ever buy anything again from that vendor. Second, I would bet that the word got around about what the vendor did, and that this didn’t do the vendor’s reputation any good.

Meso Scale Diagnostics, LLC v. Roche Diagnostics GmbH, No. 5589-VCP (Del. Ch. Apr. 8, 2011) (denying motion to dismiss).

The Delaware Chancery Court refused to rule out the possibility that a reverse triangular merger could act as an assignment of a contract, which under the contract terms would have required consent. See also the discussion of this opinion by Katherine Jones of the Sheppard Mullin law firm.

Assignment with transfer of business assets

Model language

Consent is not required for an assignment of this Agreement in connection with a sale or other disposition of substantially all the assets of the assigning party’s business.

Optional: Alternatively, the sale or other disposition may be of substantially all the assets of the assigning party’s business to which this Agreement specifically relates.

Optional: The assignee must not be a competitor of the non-assigning party.

Takeaways

• A prospective assigning party might argue that it needed to keep control of its own strategic destiny, for example by preserving its freedom to sell off a product line or division (or even the whole company) in an asset sale.

• A non-assigning party might argue that it could not permit the assignment of the agreement to one of its competitors, and that the only way to ensure this was to retain a veto over any assignment.

• Another approach might be to give the non-assigning party, instead of a veto over asset-disposition assignments, the right to terminate the contract for convenience. (Of course, the implications of termination would have to be carefully thought through.)

Assignment to affiliate

Model language

[Either party] may assign this Agreement without consent to its affiliate.

Optional: The assigning party must unconditionally guarantee the assignee’s performance.

Optional: The affiliate must not be a competitor of the non-assigning party.

Optional: The affiliate must be a majority-ownership affiliate of the assigning party.

Takeaways

• A prospective assigning party might argue for the right to assign to an affiliate to preserve its freedom to move assets around within its “corporate family” without having to seek approval.

• The other party might reasonably object that there is no way to know in advance whether an affiliate-assignee would be in a position to fulfill the assigning party’s obligations under the contract, nor whether it would have reachable assets in case of a breach.

Editorial comment: Before approving a blanket affiliate-assignment authorization, a party should consider whether it knew enough about the other party’s existing- or future affiliates to be comfortable with where the agreement might end up.

Consent may not be unreasonably withheld or delayed

Model language

Consent to an assignment of this Agreement requiring it may not be unreasonably withheld or delayed.

Optional: For the avoidance of doubt, any damages suffered by a party seeking a required consent to assignment of this Agreement, resulting from an unreasonable withholding or delay of such consent, are to be treated as direct damages.

Optional: For the avoidance of doubt, any damages suffered by a party seeking a required consent to assignment of this Agreement, resulting from an unreasonable withholding or delay of such consent, are not subject to any exclusion of remedies or other limitation of liability in this Agreement.

Takeaways

• Even if this provision were absent, applicable law might impose a reasonableness requirement; see the discussion of the Shoney case in the commentary to the Consent at discretion provision.

• A reasonableness requirement might not be of much practical value, whether contractual or implied by law. Such a requirement could not guarantee that the non-assigning party would give its consent when the assigning party wants it. And by the time a court could resolve the matter, the assigning party’s deal could have been blown.

• Still, an unreasonable-withholding provision should make the non-assigning party think twice about dragging its feet too much, becuase of the prospect of being held liable for damages for a busted transaction. Cf.Pennzoil vs. Texaco and its $10.5 billion damage award for tortious interference with an M&A deal.

• Including an unreasonable-delay provision might conflict with the Materiality of assignment breach provision, for reasons discussed there in the summary of the Hess Energy case.

Consent at discretion

Model language

A party having the right to grant or withhold consent to an assignment of this Agreement may do so in its sole and unfettered discretion.

Takeaways

• If a party might want the absolute right to withhold consent to an assignment in its sole discretion, it would be a good idea to try to include that in the contract language. Otherwise, there’s a risk that court might impose a commercial-reasonableness test under applicable law (see the next bullet). On the other hand, asking for such language but not getting it could be fatal to the party’s case that it was implicitly entitled to withhold consent in its discretion.

• If a commercial- or residential lease agreement requires the landlord’s consent before the tentant can assign the lease, state law might impose a reasonableness requirement. I haven’t researched this, but ran across an unpublished California opinion and an old law review article, each collecting cases. SeeNevada Atlantic Corp. v. Wrec Lido Venture, LLC,No. G039825 (Cal. App. Dec. 8, 2008) (unpublished; reversing judgment that sole-discretion withholding of consent was unreasonable); Paul J. Weddle, Pacific First Bank v. New Morgan Park Corporation: Reasonable Withholding of Consent to Commercial Lease Assignments, 31 Willamette L. Rev. 713 (1995) (first page available for free at HeinOnline).

Case illustrations

Shoney’s LLC v. MAC East, LLC, No. 1071465 (Ala. Jul. 31, 2009)

In 2009, the Alabama Supreme Court rejected a claim that Shoney’s restaurant chain breached a contract when it demanded a $70,000 to $90,000 payment as the price of its consent to a proposed sublease. The supreme court noted that the contract specifically gave Shoney’s the right, in its sole discretion, to consent to any proposed assignment or sublease.

Significantly, prior case law from Alabama was to the effect that a refusal to consent would indeed be judged by a commercial-reasonableness standard. But, the supreme court said, “[w]here the parties to a contract use language that is inconsistent with a commercial-reasonableness standard, the terms of such contract will not be altered by an implied covenant of good faith. Therefore, an unqualified express standard such as ‘sole discretion’ is also to be construed as written.” Shoney’s LLC v. MAC East, LLC, No. 1071465 (Ala. Jul. 31, 2009) (on certification by Eleventh Circuit), cited byMAC East, LLC v. Shoney’s [LLC], No. 07-11534 (11th Cir. Aug. 11, 2009), reversingNo. 2:05-cv-1038-MEF (WO) (M.D. Ala. Jan. 8, 2007) (granting partial summary judgment that Shoney’s had breached the contract).

Termination by non-assigning party

Model language

A non-assigning party may terminate this Agreement, in its business discretion, by giving notice to that effect no later than 60 days after receiving notice, from either the assigning party or the assignee, that an assignment of the Agreement has become effective.

Consider an agreement in which a vendor is to provide ongoing services to a customer. A powerful customer might demand the right to consent to the vendor’s assignment of the agreement, even in strategic transactions. The vendor, on the other hand, might refuse to give any customer that kind of control of its strategic options.

A workable compromise might be to allow the customer to terminate the agreement during a stated window of time after the assignment if it is not happy with the new vendor.

Assignment – other provisions

Model language

Optional:Delegation: For the avoidance of doubt, an assignment of this Agreement operates as a transfer of the assigning party’s rights and a delegation of its duties under this Agreement.

Optional:Promise to perform: For the avoidance of doubt, an assignee’s acceptance of an assignment of this Agreement constitutes the assignee’s promise to perform the assigning party’s duties under the Agreement. That promise is enforceable by either the assigning party or by the non-assigning party.

Optional:Written assumption by assignee: IF: The non-assigning party so requests of an assignee of this Agreement; THEN: The assignee will seasonably provide the non-assigning party with a written assumption of the assignor’s obligations, duly executed by or on behalf of the assignee; ELSE: The assignment will be of no effect.

Optional:No release: For the avoidance of doubt, an assignment of this Agreement does not release the assigning party from its responsibility for performance of its duties under the Agreement unless the non-assigning party so agrees in writing.

Optional:Confidentiality: A non-assigning party will preserve in confidence any non-public information about an actual- or proposed assignment of this Agreement that may be disclosed to that party by a party participating in, or seeking consent for, the assignment.

The Delegation provision might not be necessary in a contract for the sale of goods governed by the Uniform Commercial Code, because a similar provision is found in UCC 2-210

The Confidentiality provision would be useful if a party to the agreement anticipated that it might be engaging in any kind of merger or other strategic transaction.

Materiality of assignment breach

Model language

IF: A party breaches any requirement of this Agreement that the party obtain another party’s consent to assign this Agreement; THEN: Such breach is to be treated as a material breach of this Agreement.

A chief significance of this kind of provision is that failure to obtain consent to assignment, if it were a material breach, would give the non-assigning party the right to terminate the Agreement.

If an assignment-consent provision requires that consent not be unreasonably withheld, then failure to obtain consent to a reasonable assignment would not be a material breach, according to the court in Hess Energy Inc. v. Lightning Oil Co., No. 01-1582 (4th Cir. Jan. 18, 2002) (reversing summary judgment). In that case, the agreement was a natural-gas supply contract. The customer was acquired by a larger company, after which the larger company took over some of the contract administration responsibilities such as payment of the vendor’s invoices. The vendor, seeking to sell its gas to someone else at a higher price, sent a notice of termination, on grounds that the customer had “assigned” the agreement to its new parent company, in violation of the contract’s assignment-consent provision. The appeals court held that, even if the customer had indeed assigned the contract (a point on which it expressed considerable doubt) without consent, the resulting breach of the agreement was not material, and therefore the vendor did not have the right to terminate the contract.

Form-of-the-week: Assignment of Lease – Form 595 and 596

Transfer of any interest

A commercial lease agreement entered into by a tenant contains an assignment and subletting provision. This provision is also called a:

  • restriction-on-transfer provision;
  • restraint-on-alienation provision; and
  • lease assumption.

This restriction-on-transfer provision either prohibits any transfer of the tenant’s interests in the leased property or requires the landlord’s consent prior to assigning, subletting or further encumbering the tenant’s leasehold interest. If the provision permits an assignment or subletting, it states the landlord’s consent requires modifications in the terms for rent or that the landlord’s consent will not be unreasonably withheld. [See RPIForm 552 §9 and 552-7]

An assignment of the leasehold held by the original tenant under a lease agreement transfers the tenant’s entire interest in the property to a successor tenant, leaving no interest held by the original tenant. However, on an assignment the original tenant named on the lease agreement remains liable for the successor tenant’s performance on the lease, whether or not the landlord consents to the assignment or that the successor tenant becomes primarily responsible for the lease obligations.

The successor tenant’s act of accepting responsibility on the prior tenant’s lease agreement is called an assumption. [See RPIForm 596]

For the original tenant to be released of their liability under the lease agreement on an assignment, a novation (also known as a substitution of liability) needs to be negotiated and entered into by the landlord and both the original and successor tenants. [Samuels v. Ottinger (1915) 169 C 209]

In contrast to an assignment, when entering into a sublease with a subtenant, the original tenant (who is now a master tenant) transfers to the subtenant less than all of the master tenant’s interest in the property. Also, possession reverts back to the master tenant on expiration of the sublease.

The master tenant granting the sublease remains obligated to perform under the terms of the master lease agreement. The subtenant does not assume liability of the master lease. However, the subtenant may not act in any way to breach the master lease agreement. The subtenant receives a copy of the master lease agreement as an attachment to the new lease agreement they enter into to create the sublease. [See RPIForm 552 §2.5]

The tenant’s assignment on their transfer of possession

Consider a tenant who sells or transfers the business they operate on the premises to a new business owner. Together with the sale of the business, the lease for the premises which the business occupies is also transferred to the new business owner.

The tenant inquires of the landlord to be released of any further obligations and liability arising from the lease agreement. With the consent of the landlord, the tenant and the new business owner execute an assignment of lease form transferring the original tenant’s leasehold interest in the property to the successor tenant. To be further released of any obligations and liability arising under the master lease, a novation is also negotiated and entered into by the landlord and the original and successor tenant. [See RPIForm 596]

The Assignment of Lease – By Tenant/Lessee form published by RPI (Realty Publications, Inc.) is used by a tenant when the buyer of a tenant’s leasehold interest in the property takes possession and assumes the tenant’s rights and obligations under a rental or lease agreement. Thus, it serves to transfer ownership of the tenant’s leasehold interest in the property to the buyer. [See RPIForm 596]

The Assignment of Lease – By Tenant/Lessee form references:

  • the original lease and the premises subject to the assignment [See RPIForm 596 §1];
  • the successor tenant to whom the lease is assigned [See RPIForm 596 §2]; and
  • the agreement by the successor tenant to assume and timely perform all lessee obligations under the lease. [See RPIForm 596 §3]

The Assignment of Lease form is signed by both the tenant and the assignee in the presence of a notary when recording the assignment. The form is then recorded with the office of the county recorder in the county in which the premises is located.

The owner’s assignment on a sale of income property

Similarly and in juxtaposition, consider an owner of income property subject to a lease or rental agreement who intends to sell or transfer their fee ownership in the property to a new owner. Here, in addition to signing a grant deed to the property, the owner also enters an assignment of all the lease agreements entered into with the existing tenants.

An owner of income property assigns their interest in existing lease agreements as part of a transaction for a:

  • concurrent sale of the fee ownership to the property;
  • concurrent creation of a master lease as the landlord to a master tenant; or
  • sale of an existing lease without the concurrent sale and transfer of the fee ownership in the property. [See RPIForm 595]

The Assignment of Lease – By Owner/Landlord published by RPI is used by a fee owner of income property, a broker or escrow when a buyer of the property assumes the owner’s rights and obligations under rental and lease agreements entered into with existing tenants, to transfer the owner’s interest in the lease agreements to the buyer. [See RPIForm 595]

The Assignment of Lease – By Owner/Landlord form references:

  • the original lease and the premises subject to the assignment [See RPIForm 595 §1];
  • the purpose of the transfer [See RPIForm 595 §2];
  • the new owner to whom the lease is assigned [See RPIForm 595 §3]; and
  • the agreement by the new owner to assume and timely perform all lessor obligations under the lease. [See RPIForm 595 §4]

As with the tenant’s Assignment of Lease form, when recording the owner’s Assignment of Lease form, it is signed in the presence of a notary by both:

  • the owner of the property as the lessor under the lease agreement transferring their interest in the lease; and
  • the successor owner acquiring the property subject to the lease.

The form is then recorded with the office of the county recorder in the county in which the premises is located.

0 Replies to “Successor In Interest Versus Assignment Of Lease”