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Less than 10 years ago residential real estate assignments were a license to print money. As the British Columbia real estate market boomed, thousands of buyers signed condo pre-sale contracts - not because they intended to ever move into the suite, or even rent them out, but because they wanted to ‘flip’ the contracts for a profit as prices continued to rise or when the developments were complete. Some condos were bought and sold two or three times before construction was even finished.

In both the commercial and residential real estate industries, it has become common for contract holders to assign leases or contracts of purchase and sale to other individuals and entities. In the commercial realm, business owners may opt for an assignment if they change their corporate identity, if the premises are sold, or if they sublease unused space to another business. If all goes well, and the rent keeps getting paid, things go smoothly. However, given that most commercial landlords will experience a tenant dispute, and that residential real estate law more very complex than most people realize, that’s a big “if”.

Residential real estate pre-sale assignments

Assignments of pre-sale purchase contracts for condominium developments can carry significant risks for all of the parties involved. Most buyers trying to assign one of these contracts are surprised when legal complications arise. The typical reasoning is that since the development is not completed and since the contract seems simple, the assignee should bear any risk and the assignor should generate an easy profit from a rising real estate market.

The most common misunderstanding people have is the belief that once a contract is assigned, the assignor no longer has any obligations to the vendor (typically, a developer or original pre-sale contract holder). As a general rule, this is a false belief. Unless the agreement expressly states the assignor will not be liable for anything - and the vendor agrees to it - the assignor remains exposed if anything goes wrong.

In the case of a condo pre-sale, if the new buyer fails to complete the purchase for any reason (e.g. inability to qualify for a mortgage when the building is ready for occupancy), the vendor can sue both the assignee and assignor for forfeiture of the deposit, as well as any additional damages, such as the cost to sell the unit to someone else.

This risk was highlighted in late 2008 and 2009 when real estate prices declined significantly due to the recession. This left many people with pre-sale contracts for condos they could no longer afford or could not assign to someone else. Vendors such as developers sued assignees and assignors for tens or even hundreds of thousands of dollars of damages as a result. I met more than one assignor who was shocked to be named as a defendant in a lawsuit during this time.

Commercial assignments

The risks in an assignment of a commercial lease are less obvious than those in a residential situation. For example, a commercial lease often requires the lessee to provide formal notice of changes to the landlord before the landlord can exercise its right to terminate the lease or sue for accelerated rent. A lease assignment affects this obligation.

Once a contract is assigned, landlords often stop dealing with the old tenant (assignor). If the new tenant (assignee) fails to meet its obligations, the landlord will provide notice of default to the new tenant.

In some cases, however, the landlord may sue both the old and new tenants. If the old tenant did not notify the landlord of the assignment, if the original lease was altered in any way without the landlord’s approval or if the new tenant damaged the property, the landlord may have cause to sue both parties. The benefit of the assignment - as opposed to replacement of the contracting parties - will have been inadvertently lost. To make matters worse, the new tenant might not have the resources to pay a judgment against it, and the landlord will be out-of-pocket for damages such as lost rent or repairs unless the money is recovered from the original assignor.

Practical steps to protect yourself

An assignor should first determine if the vendor or commercial landlord will agree that the assignment will free him/her/the business of any liability. Most savvy businesses will not agree to this. If that is the case, the assignor should obtain an indemnity (an exception against penalties) from the assignee. Furthermore, the assignor should be satisfied that the assignee has the means and capability of following through on any obligations.

Landlords can safeguard their interests by including language in the original lease and/or assignment stipulating that notice to an assignee will be deemed sufficient notice to the assignor, thus getting around the need to provide separate notice to both. This, however, may not be enough to overcome legislated requirements to provide statutory notice.

Assignments can be a useful and profitable tool for landlords, tenants, developers and real estate purchasers. That said, everyone involved should remember that assignments are legal documents. Failing to understand the associated risks may leave all parties involved ill-prepared to deal with liabilities. It is always prudent to get advice from a professional before entering into, or approving, an assignment of a commercial lease or a residential property purchase contract.

Assignments and Sub-Leases

Terms:


Assignment:
The transfer of an entire leasehold interest from a tenant to a third party.

Sub-letting:
The transfer of part of a leasehold interest from a tenant to a third party, in which the tenant keeps a remainder interest in the leasehold estate so that the property will go back to the tenant before eventually reverting to the landlord.

Privity of Estate:
A relationship that exists between two people who have a successive interest in the same property.

Privity of Contract:
The relationship between two parties to a contract that allows each party to enforce the terms of the contract against each other.


Assignments and subleases are terms for situations in which a tenant in possession of property transfers his or her right to possess that property to a third party. If the lessee transfers his or her entire remaining interest in the tenancy, then the transfer is known as an assignment. If the lessee transfers only part of his or her interest, then the transfer is known as a sublease. For example:

  1. Barney leases Rubbleacre from Fred for two years, beginning January 1, 2013 and ending on December 31, 2014 at the rental price of $1,000 per month. On January 1, 2014, with one year remaining on the lease, Barney and Kazoo agree that Kazoo will occupy the land for the remainder of the lease, and that Kazoo will pay the $1,000 per month rent to Fred. In this case, Barney has “assigned” his lease to Kazoo.
  2. Barney leases Rubbleacre from Fred for two years, beginning January 1, 2013 and ending on December 31, 2014 at the rental price of $1,000 per month. On January 1, 2014, with one year remaining on the lease, Barney and Kazoo agree that Kazoo will occupy the land for the next six months and pay the rent for those months. At the end of six months, Barney will move back onto the land and finish out the remainder of the lease. In this case because Barney and Kazoo have agreed that Kazoo will assume less than the full remainder of the lease, Barney has “sublet” part of his interest in Rubbleacre to Kazoo.

See McClain Airlines, Inc. v. Republic Airlines, Inc., 1991 U.S. App. LEXIS 18047 (1991).

As a general principle, both assignments and subleases are allowed, and so any tenant can assign his or her lease to a third party or sublease his or her interest in the property to a third party at any time. However, as a practical matter, many lease agreements specifically prohibit assignments or subleases. Of course, any agreement between landlord and tenant that prohibits assignments or subleases is fully binding and enforceable.

The key issue to be discussed, then, is what affect the transfer of interest has on all the involved parties. Since there are several parties involved in these transactions, we will start by defining the parties. In an assignment, there is the landlord/ lessor (the property owner), the tenant/ assignor (the person who leased it from the landlord and then assigned his or her interest to a third party) and the assignee (the person who received the assignment). In a sublease, there is the landlord/ lessor, the tenant/ sublessor (the party who leased the property from the landlord but is now subleasing the property to a third party), and the sublessee.

As a further necessary introduction, there are two forms of relationship between every landlord and tenant. There is a contractual relationship that took effect and exists by virtue of the lease agreement itself. That relationship is known as “privity of contract”. In addition, there is a property ownership relationship, by virtue of their sharing of the ownership of the property. That relationship is known as “privity of estate”. “Privity of estate” exists between two parties when those two parties have successive ownerships in the same property (i.e., one holds a present interest while the other holds a future interest or they both hold future interests, one after another).

The Assignment

An assignment is a full transfer of the lease between the tenant and the assignee. Therefore, since the tenant no longer has any ownership interest in the property, there is no longer any relationship between the landlord and the tenant as far as the property ownership is concerned. Therefore, there is no longer “privity of estate” between the landlord and the tenant. On the other hand, there now is privity of estate between the landlord and the assignee. This is because the assignee now owns the present interest in the property. This present interest will end only at the end of the lease when it will go back to the landlord. Since the landlord’s right to possession is now successive to the possession of the assignee, the landlord and assignee are in privity of estate.

Privity of contract, on the other hand, still exists between the landlord and the tenant. This is because the original contract that existed between the landlord and the tenant is still fully valid even after the assignment. In other words, the landlord does not give up his or her right to enforce the lease agreement with the tenant just because the tenant transfers his or her interest to the third party. There is no privity of contract, of course, between the landlord and the assignee because those two parties never agreed to anything between themselves. For example:

Ethel owns Blackacre. She leases Blackacre to Lucy for 5 years. During year 2, Lucy assigns her interest in Blackacre to Ricky. Ethel is in privity of estate with Ricky and not Lucy and in privity of contract with Lucy and not Ricky. Also note that Lucy and Ricky are in privity of contract (because they made an agreement with each other), but not in privity of estate (Lucy has no possession interest in Blackacre, and so she does not have an interest that either follows or is followed by Ricky’s interest).

The Sublease

The sublease is only a partial transfer of interest from the tenant to the sublessee. The tenant is transferring part of his or her interest in time to the sublessee. Therefore, there is no privity of contract or privity of estate between the landlord and the sublessee in a sublease. The reason that there is no privity of estate between the landlord and the sublessee is that the landlord’s right to possession of the property does not follow the sublessee’s right to possession. Instead, it still follows the tenant’s right of possession. The landlord is, however, still in both privity of estate and privity of contract with the tenant. Privity of contract is still applicable for the same reason as with the assignment (the landlord and the tenant agreed on the terms of the original lease). In addition, there is privity of estate between the landlord and the tenant because the right to possession of the landlord still follows the right of possession of the tenant. For example:

Ethel owns Blackacre. She leases Blackacre to Lucy for 5 years. During year 2, Lucy subleases Blackacre to Ricky for one year. Ethel is not in privity of estate or privity of contract with Ricky because she did not make an agreement with Ricky and because her interest in possession of Blackacre does not follow Ricky’s (it follows the end of Lucy’s five year lease). On the other hand, Ethel and Lucy are in both privity of contract (because their agreement is still valid) and privity of estate (because Ethel’s interest follows the end of Lucy’s lease). Note that Lucy and Ricky are in both privity of estate and privity of contract. They are in privity of contract because they made an agreement with each other. They are in privity of estate because Lucy’s interest (in the remainder of her lease) follows Ricky’s interest (Lucy will get Blackacre at the end of Ricky’s one year sublease).

The ramifications of who is in privity of what with whom can be crystalized in a few rules:

  1. A party collecting rent (landlord from the tenant or tenant from assignee or sublessee) can collect rent from someone with whom he or she is in privity of contract or privity of estate.
  2. A party looking to enforce obligations of the landlord can only enforce those obligations against a party with whom he or she is in privity of estate.
  3. The contractual terms of the lease itself can only be enforced against a party with whom the party seeking to enforce the terms is in privity of contract.

For example:

1. Ethel owns Blackacre. She leases Blackacre to Lucy for 5 years. During year 2, Lucy assigns her interest in Blackacre to Ricky.

  • Ethel may collect rent from Ricky or Lucy.
  • Lucy may not collect rent from Ricky.
  • Ricky may enforce landlords’ obligations against Ethel, but not against Lucy. Lucy may not enforce landlords’ obligations against Ethel.

2. Ethel owns Blackacre. She leases Blackacre to Lucy for 5 years. During year 2, Lucy subleases Blackacre to Ricky for one year.

  • Ethel may collect rent from Lucy, only, not Ricky.
  • Lucy may collect rent from Ricky.
  • Ricky may enforce landlords’ obligations against Lucy, but not against Ethel.
  • Lucy may enforce landlords’ obligations against Ethel.

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