Washington trade associations, law firms and others who hold long-term office leases can legally sublease space at rates higher than they are paying and keep the profits, if their leases do not specifically restrict the practice, according to a D.C. Court of Appeals ruling.
The court, in a long-awaited opinion, upheld a precedent-setting decision by D.C. Superior Court Judge George H. Revercomb, who ruled in 1981 that landlords could not withhold approval of a sublease merely to enhance their own economic position.
Revercomb's ruling came in a suit filed against the landlord of the Waterfront Center at 1010 Wisconsin Ave. NW.
The plaintiff, the Grocery Manufacturers of America, a trade group, had leased an entire floor in the building, and later subleased some of the space to a law firm at twice the rate it was paying.
But the landlord refused to approve the arrangement, arguing that the lease provision allowing GMA to sublet space was never intended to allow the association to compete against the owners in their own building.
"It's a very unfortunate ruling. I don't think the case was ever understood by the trial court," said lawyer J. Jonathan Schraub, who represented 1010 Potomac Associates and John H. Safer, the building owners.
Others, however, hailed the outcome.
"Frankly, it's a decision I applaud," said F. Joseph Moravec, president of Leggat, McCall & Werner Co. Inc., a D.C. brokerage firm. "If a tenant accepts the risk of the marketability of space it doesn't need or can't use, he should be entitled to the entire profit," he said.
Subleasing was a fast-growing trend a few years ago when dozens of downtown businesses that had negotiated highly favorable, long-term leases during an office rental glut in the mid '70s sought to cash in on their good fortune when the market tightened a few years later.
During the market glut, landlords typically negotiated bargain-rate, long-term leases, and often were successful in getting tenants to lease more space than they needed. Subleasing restrictions were often minimal.
Although the exact number is unknown, real estate experts estimate that dozens of such leases were negotiated, often for periods of up to 10 years, with options to renew the lease after that.
The GMA began negotiating a lease for 10,000 square feet of space at the Waterfront Center in 1977.
At the time, only three of eight floors at the center had been leased, and the landlord "expressed a strong desire" to lease an entire floor (16,000 square feet) to the association, according to court papers.
The association agreed to lease 12,000 square feet at $12 per foot, and took an option to lease the remaining 4,000 square feet at the same price.
The agreement granted GMA the right to sublease space upon the written consent of the landlord.
No other pertinent restrictions applied.
By the time it came to exercising the option, during the third year of the 10-year lease, the office rental market was changing drastically. In 1981, the trade group was able to sublease 4,000 square feet of space to a law firm at $24 per square foot.
The owners first demanded to split the profits and when the association refused, it rejected the sublease, touching off the four-year legal fight, according to court papers.
After taking the case under advisement for two years, the appeals court ruled in December that the landlord, absent any language in the lease restricting the terms of a sublease, had no reasonable grounds to withhold its appoval.
"The purpose of the consent clause is protection of the landlord in its ownership and operation of a particular property, not protection of the landlord's general economic condition," the court opinion stated.
Office rents doubled in the District between 1979 and 1981, but the market fell into a glut in 1982.
It has since recovered and is now entering into a period of "manageable oversupply," Moravec said.
"The market today in Washington is stable, but it's not necessarily a landlord's market," he said.
"You are seeing a lot of sublease space on the market, although it is less than a few years ago," Moravec said.
Schraub said landlords today are carefully drafting leases to avoid the problems that arose in the GMA case.
The appeals court ruling does not apply to leases that contain specific restrictions regarding subleasing, the lawyer said.
Commercial leases, for example, now require tenants to first offer surplus space back to the landlord, or to split the profits from a sublease.
Landlords are also shouldering the burden of finding short-term tenants until the major tenant is ready to take over the space.
"Depending on market conditions, different clauses find their way into leases at any given time," said Moravec.
"Whoever takes the risk should be entitled to the profits, just as they are entitled to suffer if the market deteriorates," he said.