IFRS 16 Assignment of Lease

[BrinZ]

Hello All,

Our head office lease has been legally assigned to a third party who now occupies the space and is making rent payments to the landlord. This is not a sublease although we remain liable for the lease payments if the third party defaults on the lease during the original lease term. The issue: is the assignment of a lease a lease modification (termination) or a sub-lease? Under IFRS 16 S9 "... the right to control the use of an identified asset for a period of time in exchange for considerations." As the company no longer has the right to control the use of the office space and it is no longer making payments to the landlord, we believe it's a lease modification. However, our auditors say it's a sublease as we are still liable for the lease obligations.

Any comments or insights into this issue would be appreciated.

Thanks,
BrinZ

[Marek Muc]

Hi, what do you mean by 'assignment of the lease' and how does it differ from a sublease in your opinion?

[BrinZ]

Hello,

Best to explain as an example. Generally, a typical lease would be: Lessee (tenant) leases an office space for 5 years from the Lessor (landlord). In Year 3, the tenant decides to move to bigger offices but has 2 years remaining on the lease. There are two ways the existing tenant can bring a third party into the lease agreement to cover the remaining two years. In a sublease, the Lessee rents the office space to a third party (subtenant) but they remain the tenant of head lease. The third party pays rent to Lessee and the Lessee as the tenant, continues to pay rent to Landlord. The relationship between the original tenant and landlord remains intact. The rent the subtenant pays may or may not be the same as what Lessee pays. In an assignment of a lease to a third party, it’s the third party (assignee) who becomes the tenant and the Lessee (assignor) is removed from the relationship of tenant and landlord. The third party (assignee or new tenant) makes payments to the landlord. However, often in an assignment agreement, the original tenant will be liable for any remaining lease term if the new tenant defaults.

Hope this answers your question.

Best,
BrinZ

[Marek Muc]

Thanks for this clarification. One more question here: the new tenant signs a new lease agreement directly with the landlord in the lease assignment scenario? And the agreement between original tenant and landlord is amended to say that basically the lease is no longer in force but the original tenant is responsible to step in should the new tenant defaults on its payments? Is that a fair summary?

[BrinZ]

Hello,

No, there is no new lease between the new tenant and the landlord. Under the assignment agreement the new tenant agrees to be responsible for the original lease for the rest of the lease term. In addition, the Landlord is entitled to enforce the lease directly against the new tenant. However, should the new tenant default, then the original tenant is responsible for the lease for the rest of the lease term. If this happens a new lease may be initiated for the rest of the term.

Best,
BrinZ

[Marek Muc]

to be honest I'm not clear about the terms of the agreement, particularly I don't understand how this can work without a direct contract between the landlord and new tenant

anyway, it all boils down to the question of whether the lease liability should be derecognised by the original tenant, as the right-of-use asset will be derecognised even if this arrangement is treated as a sublease

the definition of a sublease states that the ‘head lease’ between the head lessor and lessee remains in effect, which seems to be true based on what I understand from your description

so my tentative conclusion is that the lease liability should remain in the books of the original lessee (i.e. a sublease under IFRS 16), but as I wrote I'm still not 100% clear about the terms of the arrangement

[BrinZ]

Thank you for giving us you insight into this issue.

[nauman]

Is the "assignment of lease" agreement between you and the new tenant or land lord and the new tenant?

[Andreas Kyriacou]

Hii,

In my personal opinion, since the rights and obligations of the original lease agreement have been assigned to a new lessee, the original lessee should derecognize entirely the ROU and the lease liability.

The only thing that remains is a commitment/guarantee to repay in case the new lessee defaults. The guarantee must be treated in accordance with IFRS 9.

I cannot see the sublease in your case, and the lease liability cannot remain since the contractual obligations are shifted to another party. And eventually if you leave it there and the lease continues smoothly then you will be stuck with it and you will need to derecognize it to P/L which would be wrong.

[JRSB]

There's something else to this, isn't there? Why are you effectively guaranteeing a lease for a third party? So they decide not to pay and it's your problem? Sounds like it's some hard-to-let , unusual, or remote space and the only way you could find a replacement/sublessee was to effectively act as guarantor for a third party.

If you couldn't 'sublet' it they presumably it's onerous , since you don't need it and are stuck in the lease contract.