Landlords seek them. Tenants shudder at the prospect of signing them. And the financial status of the tenant and the economy….well they help to gauge the amount of them. Sort of.
In the absence of a letter of credit, mortgage/deed of trust or a very large security deposit, the guaranty may also be the only method a commercial tenant has to help secure its obligations under a lease. The corporate or personal guaranty is also a source of independent recovery in situations where the tenant has filed bankruptcy. This post discusses the ins and outs of personal and corporate guaranties, as well as factors to consider in drafting these agreements.
WHEN should a Landlord obtain a guaranty?
The most obvious example would be where the tenant is a small or start-up business with little or no track record of sales, income or profits. Despite the most well-crafted business plan, management and intentions, landlords need the additional security of personal assets to protect themselves in the event the business does not flourish, or perhaps fails. Another instance where the request is appropriate is where landlord has invested a significant amount of cash to up-fit the premises for the tenant. Custom upfits or the installation of specialized fixtures increase the necessity for this additional protection. If the tenant is a franchisee, a franchisor guaranty may be appropriate. Query though when the franchisee is successful and has a long track record of successful business operations?
WHO should guaranty the obligation?
The obvious candidates are the principals or operators of the business/corporate tenant. Unless the landlord is dealing with a large company, this will be something requested. Other likely candidates are:
1. (If the tenant is a small business) the investors may be asked to sign on as a pledge of good faith. This will be especially true if the tenant is a start-up business or new venture.
2. If the tenant is a close corporation or a family company, both spouses or other relatives may be asked to sign on as guarantors. In NC and many other states , this will allow the landlord to access the assets of all involved, including property held “by the entireties” or “jointly and severally” by those closely involved in the business.
3. There may be some instances where a parent corporation may be asked to guaranty the obligations of the subsidiary, especially where the financials of the latter are thin.
4. Franchisors should be investigated too. This is somewhat of a push and pull situation as the Landlord may want the corporate security of the franchisee’s home base and franchisors will want to maintain close scrutiny on their franchisee’s performance as the lease progresses. (See REAL ESTATE DRILL DOWN Post from July 28, 2014).
5. If the lease is assigned, landlord will likely want the assignor to remain fully responsible for the assignee’s contractual responsibilities for at least a certain amount of time to make landlord comfortable that the assignee can perform adequately under the terms of the agreement (see below for more discussion on this topic).
WHAT should be guaranteed?
Most landlords will require all of the lease obligations to be guaranteed, including minimum rent, percentage rent (if applicable), CAM, Taxes, insurance and other lease obligations. In certain situations where landlord has invested a significant amount of upfront cash in customized upfits, this cost – amortized over time – will be subject to the guaranty. Many landlords will also require guarantors to be responsible for the cost of repairs and the expenses related to removal of all tenant property including storage fees. Finally, the guaranty may also include collateral costs such as reletting expenses, broker commissions, attorneys fees (perish the thought!), free rent, rent concessions, extraordinary insurance premiums required by the tenant use, and other collateral costs that were included in the lease.
HOW should the guaranty be structured?
Landlords should investigate the financial status of the guarantor(s) as vigorously as the tenant. The investigation of guarantor assets/debts should be undertaken at the same time as the lease negotiations are in progress. Landlords should also take care to note the independent consideration for the guaranty as well. As an independent obligation, this is necessary for enforcement of the guaranty. If the tenant appears to have adequate means to insure payment of rent and other lease charges, under most state laws, landlord must provide some separate value that guarantor or tenant will receive as a result of providing the guaranty. Several structures can be considered for the form of the guaranty:
1. Full guaranty of all lease obligations;
2. Limited liability – a specific amount guarantor will be responsible for during the term; and
3. Sunset Provisions – guarantor remains liable for a certain amount of time after the lease commencement date.
CAREFUL NOTE for all parties! Make sure the time period is clearly defined. Most landlords will want the period of guaranty to run from the time of any default until the end of the guaranty obligation. This may seem easy to draft at first glance, but the demon is in the details. Make sure the guaranty language tracks the default period and notice provisions to avoid problems later.