What’s My Lease Guaranty Really Worth?
Landlords in commercial leases, whether office, retail or industrial, generally require the principals of the tenant to personally guaranty the lease. A guaranty provides the landlord security in the event that the tenant stops paying rent. It allows the landlord a real person to collect from in the event of default, as most tenants are shell entities with no assets other than the lease and the equipment and fixtures necessary to operate the business, which would leave the landlord with an uncollectible entity in the event of default absent a solvent guarantor. With the principal of the tenant as guarantor, the landlord can obtain a judgment against the guarantor and execute against the guarantor’s assets to collect unpaid rent.
With this framework in mind, a landlord should make every effort to obtain the spouse’s guaranty as well to help insure the collectability of judgments. Most married couples hold their assets jointly and, if the threat of a large judgment looms against one, assets can easily be transferred to the other spouse, leaving the creditor to sort through fraudulent transfer lawsuits in addition to the collection actions.
If a landlord does not require a guaranty, or is unable to obtain one (large corporate tenants don’t usually provide guaranties), landlords are often forced into the bankruptcy process when a tenant defaults. This ties up the space for a longer period of time and delays the landlord’s ability to get paid.
Knowing that a guaranty is required in order to secure a lease for desirable space, there are strategies that a tenant can use to limit its liability under the guaranty.
- Limit the length of time of the guaranty. Make the guaranty term shorter than the term of the lease.
- Limit the dollar amount of the guaranty. Limit it to a percentage of the amount due under the lease.
- Add “burn off” provisions to the guaranty. Reduce the percentage amount of the guaranty over the term of the guaranty.
- Create a “good guy” guaranty. Guarantor agrees to guaranty the rent until tenant vacates the premises after default.
- Guaranty the cost of Tenant Improvements only.
If a tenant is adamant against providing a guaranty, the tenant will likely need to be prepared to provide security to the landlord in some other form, such as a larger security deposit or a letter of credit. To me, this makes no sense as it is cash out of pocket. The guaranty is a promise to pay IF the tenant does not pay. Yes, it is a primary obligation, but it only comes into play if the tenant defaults. The guarantor, being closely related to the tenant, is going to have significant influence on whether there will be liability on the guaranty. Therefore, when I represent a landlord and a tenant “refuses” to provide a guaranty, I question whether the tenant is really strong enough to take the space and make the payments. Why doesn’t the tenant have confidence in its own ability to succeed? Funny how when I ask this question, one of the first responses many tenants give me is to look at their financial statements and tax returns. These are usually the principal’s financial statements and tax returns as the tenant, the new LLC or S corp, has not yet begun to operate. The tenant has answered its own question.
A guaranty has strong value to a landlord, but it also has value to a tenant. It shows the landlord that the tenant is strong and is serious and will be successful because no guarantor wants to make the payments due under a lease. But no landlord should enter into a lease with a newly created entity with no track record unless the landlord has adequate security.