A guarantee on a business loan requires a borrower to promise to make good on the loan, even if the business cannot repay it. Leases are treated in a similar manor; the landlord may require the tenant, the business owner(s) to sign a Personal Guarantee to pay the required rent for the entire term of the lease. It may be secured by the tenants’ personal assets, like the owners home equity.
When a business enters into a lease it is usually signed by any officer on behalf of the corporation, LLC or other business entity. With a personal guarantee, if the business fails the burden of paying their rent fall on the business owner(s) to personally pay the rent. Today landlords require personal guarantees by all the corporate officers or partners, plus a complete financial check on the business owner(s) assets to ensure the owner(s) have the finances to back up the guarantee.
Complications arise with multiple owners and corporations, most boilerplate lease guarantees impose “joint and several” liability on the guarantors. This means that the landlord has the right to collect all its damages from any one of the guarantors. The guarantor with ”deep pockets” may get stuck with the bill and have the burden of seeking contributions from their fellow guarantors.
Another issue arises if one of the officers or partners wants to leave the business or is bought out by the others. Is there a release of liability? Liability assumed by the others? A new person replaces the one leaving? These issues need to be addressed. “Tenant retains the right to substitute a guarantor at any time.” “Landlord must approve (financially) any substitute guarantor.”
The building is being sold. The guarantee is between the tenant(s) and current owner. Tenants may want to negotiate that the personal guarantees end if the building or their lease is sold.
The liability can be tremendous! It’s a five year lease; rent is $25,000 a year (without escalations). The personal guarantee required of the owner(s) is over $125,000. A ten year lease, rent is $50,000 a year (without escalations). The personal guarantee required of the owner(s) may be over $500,000. In a lease buyout this outstanding obligation will be negotiated, typically discounted by “time value of money”. Even so this buyout will be a tremendous amount of money; perhaps affordable by large corporations, but not by the failing business on ”Main Street”.
It is in the Tenants best interest to negotiate in the lease that a Landlord “mitigate” any loss (local laws must be checked). Generally in Loss Mitigation before a landlord can go after the guarantor they must: actually market the space and only after a replacement tenant is found, determine the amount of the loss. The landlord would calculate: the number on months not receiving rent, marketing costs, legal costs, renovation expenses, commissions paid, and any other expenses to determine the total loss owed by the tenant.
Landlords often assume when a National Franchise is suggested as a tenant the National Company will sign the lease, or at least guarantee the lease. In fact, typically the Franchisee signs the lease and the parent company will not guarantee it. What is the financial strength of the franchisee?
This is a very complicated area; both sides need legal representation in determining the lease language of personal guarantees.
Negotiating Personal Guarantees
Landlords require Tenants, the business owner(s), to sign personal guarantees, obligating them personally to pay all rent due during the term of the lease. If the business fails their personal assets (like the equity in their home) are at risk. In Corporations, Partnerships, LLC’s etc. all the officers will share the risk.
The real goal of the landlord is not to have the loss and expenses of a tenant whose business fails.
Here are some alternatives when negotiating for the Tenant(s):
Security Deposit
In lieu of a guarantee increase the security deposit. (Check local laws for possible restrictions.) Perhaps six months’ rent would give the landlord time to find a replacement tenant without loss. These funds come from the business without additional risk to the business owners.
Letter of Credit
An established business with good financial resources may be able to get a Letter of Credit from their bank to guarantee the lease. This is based on the financial worth of the business with no additional liability to the business owners.
New Business
Most business, if they fail, do so within the first two years of opening the business. Agree to a personal guarantee, but limit it to two years. Agree to a review of the business activity after two years and if the business sales have increased remove the guarantee.
Establish a Time Limit
Landlords want to see a record of rent payments that establish credibility. It is a five year lease; ask the landlord, if we make all our rent payments on time for three years will you remove the guarantee?
Cap the Guarantee
Agree that if the tenant terminates the lease the landlord should be able to find a replacement tenant within ____ months. Tenant agrees to pay rent up to _____ months after lease termination (or until another tenant commences rent payments, which ever period is shorter).
Tenant Improvements
Landlords are concerned in recovering the cost of tenant improvements or the cost of removing those improvements in the event the tenant fails. Equate the tenant improvements to the cost of the guarantee, perhaps with a reducing scale over a number of years.
Early Termination Guarantee
Tenant agrees if they terminate the lease early, they guarantee the payment of an additional 6-12 months’ rent.
Liquated Damages Clause
Tenant agrees to a preset and mutually agreed amount of money to settle any default.
Representing the tenant, you may negotiate some of these alternatives but the tenant’s lawyer must draft and/or review all Personal Guarantee language in their lease.
Edward S. Smith, Jr.
CREI, ITI, CIC, GREEN, MICP, CNE
CIREC Program Developer
Commercial and Investment Real Estate
Instructor, Author, Broker and Consultant
www.linkedin.com/in/CommercialEd
Phone 631 807 2050
Smith Commercial Real Estate
Edward S. Smith Jr., Real Estate Broker
Licensed in New York and Connecticut
Berkshire Road, Sandy Hook, CT