Personal Guarantees Provided In Commercial Leases
In taking on a commercial lease for
a business premises, there are
many things for a business owner
to consider. One of these could be
a request from a landlord for a
personal guarantee. Generally a
landlord will require a combination
of a security deposit/bond or bank
guarantee as well as a personal
guarantee, as security.
The higher
the risk or weaker the ‘covenant strength’ the
landlord perceives the tenant to be, the more
security the landlord will likely require before
committing to a lease.
A guarantor, in the context of a commercial lease,
is a person who gives a written undertaking to
provide payment for a debt in the event that the
tenant company to the lease defaults in its
obligations. If called upon, the guarantor could be
required to cover many costs that they may not have considered.
These costs
could include, but are not limited
to, any unpaid rent and operating
expenses, rent and operating
expenses for the remainder of the
lease, and other expenses
incurred by the landlord such as
legal fees, penalties, agent’s fees
and financial inducements to
secure a replacement tenant.
Unless the tenant and landlord can come to an
agreement as to an exit strategy, the landlord can
apply to the court and the guarantor’s personal
assets could be forcibly sold through a court order
to recover any outstanding amount.
For example, a company (tenant) signs up to a five
year lease in a new shopping centre, and the
shareholder, who owns a house in their own name
valued at $450,000, has provided a personal
guarantee to the landlord.
After two years it is evident that the business is not profitable and the
decision is made to cease trading and exit the
premises. As the lease still has three years to run,
the tenant is liable for the remaining three years of
rental payments and operating costs; and is only
limited by the landlord’s obligation to take all
measures to mitigate the tenant’s losses by
securing a replacement occupant.
Let’s assume the landlord agrees that the tenant
may exit, on the condition they pay $200,000 to
cover six months’ rent, legal fees and agent’s fees
to find a new tenant. As might be expected with a
financially challenged business, the tenant simply
has no money to cover this payment. The landlord
has the legal right to apply to the court to liquidate
the tenant. As the shareholder has provided a
personal guarantee to the landlord, the
shareholder could lose their home to meet the
$200,000 liability.
In practical terms, when negotiating a lease, a
landlord will always want to include a personal
guarantee as part of the lease. If the requirement
for a personal guarantee seems unreasonable,
based on the tenant’s circumstances (financial
position etc), the tenant should push back on the
requirement, given the potential for loss. The result
will ultimately depend upon the bargaining power
of each party, such as how desperate the landlord
is to secure a tenant, or how much a tenant wants
to operate in a particular location.
So beware when signing a personal guarantee
whether for your own business or someone else’s,
you may be putting at risk more than you
anticipate. Legal advice should be obtained to
determine the best course of action to protect your
assets when entering into such an agreement.