Personal guarantees provided in commercial leases

In taking on a commercial lease for 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 have, the more security the landlord will be likely to 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.

Published Summer 2013.

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