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What Is a Lease Guarantee? (Definition, Types and How to Negotiate)

By: Taylor McHargue, SIOR

You’ve found your ideal commercial real estate space, but your prospective landlord mentions that you will need a lease guarantee. What does that mean?

At AQUILA, we’re committed to answering your questions before you sign on the dotted lines. We know that negotiating your lease can be an intimidating process, but after helping hundreds of other tenants successfully negotiate their leases, we realize the importance of having an expert lead you through the process.

Read next: Your Guide to the Elements of a Commercial Lease

In this article, we’ll cover:

• What is a lease guarantee?
• Who can guarantee a lease?
• Types of lease guarantees
• How to negotiate a lease guarantee

What Is a Lease Guarantee and What Does It Cover?

A lease guarantee is an official agreement signed by the landlord, tenant, and in addition, a third party who meets the monetary requirements of the landlord. A lease guarantor serves as a financial intermediary and is responsible for the tenant’s defaults, which protects the tenant from eviction.

The purpose of a lease guarantee is to provide protection for both the landlord and the tenant. If a tenant does not meet a landlord’s credit requirements, the landlord may propose a lease guarantee, which should be mutually beneficial if negotiated correctly.

Read Next: Understanding Security Deposits in Commercial Real Estate Leases

Who Can Guarantee a Lease?

If you are looking for someone to sign as a guarantor on your lease , you have several options.

Corporations: The most common lease type that will require a guarantor is retail, which is often already under the umbrella of a corporation. In this case, it’s not uncommon for the corporation to guarantee the lease on behalf of the entity. The assets of the tenant will still be taken into account, but the new business already has protection from its larger counterparts.

Banks: If you are looking for someone to sign a lease guarantee for you and you’re not automatically guaranteed under a corporation, this may be your best option. Banks have an easily recognizable reputation and standing credit, and landlords may seek immediate encashment without legal action if there is a default.

Individuals: An individual may sign as your guarantor, but keep in mind that their assets as an independent will be taken into account when being considered as your guarantor. 

What Information Will the Landlord Look Into?

Whether the guarantor is a corporation, a bank, or an individual, the landlord will do due diligence to assure that the cosigner has the assets to support the tenant. Here is the information a landlord may require from a prospective guarantor: 

Read Next: What Is a Triple Net (NNN) Lease and What’s Included in It?

Types of Lease Guarantees and What They Cover

Absolute/full guarantee.

The Absolute Guarantee is the most basic type and is by default will set the guarantor to cover all of the tenant’s obligations, and potentially any renewals and modifications as well. Landlords may propose this type of lease to a larger retail tenant or someone who is redesigning their space before moving in. Remember, just as a lease guarantee protects you, it protects the landlord as well. With more on the line, a Full Guarantee could be considered for full-term insurance.

Limited Guarantee

The Limited Guarantee may be more attractive to a guarantor as it limits some of the risks that come with signing on as a guarantor, but still gives the tenant a safety net of protection. This agreement limits the types of tenant obligations covered by the guarantee such as:

• Limiting the extent to which a guarantor is liable for a tenants lease obligations
• Fixing the dollar amount of maximum liability the guarantor could be liable for
• Beginning with an Absolute Guarantee for some initial portion of time up until the tenant defaults, full coverage is limited in some way 

Good Guy Guarantee

The Good Guy Guarantee is a Limited Personal Guarantee where the guarantor is fully chargeable for the payment of the rent and potentially other lease obligations of the tenant. This only applies while the tenant remains in possession of the leased space, but only if certain conditions are met. If the tenant meets the subsequent conditions, the guarantor’s liability will expire at the tenant’s surrender date:

• The tenant gives the landlord suitable advanced notice (usually 90 to 180 days) of the date they will vacate the premises
• The tenant surrenders the establishment within the condition required by the lease
• The tenant is current and up to date on their lease obligations at the time of premise vacation

Read Next: How Long of a Commercial Lease Should I Sign?

A Good Guy Guarantee will not cover all of the landlord’s potential losses, therefore it is often used hand in hand with a formula-based cap or dollar amount to pad the landlord’s liability. 

Bad Acts Guarantee

With a Bad Acts Guarantee , the guarantor is liable for only “bad acts,” which include items such as the following:

• Hazardous substance contamination
• Grossly negligent or intentional damage to the premises 
• Misappropriation of tenant funds by the guarantor 

Personal/Corporate Guarantee Versus Bank Guarantee

The difference here is based on the type of entity signing the guarantee. Usually, and especially in retail leases, an owning corporation will take on the role of guarantor. A bank is still able to sign and take on the role of guarantor, though. In this case, if the tenant breaches a contract, the landlord may immediately collect payment without the process of legal action.

Read more : Typical Types of Commercial Leases in Austin, Texas (NNN Lease vs. Gross Lease, more)

How to Negotiate a Lease Guarantee

Negotiating your lease guarantee can significantly benefit you in the long run. If you need to challenge one of the details in your agreement later, something important to keep in mind is that discrepancies will always lean in favor of the tenant. 

If you still feel like you could use more direction, connect with one of our expert Tenant Representation Brokers to negotiate the best possible terms on your lease for you. 

With that aside, here are a few things to consider negotiating before signing your lease guarantee:

• The limits on which the lease guarantee will cover
• Expiration date
• Cap it at a certain dollar amount 
• Set liability cap
• Terminating a lease guarantee once reaching a financial benchmark

To continue learning about lease guarantees, schedule a consultation with one of our expert brokers today .

Or, to continue learning about what your lease means and how to negotiate it, visit the AQUILA Learning Center .

Taylor McHargue, SIOR

Taylor is a key player at AQUILA, acting as the lead for the firm’s tenant representation platform.

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Negotiating a Lease Guarantee: 6 Bottom-Line Issues — Checklist Included

Articles , Leases

Landlords often require a personal or corporate lease guarantee, a separate document executed simultaneously with the lease, which makes the guarantor liable for the tenant’s defaults. The landlord and guarantor have conflicting interests regarding the desired scope of the guarantee. Landlords want an unconditional and unlimited guarantee, holding the guarantor liable for all of the tenant’s defaults. Guarantors, on the other hand, want a conditional, less sweeping guarantee. Following is a discussion of bottom-line issues as well a a checklist with points to consider when negotiating a limited guarantee.

Set a Maximum Dollar Cap

The parties can set a maximum dollar cap on the guarantor’s liability. The amount of the cap generally bears some relationship to the landlord’s potential losses and the tenant’s creditworthiness.

Decrease Dollar Cap Over Time.  If the tenant does not default for a period of time, the landlord’s risk presumably decreases, and guarantors argue that in this case the maximum liability should decrease over time. For example, if the guarantor’s maximum liability is set at $500,000 for a 10-year lease, the parties can agree that the guarantor’s maximum liability will decrease by one-tenth ($50,000) with the passage of each default-free year.

Set a Formula-Based Liability Cap

Another option is to limit a guarantor’s liability by setting a cap based on a formula that will cover the landlord’s likely losses in the event of a tenant default. Generally, the formula includes lost rent, the amount of the unamortized tenant improvement allowance and brokerage fees, costs to restore the premises to the condition required under the lease, and attorneys’ fees and costs incurred in evicting the tenant. If, for example, the landlord estimates a maximum of 12 months as the time required to lease the premises following the termination of the tenant’s lease, the guarantor’s maximum liability could be set by adding:

• twelve months rent and common area expenses,
• unamortized tenant improvement allowance and brokerage commissions, and
• costs to restore the premises to the condition required under the lease.

Good Guy Liability

There are variations of the Good Guy Guarantee, but generally the guarantor will be released from liability under the guarantee if (a) the guarantor provides advance notice of tenant’s vacation of the premises (e.g., three months, which will allow the landlord time to market the premises), (b) the premises are delivered to landlord in the condition required under the lease, and (c) the tenant is not in monetary default at the time of the guarantor’s notice or the date on which the tenant vacates the premises.

A Good Guy Guarantee does not cover all of the landlord’s potential losses. Therefore, it is often used in conjunction with a dollar or formula-based cap on the guarantor’s liability. In this scenario, the guarantor will be liable for the capped amount and rent from the date of tenant’s monetary default until the date on which the tenant turns over possession of the premises to the landlord in the condition required under the Lease.

A Good Guy Guarantee creates an incentive for the guarantor to be a good person and make sure the tenant vacates the premises in the condition required under the lease prior to monetary default.

Bad Acts Liability

Under a “Bad Acts Guarantee,” the guarantor is liable for so called “bad acts” such as hazardous substance contamination, grossly negligent or intentional damage to the premises, fraud, or misappropriation of tenant funds by the guarantor. As with a Good Guy Guarantee, a Bad Acts Guarantee is often used in conjunction with a dollar or formula-based cap on the guarantor’s liability and/or a Good Guy Guarantee.

Attorneys’ Fees, Costs of Collection

Attorneys’ fees and costs of collection incurred in pursuing recovery from the guarantor should not be credited against caps on guarantor’s liability. If this were not the case, a landlord could find itself spending more on attorneys’ fees and collection costs than the guarantor is obligated to pay, giving the guarantor a perverse incentive to litigate rather than pay under the guarantee.

Guarantee Termination, Tenant’s Benchmarks

A guarantee (or certain liabilities thereunder) can also terminate with the passage of time or if tenant hits a financial benchmark. Landlords want a guarantee because they are not confident that the tenant has the financial wherewithal to support the monetary obligations under the lease. If the tenant does not default under the lease or if the tenant’s financial situation changes for the positive, there may no longer be a strong rationale for requiring a guarantee.

Guarantee Termination at a Point in Time. Under this approach, if the tenant has not defaulted after a predetermined period of time, the guarantee terminates. For example, the parties can agree that the guarantee will terminate after the third year if the tenant has not defaulted under the lease.

Predetermined Financial Benchmarks. Certain predetermined financial benchmarks can be negotiated which, if met, will terminate the guarantee. Examples of benchmarks are:

• an agreed-upon net worth of the tenant,
• an agreed-upon level of tenant’s gross sales, or
• any other financial target the parties agree upon.

Basic Framework

While this article provides a basic framework for negotiations between landlords and guarantors, there are many other financial considerations and legal nuances that are beyond the scope of this discussion. Some of them are financial. Examples include the (a) application of the security deposit to reduce the guarantor’s liability, (b) joint and several liability – and potential limitations on such liability, and (c) the release and substitution of guarantors, which may arise upon an assignment of the lease or the removal and replacement of partners. Other considerations are inherent legal issues, such as defenses against enforcement, subrogation, bankruptcy, and local law issues. These considerations should be taken into account by both parties before entering into any guarantee.

LEASE GUARANTEE CHECKLIST:

• The guarantee can be (i) limited, or (ii) unlimited.

2.  If the guarantee is limited, select one, two or all three of the following to include in the guarantee:

a.   Cap guarantee (choose one)

i.   Dollar cap.  Dollar cap can decrease over time if tenant does not default.

ii.  Formula-based cap.

b.   Good Guy Guarantee

c.   Bad Acts Guarantee

3.  Terminate a limited or unlimited guarantee, or portions thereof, if tenant (i) does not default for a specified period of time, or (ii) reaches financial benchmarks.

4.   Attorney’s fees and costs incurred in pursuing the guarantor should not credited against or subject to limitations on guarantor’s liability.

If you have any questions or comments, email Rick.

Disclaimer: This article is provided by Angel Law Offices for general education purposes only.  The information should not be relied on as legal advice, nor does it serve to create an attorney-client relationship. Laws vary from one state to another. For legal advice on a specific matter, consult an attorney.

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Assignment of Lease

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What is an assignment of lease.

The assignment of lease is a title document that transfers all rights possessed by a lessee or tenant to a property to another party. The assignee takes the assignor’s place in the landlord-tenant relationship.

You can view an example of a lease assignment here .

How Lease Assignment Works

In cases where a tenant wants to or needs to get out of their lease before it expires, lease assignment provides a legal option to assign or transfer rights of the lease to someone else. For instance, if in a commercial lease a business leases a place for 12 months but the business moves or shuts down after 10 months, the person can transfer the lease to someone else through an assignment of the lease. In this case, they will not have to pay rent for the last two months as the new assigned tenant will be responsible for that.

However, before the original tenant can be released of any responsibilities associated with the lease, other requirements need to be satisfied. The landlord needs to consent to the lease transfer through a “License to Assign” document. It is crucial to complete this document before moving on to the assignment of lease as the landlord may refuse to approve the assignment.

Difference Between Assignment of Lease and Subletting

A transfer of the remaining interest in a lease, also known as assignment, is possible when implied rights to assign exist. Some leases do not allow assignment or sharing of possessions or property under a lease. An assignment ensures the complete transfer of the rights to the property from one tenant to another.

The assignor is no longer responsible for rent or utilities and other costs that they might have had under the lease. Here, the assignee becomes the tenant and takes over all responsibilities such as rent. However, unless the assignee is released of all liabilities by the landlord, they remain responsible if the new tenant defaults.

A sublease is a new lease agreement between the tenant (or the sublessor) and a third-party (or the sublessee) for a portion of the lease. The original lease agreement between the landlord and the sublessor (or original tenant) still remains in place. The original tenant still remains responsible for all duties set under the lease.

Here are some key differences between subletting and assigning a lease:

• Under a sublease, the original lease agreement still remains in place.
• The original tenant retains all responsibilities under a sublease agreement.
• A sublease can be for less than all of the property, such as for a room, general area, portion of the leased premises, etc.
• Subleasing can be for a portion of the lease term. For instance, a tenant can sublease the property for a month and then retain it after the third-party completes their month-long sublet.
• Since the sublease agreement is between the tenant and the third-party, rent is often negotiable, based on the term of the sublease and other circumstances.
• The third-party in a sublease agreement does not have a direct relationship with the landlord.
• The subtenant will need to seek consent of both the tenant and the landlord to make any repairs or changes to the property during their sublease.

Here is more on an assignment of lease here .

Parties Involved in Lease Assignment

There are three parties involved in a lease assignment – the landlord or owner of the property, the assignor and the assignee. The original lease agreement is between the landlord and the tenant, or the assignor. The lease agreement outlines the duties and responsibilities of both parties when it comes to renting the property. Now, when the tenant decides to assign the lease to a third-party, the third-party is known as the assignee. The assignee takes on the responsibilities laid under the original lease agreement between the assignor and the landlord. The landlord must consent to the assignment of the lease prior to the assignment.

For example, Jake is renting a commercial property for his business from Paul for two years beginning January 2013 up until January 2015. In January 2014, Jake suffers a financial crisis and has to close down his business to move to a different city. Jake doesn’t want to continue paying rent on the property as he will not be using it for a year left of the lease. Jake’s friend, John would soon be turning his digital business into a brick-and-mortar store. John has been looking for a space to kick start his venture. Jake can assign his space for the rest of the lease term to John through an assignment of lease. Jake will need to seek the approval of his landlord and then begin the assignment process. Here, Jake will be the assignor who transfers all his lease related duties and responsibilities to John, who will be the assignee.

You can read more on lease agreements here .

Image via Pexels by RODNAE

Assignment of Lease From Seller to Buyer

In case of a residential property, a landlord can assign his leases to the new buyer of the building. The landlord will assign the right to collect rent to the buyer. This will allow the buyer to collect any and all rent from existing tenants in that property. This assignment can also include the assignment of security deposits, if the parties agree to it. This type of assignment provides protection to the buyer so they can collect rent on the property.

The assignment of a lease from the seller to a buyer also requires that all tenants are made aware of the sale of the property. The buyer-seller should give proper notice to the tenants along with a notice of assignment of lease signed by both the buyer and the seller. Tenants should also be informed about the contact information of the new landlord and the payment methods to be used to pay rent to the new landlord.

You can read more on buyer-seller lease assignments here .

Get Help with an Assignment of Lease

Do you have any questions about a lease assignment and want to speak to an expert? Post a project today on ContractsCounsel and receive bids from real estate lawyers who specialize in lease assignment.

ContractsCounsel is not a law firm, and this post should not be considered and does not contain legal advice. To ensure the information and advice in this post are correct, sufficient, and appropriate for your situation, please consult a licensed attorney. Also, using or accessing ContractsCounsel's site does not create an attorney-client relationship between you and ContractsCounsel.

Meet some of our Assignment of Lease Lawyers

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Types of Guarantees in Commercial Leases

Many commercial landlords require that a guarantor secure the obligations and liabilities of a tenant as a prerequisite for entering into a lease. A lease guaranty is a contract between an individual or entity (guarantor) that is typically related to the tenant. The guarantor promises to pay the landlord any and all payments due under the lease in the event the tenant defaults under its lease obligations and otherwise cure the tenant's defaults.

Today, most commercial leases are entered into by an entity as the tenant, such as a limited liability company or corporation. That entity is often a shell company that is created solely to engage in the business at the leased premises and may be part of a multilayered corporate structure designed to provide maximum liability protection for the tenant's principals. This creates significant hurdles for the landlord in the event the tenant defaults under the lease. Even if the landlord is ultimately successful in securing a court judgment against the tenant, it may be a hollow victory as the tenant may have little or no assets to collect against. To mitigate this risk, landlords now routinely require either a personal or corporate guaranty to secure a tenant's obligations under the lease.

Depending on the financial condition and bargaining position of the tenant and guarantor, the parties may enter into various types of lease guarantees, which are outlined below:

• Full or Absolute Guaranty. This is the gold standard for most landlords, as this guaranty provides the landlord the most comprehensive coverage. It requires the guarantor to cover all of the tenant's obligations under the lease, without limitation. This can include payment of all monetary obligations under the lease (i.e., payment of rent, tenant's share of operating expenses and utility charges), as well as non-monetary obligations (i.e., maintenance of insurance coverage, repairs, licenses and permits). Another benefit for landlords is that a full guaranty does not impose any conditions upon the landlord before it may pursue the guarantor. Thus, the landlord can move quickly to enforce the guaranty following a default by the tenant to be made whole.
• Partial or Limited Guaranty. Sometimes referred to as "rolling" or "floating" guarantees, partial guarantees provide more protections for tenants before they may be enforced. A partial guaranty may be limited to just a tenant's monetary obligations under the lease, and the guarantor's liability may be capped at a specific dollar amount. A partial guaranty may begin as a full guaranty, then transition to a partial guaranty following a certain period of time. In addition, a partial guaranty may include a "burn off" or "sunset" provision whereby the amount of guarantor's financial liability is decreased over a period of time before terminating completely. A partial guaranty may also impose certain conditions on a landlord such as requiring the landlord to pursue or exhaust its remedies against the tenant before it can enforce its rights under the guaranty.
• Springing or Bad Acts Guaranty. This is a form of partial guaranty that becomes enforceable only upon the occurrence of a specified event. The triggering event is typically an event of default by tenant under the lease, which can include the tenant entering bankruptcy or insolvency proceedings or the tenant's net worth falling below a certain threshold. The triggering event may also be a result of tenant's "bad acts." These include fraud, damage to the premises resulting from tenant's actions or negligence, contamination of the premises by hazardous substances or criminal prosecution of the tenant or guarantor.
• Good Guy Guaranty. This is a form of limited guaranty and that is attractive for many tenants. Under a traditional Good Guy Guaranty, which is common in New York City, the guarantor's liability is terminated upon the tenant's surrender of the premises. The tenant must pay all lease payments through the date of surrender and return the keys to the landlord. Most Good Guy Guarantees require the tenant to provide the landlord reasonable advance notice of the intended surrender date, and the tenant must surrender the premises in good condition. However, a Good Guy Guaranty may also impose certain requirements on the guarantor that may survive the tenant's surrender of the premises, such as requiring the guarantor to remove the tenant's alterations and restore the premises to its condition upon commencement of the lease term.

Most limited guarantees are subject to the tenant being in good standing under the terms and conditions of the lease. The parties may agree to some combination of a standard guaranty with full liability against the guarantor that may convert into a rolling guaranty provided that no event of default has occurred under the lease. Further, any limit on a guarantor's liability may be subject to reimbursing the landlord the amortized cost of any improvements that were constructed for the tenant or tenant improvement allowance, brokerage commissions, and for all costs and expenses incurred by the landlord in enforcing and collecting under the lease and the guaranty.

Ultimately, these are general concepts, and there is room for negotiation between the parties depending on many factors – including financial condition of the tenant and/or guarantor, desirability of the location, lender requirements, etc. Landlords, tenants and guarantors should carefully consider these and other factors when negotiating a guaranty of a commercial lease.

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Assignment and Consent Standards in Commercial Leases

Mar 6, 2020

Assignment provisions in commercial leases are heavily negotiated and very important to both landlords and tenants. This article presents a brief overview of the assignment provision in commercial leases, both office and retail.

Assignment provisions in commercial leases are heavily negotiated and very important to both landlords and tenants. When a tenant’s interest in a lease is assigned, the tenant is transferring its entire leasehold interest and 100% of the leased premises to a third party for the entire remaining term of the lease. For the tenant, the assignment provision represents a potential exit strategy, dependent of course on the local market, and increased flexibility for future needs. For the landlord, the assignment offers greater security for its revenue stream and hopefully the avoidance of a tenant bankruptcy or default while keeping its building occupied. The tenant’s desire for flexibility and the landlord’s need for control is where the negotiations are focused. This article presents a brief overview of the assignment provision in commercial leases, both office and retail, with particular attention on the laws of Maryland, Virginia and the District of Columbia. The landlord’s standard for providing consent to a request to an assignment will be reviewed, and we will conclude by offering suggested language.

What If The Lease Does Not Contain An Assignment Provision?

The law traditionally favors the free alienation of property. Therefore, under the laws of almost every state, if the lease is silent on whether the landlord’s consent to an assignment is required, then the commercial tenant has the right to assign its interest. This is true in Maryland, Virginia and the District of Columbia. Given this baseline, almost every lease form will have a detailed provision setting forth the assignment process. Note also, however, that in most states it is also enforceable for a commercial lease to have an outright prohibition against assignments. Such a provision would likely be a non-starting deal point for most sophisticated tenants.

What Does Reasonable Mean?

If a lease simply provides that the tenant requires landlord’s consent to an assignment, but does not include the standard for giving or withholding that consent, then in many states the implied standard is that the landlord’s consent may not be unreasonably withheld. Historically this was the minority view, with the historical rule allowing the landlord to withhold consent for any reason. The implied duty of reasonableness is now more the norm as more states adopt this position when presented with the issue. There is express case law establishing this rule in Maryland, and most courts in Virginia and Washington, DC will imply such a covenant of good faith and fair dealing. Most states, though, do allow a landlord the sole right to grant or withhold its consent if the lease clearly expressly provides, and in Maryland the lease must specifically state that the landlord’s consent may be granted or withheld in the sole and absolute subjective discretion of the landlord. Again though, a sophisticated tenant with any leverage should never agree to such a provision.

Most negotiated leases will instead contain a provision requiring that landlord’s consent to an assignment is required, but such consent will not be unreasonably withheld. The tenant will likely also try to include landlord’s obligation to not unreasonably delay or condition its consent. A short clause without further defining what constitutes “reasonableness” generally favors the tenant, and landlords typically prefer including specific standards as to the criteria it can consider when reasonably deciding whether or not to consent to an assignment. Without such specificity, defining “reasonable” is difficult as the landlord and tenant clearly will have differing viewpoints and it may be left as a factual question to be decided in litigation. The typical definition (set forth in the Restatement (Second) of Property) would be that of a reasonably prudent person in the landlord’s position exercising reasonable commercial responsibility.

Absent a detailed provision listing the criteria a landlord can consider when reasonably reviewing a request to assign, a landlord is typically found to be considered reasonable if it considers certain general broad factors. First, the landlord reviews the assignee’s proposed use. In a retail setting, the landlord will be concerned whether the proposed use fits with the existing center and/or violates any existing exclusives or insurance requirements. In an office setting, the landlord might review the expected traffic and wear and tear on the building. Second, the landlord will consider the creditworthiness of the assignee. The landlord (and the assignor) will want to be confident that the assignee is capable of performing tenant’s obligations under the lease and a large creditworthy tenant increases the value of the asset. The assignor might argue that a strict financial test (such as a minimum net worth, for example) is unfair since the assignor is likely not being released upon the assignment and the landlord can still pursue the assignor in the event of a default. Third, the landlord will review the experience and history of the assignor. As mentioned above, landlords instead prefer a detailed list setting forth the many factors that they can include as part of reasonably reviewing a request for a lease assignment.

Without further establishing the criteria, the landlord puts itself at risk of a challenge by the tenant that a denial of a consent is unreasonable.

In defining “reasonable,” courts typically do not allow a landlord to deny or condition consent to an assignment based purely on economic reasons where the landlord results in substantially increasing what it was entitled to under the lease. In Washington, DC, there is well established case law holding that it is unreasonable for a landlord to withhold consent solely to extract an economic concession or improve its economic position. For example, a court would not consider it reasonable for a landlord to condition its consent on the assignee paying a greatly increased rent. Instead, as discussed below, landlords should look to protect their interests in a market of increasing rents by providing for either the sharing of excess rentals or a right to recapture.

What Are Typical Provisions In an Assignment Clause?

As discussed above, tenants generally prefer a short assignment provision simply requiring the landlord to not unreasonably withhold, condition or delay its consent to an assignment. But most leases are drafted by landlords, and over the years the assignment provisions have evolved to contain many typical provisions in addition to further defining “reasonableness,” including the following below.

• Sharing of Excess Rents. Since many states do not permit a landlord to condition its consent on improving its economic position (e. g. , by increasing the rent), most leases instead contain a provision where the landlord is entitled to all or a portion of the profits. The profits may mean increased rent, or it may even be construed more broadly to consider the value of the location in a sale of the tenant’s business. The landlord’s argument is that it doesn’t want the tenants competing in the real estate market. The tenant should push back here, and certainly try to lower the percentage shared, carve out any consideration received in the sale of tenant’s business, and only share profits after all of the tenant’s reasonable costs incurred in connection with the assignment were first deducted.
• Corporate Transfers. Since a purchase of the entity constituting tenant is likely not deemed an assignment under the law, most leases make clear that any such corporate sale, including the sale of either a controlling interest in the stock or substantially all of the assets of the tenant, is deemed an assignment for purposes of the lease. The tenant should carve out permitted transfers for typical mergers and acquisitions under certain conditions, and also carve out routine transfers of stock (or other ownership interests) between existing partners or for estate planning purposes. The landlord will likely accept a permitted transfer concept provided they receive adequate notice and the successor entity succeeds to all of the assets of the original tenant with an acceptable net worth.
• Assignment Review Fee. Most landlords include in their form lease the requirement that the tenant reimburse them for legal and administrative expenses incurred in reviewing the request for consent and preparing the assignment. The tenant clearly wants to keep these fees reasonable and in keeping with the local market.
• Recapture Rights. Landlords like to include the express right to recapture the premises in the event the tenant comes to it to request a consent for an assignment. A recapture clause allows the landlord to terminate the lease if market rents have increased or if it needs the space for another use. Sophisticated tenants should push back here as much as leverage allows, try to limit the time periods, and if nothing else try for the right to nullify the recapture by rescinding its request for the consent.
• Tenant’s Remedy. To protect themselves from claims for damages from the tenant if the landlord withholds its consent to a requested assignment, landlords often include a provision where the tenant waives its rights to monetary damages in such a situation and can only seek injunctive relief. The tenant should try to delete this provision, or at least, if leverage permits, provide for the right to seek damages if the landlord is subsequently found to have acted in bad faith.

Assignment provisions are heavily negotiated and both the commercial landlord and tenant need to be advised to the applicable local law and know the market for a comparable transaction. ( Note: The author represents office and retail landlords and tenants throughout Virginia, Maryland and the District of Columbia.) Sample reasonableness provisions for both office and retail uses are copied below for reference.

Retail Lease

Landlord and Tenant agree, by way of example and without limitation, that it shall be reasonable for Landlord to withhold its consent if any of the following situations exist or may exist: (i) In Landlord’s reasonable business judgment, the proposed assignee lacks sufficient business experience to operate a business of the type permitted under this Lease and to a quality required under this Lease; (ii) The present net worth of the proposed assignee is lower than that of Tenant’s as of either the date of the proposed assignment or the date of this Lease; (iii) The proposed assignment would require alterations to the Premises affecting the Building’s systems or structure; (iv) The proposed assignment would require modification to the terms of this Lease, or would breach any covenant of Landlord in any other lease, insurance policy, financing agreement or other agreement relating to the Shopping Center, including, without limitation, covenants respecting radius, location, use and/or exclusivity; (v) The proposed assignment would conflict with the primary use of any existing tenant in the Shopping Center or any recorded instrument to which the Shopping Center is bound; and/or (vi) The proposed assignment or subletting would result in a reduction in the Rent collected by Landlord during any portion of the term of this Lease.

Office Lease

Without limitation as to other reasonable grounds for withholding consent, the parties hereby agree that it shall be reasonable under this Lease and under any applicable law for Landlord to withhold consent to any proposed Transfer where one or more of the following apply: (i) The Transferee is of a character or reputation or engaged in a business which is not consistent with the quality of the Building; (ii) The Transferee intends to use the Premises for purposes which are not permitted under this Lease; (iii) The Transferee is a governmental agency; (iv) The Transfer occurs prior to the first anniversary of the Lease Commencement Date; (v) The Transferee has a net worth of less than $10,000,000.00; (vi) The proposed Transfer would cause a violation or trigger a termination right of another lease for space in the Building; or (vii) Either the proposed Transferee, or any person or entity which directly or indirectly, controls, is controlled by, or is under common control with, the proposed Transferee, (i) occupies space in the Building at the time of the request for consent, or (ii) is negotiating with Landlord to lease space in the Building at such time, or (iii) has negotiated with Landlord during the six (6)-month period immediately preceding the Transfer Notice.

Reprinted with permission from the March edition of the Commercial Leasing Law & Strategy© 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or [email protected] .

• John G. Kelly

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Guaranties of Leases

• November 14, 2015

As protection against tenant defaults, commercial landlords rely primarily on three devices: security deposits, letters of credit and guaranties of the leases. This article will focus primarily on the third, from the perspective of the landlord.

A guaranty is a promise to answer for the debt, default or miscarriage of another (California Civil Code Section 2787). Key considerations with lease guaranties relate to the obligations that are guaranteed; the guarantor parties; and appropriate waivers.

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Characterization

A landlord may seek a guaranty of both payment and performance such that the guaranty relates to all obligations of the tenant under the lease in addition to the payment of amounts for which the tenant is obligated. The landlord would not want a guaranty of collection only since the guarantor’s obligation would arise in that case only if the landlord is unsuccessful in recovering amounts due from the tenant. The guaranty should also be characterized as a continuing guaranty such that all of the tenant’s present and future rent liability is guaranteed. California case law has held that a continuing guaranty without language that would limit it, extends to obligations under amendments, modifications and extensions of the lease. It would also be prudent to expressly mention these items.

Obligations Guaranteed

A significant area of guaranty negotiation involves the attempt to limit the monetary scope. This may take the form of (1) placing a cap on the total amount guaranteed; (2) limiting the duration of the guaranty; (3) decreasing the amount of the guaranty as the lease term decreases; (4) limiting the guaranty to the tenant’s obligations while it is in possession; (5) terminating the guaranty if the tenant meets certain financial benchmarks; or (6) other negotiated limitations.

If a cap is placed on total liability, the landlord should take care that all of its costs in connection with the leasing, and not just rent, are considered. These include upfront leasing expenditures and rent concessions, brokerage commissions, tenant improvement allowances and other initial investments by the landlord that may have been amortized as well as other obligations during the term. Attorneys’ fees and other costs of collection should be excluded from the calculation of any capped amount.

Any decrease in the guarantor’s liability should require that the tenant not be and never have been in default under the lease at the time that the decrease would be made.

Guarantor Parties

Where an entity, and especially a limited liability entity, is a tenant, the landlord should consider obtaining guaranties from all principals (or those with substantial net worth). The liability of all guarantors should be joint and several. Guarantors may request that the liability of each have a cap, based, for example, on its percentage of ownership of the entity or otherwise.

Care should also be taken that guaranties accurately identify the capacity of the guarantor. Thus, if the guaranty of an individual is sought, the individual should not sign in a representative capacity for the entity since that would insulate the personal assets to which access is sought. When a guarantor is married, it is always a best practice to obtain the guaranty or consent of the spouse.

Since a guarantor is obligated for the debts of another, the law provides a number of protections, most of which are contained in California Civil Code Sections 2787-2855. It is essential that the guaranty contain waivers of these protections, which waivers are enforceable in California as long as they are sufficiently clear and manifest the intent to waive. Significant protections that should be waived in a lease guaranty include: (1) exoneration of the guarantor if the obligation is modified (although good practice would dictate that even with a waiver, the landlord seek a consent from the guarantor to any modifications); (2) right of the guarantor to require that the landlord first pursue the tenant in the event of a default; (3) right of the guarantor to revoke a continuing guaranty; (4) the obligation of the landlord to make demand on the guarantor, to make disclosure; and (5) other protections.

Pre-Leasing Due Diligence

The best advice for a landlord prior to leasing is to understand the financial status of the prospective tenant since these are the best indicators of whether there will be a default or a breach. Thus, landlords should always review the prospective tenant’s business plan, credit, financial reserves and rental history prior to entering lease negotiation. In this manner, the landlord can assure itself that it will not need to enforce a guaranty. However, in the event that it does require a guaranty, this article highlights some items that should be considered in its documentation.

Ms. Williams acknowledges the contribution of Kiyana Kiel, Esq. of Williams & Associates to this article. Disclaimer: Nothing in this article shall be construed as giving legal advice. Practitioners are advised to consult with their individual legal advisers as to the legal effect of any item described in this article.  Norma J. Williams 

Norma J. Williams

Norma J. Williams is a commercial real estate attorney whose practice focuses on financing, purchase and sale and leasing transactions for office, industrial, retail, multifamily and other commercial real estate. She is a frequent speaker, has authored major real estate legislation and has held leadership positions in local, state and national real estate bar associations. Ms. Williams received her bachelor’s degree magna cum laude from Wesleyan University and her law degree from University of California, Berkeley. For more information, email [email protected] or call (213) 996-8464.

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The Ties That May Still Bind: Subleases and the Paradox of Lease Assignment

For small and large businesses alike, the commercial real estate lease is often an important and necessary tool. Whether you are opening your first retail store or expanding a successful business in a new market, leased space can provide an essential building block to success without the headaches and expense of property ownership. Leases can also provide the flexibility to contract or expand your real property as your company's needs change.

Should it come time to find a new home for your business, however, your existing commitment to a landlord might seem like an afterthought—something trivial, to be handled easily when you move. But for businesses looking to sublet or assign their rights under a lease, careful consideration must be given to the ties that may still bind you to your ex-landlord.

Among other dilemmas, you must confront the basic paradox of lease assignment: Despite appearances to the contrary, even a strict assignment of a lease is not tantamount to a release of a former tenant's liability to a former landlord. Instead, a former tenant may be and frequently is held accountable for the shortcomings of the new tenant. Put simply, you are not free of obligations to the landlord unless the landlord agrees that you are free of obligations.

To Sublease or to Assign?

No matter what your circumstance—whether you want to give up all or part of your space, and whether you have two years or ten remaining on your lease—your first step is to have someone dig up a copy of your lease from the remote filing cabinet in which it has been stored, unread, since you signed it. Next, have a real estate attorney do a thorough review—you need to know your options.

If both subleasing and an assignment of space are available options, the process of choosing between the two is often an amalgamation of legal interests and business-world practicalities. Should you find the perfect replacement tenant—someone who conducts a type of business permitted under the lease and who has the financial wherewithal to step into your shoes—an assignment is likely your best choice. In other situations, though, a sublease may be the best—or only—option. The most viable replacement tenant may, for example, be a startup business willing to commit to only a portion of the remaining term.

Though the terms are often used interchangeably, there is an important distinction between a lease assignment and a lease sublet.

The grant of a sublease conveys only a portion of the tenant's rights in the property. In a sublease scenario, the new tenant frequently leases only a portion of the original tenant's space, or the sublease covers only a portion of the remaining lease term. For this reason, a sublease is often viewed as a lease within a lease. The analogy of landlord and tenant arises and is applied to the original and new tenant, respectively.

A lease assignment can occur in two forms: a strict assignment or an assignment pro tanto (only to the extent). A strict assignment constitutes a complete disposition of all your rights and interests to the entire premises for the remaining duration of the lease. By the terms of a strict assignment, a tenant has no latent interest in the property. In contrast, an assignment pro tanto results in the disposition of the tenant's entire right to only a portion of the premises.

Due to their similarities, an assignment pro tanto and a sublease are frequently mistaken for one another. Technically, the distinction is often drawn by the presence, or absence, of a "reversionary interest" to the property. A true sublease will result in the premises being returned to the original tenant before the end of the term, if only for a day. By contrast, an assignment pro tanto carries no reversionary interest for the original tenant, and once the original tenant assigns its rights to that portion of the premises, it should never be theirs again. Though the distinction may seem amorphous, the legal ramifications can be significant.

In crafting an assignment, careful consideration must likewise be given to ancillary issues, such as whether a suitable replacement guarantor exists, if needed, and whether options for additional space or lease renewal can be assigned to the replacement tenant.

The Paradox of Lease Assignment: Why All Doesn't Necessarily Mean All

It is a common misperception that the strict assignment of a lease relieves the original tenant of its obligations to the landlord. The first substantive clause of an assignment document typically reads, "XYZ hereby assigns and ABC hereby assumes all rights, interests and obligations under the terms of the lease." The plain language— all obligations —implies that your commitments under the lease end when you turn over the keys.

Often, that is not so.

The technical basis underlying the persistence of that obligation is the legal doctrine of privity , or the connection between the original parties. A lease revolves around two essential privities, those of contract and estate. The privity of contract is created when the landlord and tenant sign the original lease, each agreeing to certain duties and obligations with respect to the other. Privity of estate represents the mutual interest of both parties in the property itself. With the assignment of the lease, the new tenant will fall into privity of estate with the landlord, since both share an interest in the premises. By law, however, privity of contract (in this case, between landlord and original tenant) is not defeated by assignment to another party. Legally, the covenants undertaken by the landlord and tenant still exist for the benefit of each other.

As a result, should a replacement tenant fail to pay rent, the landlord can look to the original tenant to be made whole. Similarly, a new tenant's failure to uphold covenants in the lease, such as those regarding proper use of common areas or restrictions against hazardous materials, could result in termination of the lease (though not the rent obligations), and with it charges for legal fees associated with the termination, or an assessment of damages incurred by the landlord as a result of the new tenant's actions. In some cases, the extent to which a landlord may recover against a former tenant will be governed explicitly by the terms of the lease. In others, the parties—and in bad cases, courts—will primarily be guided by the presumption of the original tenant's liability.

Another common cause for confusion lies in the typical lease provision governing the landlord's consent to an assignment: "Tenant shall not sublet any part of the premises or assign this lease or any interest therein without the written consent of Landlord, which consent shall not to be unreasonably withheld or delayed." But even where a landlord consents to the assignment, such consent should not be interpreted as a release of responsibility. Nor does the acceptance of rent by the landlord relieve the former tenant of its liabilities.

Avoiding Pitfalls

In order to avoid the pitfalls of the lease assignment/privity paradox, exiting tenants can take several steps to more fully sever their liability to the landlord. One approach is for the withdrawing tenant to seek indemnification from the new tenant for liabilities to the landlord as a result of the new tenant's failure under the lease. Indemnification provisions can relieve much of the financial liability you may face as a former tenant. However, recouping costs pursuant to an indemnification provision often requires further legal intervention, a process that becomes even more difficult in cases where the new tenant's default results from insolvency, bankruptcy or similar restructuring proceedings.

Another alternative—termination of the existing lease—sidesteps the assignment issues altogether. In this scenario, the landlord and original tenant terminate their lease agreement, leaving the new tenant and landlord to negotiate a lease. This option, however, often encounters resistance from the landlord, and not unjustly so. Lease negotiations are often time-consuming and costly, and landlords typically believe they have the right to gain the benefits of their original negotiations with the withdrawing tenant. Convincing a landlord to terminate an existing lease may thus require some creative thinking. Perhaps the new tenant is willing to agree to a longer lease term, or to a different rent structure that would mean greater cash flow for the landlord. The new tenant may be more creditworthy or may be willing to lease additional space. A real estate attorney may be able to provide innovative arguments for persuading your former landlord that lease termination is the best option.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

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Risks with personal guarantees, personal guarantee negotiations a on a commercial lease.

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Personal Guarantee Issues In A Retail Lease

On Behalf of Lanard and Associates | Aug 4, 2016 | Firm News

WHY ARE PERSONAL GUARANTEES REQUIRED IN A RETAIL LEASE?

What are some of the issues of a personal guaranty in a retail lease? Most landlords nationwide today require a personal guaranty from all tenants who are entering into a retail lease. The landlord had very bad experiences during the recession of 2008-2010 and found that they had many retail tenants close their doors without any notice. Since most retail tenants execute a lease under their legal entity (corporation or LLC) (see our business formation page  and our blog on choosing a proper entity), without a personal guaranty, the retail landlord has no recourse to go after the owners of the tenant. If the tenant corporation or LLC has no assets, then the landlord has nothing from which to recover the rental fees due. Today, having learned their lessons, retail landlords require the shareholders or members of the tenant entity to sign a personal guaranty. What does this personal guarantee mean?

WHAT  ARE THE TYPES OF PERSONAL GUARANTEES?

Personal guarantees can be limited or unlimited..

• Unlimited. An unlimited personal guaranty is one that means that the guarantors (people who are guaranteeing the obligations of the tenant entity [typically the owners of the tenant entity]) fully and unconditionally guaranty the full term of the lease.  This means that if a tenant defaults in year 2 of a 10-year lease, the owners of the tenant could be liable for 8 or 9 years of rent and additional rent.  This could be hundreds of thousands of dollars.
• rolling guaranty: this can be a 12 month, 24 month or some other number of months, rolling guaranty. It means that the total exposure is the number of months regardless of how many months are remaining in the lease (unless the remaining months are less than the rolling months.  For example, in a 12-month rolling guaranty, a default in year 7 of a 10-year lease will mean that 12 months of rent and additional rent will be due personally, not 3 years.
• rolling guaranty after 5 years: this is the same as the rolling guaranty defined above, but only kicks in after 5 years. In the first 5 years of the lease the guaranty is the same as an unlimited guaranty, meaning you are liable for the full remaining term for rent and additional rent.  In other words, if the default happens in year 2 of a 10-year lease with a 12-month rolling guaranty that kicks in after 5 years, then the individual owners of the tenant are liable for 8 years of rent and additional rent, not 3 years.  This is a common misunderstanding that a retail tenant has.

ARE RETAIL TENANTS AUTOMATICALLY RELEASED FROM A GUARANTEE OF THE LEASE IF ASSIGNED WHEN A BUSINESS IS SOLD?

Retail tenants and the guarantors of a lease are not automatically released from the guaranty that they signed if the lease is assigned because a business is sold (or any other reason).  When a lease is negotiated it is critical (to me one of the only “drop dead” issues in a lease) that upon an approved assignment of the lease to a buyer of the tenant’s business, the personal guarantees of the owners of tenant should be released from the guarantees. Since the recession, many landlords would like to keep as many personal guarantors on the lease as possible. However, if the personal guarantees are not released when the business is sold, those guarantors are guaranteeing the financial obligations of the buyer of the business.  If the buyer fails to pay rent or any other financial obligation to the landlord, the landlord can look to the seller’s owner’s guaranty and go after the individual for those obligations. The indemnification/hold harmless clause in the Asset Purchase Agreement that was signed between the Buyer and the Seller at the time of the sale, will likely have no significant effect or be of any real help since it is likely that neither the buyer of the business, nor the buyer’s owners, will be able to reimburse these costs to the seller.  Presumably the buyer does not have the funds or would have paid the rent in the first place.

JOINT AND SEVERAL LIABILITY OF THE PERSONAL GUARANTORS

What is joint and several liability?  This is a legal term that means that each guarantor is liable for the entire amount (not 50% if there are two guarantors) and a landlord may go after a guarantor before pursuing action against the tenant in the lease.  This is a serious issue in that a guarantor of the lease may not realize that the landlord can look to that guarantor for rental payments if there is a default before pursuing any remedies against the tenant that signed the lease.  Since most people enter into a retail lease as the entity they have formed for the purpose of protecting their personal assets, it is important to realize that in a commercial lease the personal guaranty will expose those personal assets to liabilities of the tenant entity for financial obligations to the landlord (but typically protect the individuals from 3rd party liability [customers, vendors, etc.]).

Retail leases are complex legal documents that should not be entered into without the advice of competent legal counsel to negotiate important legal clauses in the lease such as the personal guaranty.  Personal guarantees should be limited and should always be released upon an assignment to a qualified assignee of the lease.  The attorneys at Lanard and Associates can review and negotiate the retail lease for your business with these and many other important clauses in mind.  Our attorneys understand the commercial lease and the most important legal issues that should be negotiated.

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Subleasing and Assignment Provisions in Commercial Leases

• June 17, 2020

Before the COVID-19 pandemic, many business owners paid little attention to subleasing and assignment provisions when negotiating commercial leases . It was common to focus on rent, maintenance, taxes, and insurance, which affect a tenant’s bottom line, and options to renew the lease if the business thrives. Recently, however, one of the top concerns of commercial tenants is flexibility in case they no longer need to use a portion, or all, of the leased space. In this context, subleasing and assignment provisions are key deal terms.

The Difference Between Subleasing and Assignment

A sublease does not alter the relationship between the landlord and the tenant, who remains liable for all of the tenant’s obligations under the lease. However, the tenant enters into a subordinate lease (the sublease) with a subtenant regarding a portion, or all, of the leased space. After a sublease is signed, the landlord interacts with the tenant, and the tenant interacts with the subtenant.

An assignment alters the relationship between the landlord and the tenant by assigning the tenant’s rights and obligations from the first tenant (the assignor) to the second tenant (the assignee). The assignee steps into the shoes of the assignor, and has a direct contractual relationship with the landlord. After an assignment of the lease, the landlord interacts directly with the assignee.

Important Deal Points Regarding Subleasing and Assignment

Leases may include many provisions regarding subleasing and assignment. Some of the most common issues include the following:

• In what circumstances is landlord consent required? Leases typically require the landlord’s consent for any sublease or assignment. However, some leases have different provisions for special circumstances, such as subleasing or assignment to a related entity, or assignment of the lease in connection with the sale of the tenant’s business.
• What is the standard for landlord consent? Provisions that require the landlord’s consent may be followed by a standard such as “in the landlord’s sole discretion,” or “which may not be unreasonably withheld.” Obviously, the second standard is more favorable to the tenant. However, as a practical matter, if a dispute arises regarding whether a landlord’s denial was reasonable or unreasonable, arbitration or litigation would be expensive, the outcome would be uncertain, and the prospective subtenant or assignee may be unwilling to wait to see how the dispute is resolved.
• What information must be provided regarding the proposed subtenant or assignee? Many leases require confidential financial information regarding the proposed subtenant or assignee. The proposed subtenant or assignee may be more comfortable providing information if the lease contains confidentiality and non-disclosure requirements to restrict the landlord’s use of the information. An argument can be made that less information should be required regarding a proposed subtenant than a proposed assignee, because the landlord will not enter into a direct contractual relationship with the subtenant and the tenant will remain liable under the lease.
• What are the landlord’s alternatives? A tenant might assume that if the tenant requests consent to a sublease or assignment, the landlord’s alternatives will be limited to granting or withholding consent. However, many leases give the landlord a third alternative, to cancel the lease if the tenant requests a sublease or an assignment. This is known as a right of recapture.
• When is the landlord’s response due? Some leases do not set a deadline for the landlord’s response to a request for consent to a sublease or assignment. A delayed response would prevent the tenant from moving forward until the response is received. A delayed response also may result in a lost opportunity, if the proposed subtenant or assignee is under time constraints.
• What is the effect if the landlord fails to provide a timely response? A lease may provide that if the landlord fails to respond to a request for consent within a specified period of time, then consent is deemed granted, or a lease may provide that in such circumstances, consent is deemed denied. The first alternative is more favorable for a tenant, but the prospective subtenant or assignee might not be willing to rely on a “deemed consent” provision and may require actual consent before moving forward.
• What are the landlord’s remedies if a sublease or assignment is made without requesting consent? Generally, if a tenant subleases or assigns a lease without obtaining required consent from the landlord, then the tenant is in default and the landlord can exercise all remedies under the lease. The lease also may provide that a sublease or assignment without the landlord’s consent is invalid and unenforceable.
• Will the assignor be released from liability for the tenant’s obligations after an assignment? It may seem like common sense that if a lease is assigned with the landlord’s consent, then the original tenant (assignor) will no longer be responsible for the tenant’s obligations under the lease. However, a lease may provide that the assignor will remain liable under the lease after an assignment. Similarly, the landlord’s written consent may state that both the assignor and the assignee will be responsible for the tenant’s obligations after the lease is assigned. In order to be released, the assignor should obtain a written agreement from the landlord stating that after an assignment, the assignor will no longer be responsible for the tenant’s obligations under the lease.
• Will a guarantor be released from liability for the tenant’s obligations after an assignment? Many landlords require a personal guaranty from an individual, or a corporate guaranty from a related entity, to ensure payment of the tenant’s obligations under a commercial lease. Guarantees typically provide that they will remain in effect even if the lease is assigned. However, the tenant may be able to negotiate for the termination of the guarantee in the event that the lease is assigned.  In some cases, the landlord may require a substitute guarantor.
• What is the effect of subleasing on the obligations of the tenant and the guarantor? A sublease does not affect the tenant’s obligations to the landlord under the lease, or the guarantor’s obligations to the landlord under the guaranty.

If a business owner is considering entering into a new lease, it is important to carefully review the subleasing and assignment provisions and negotiate any necessary changes before signing the lease. If a tenant desires to sublease or assign an existing lease, it is important to review the applicable requirements and restrictions before taking any action. An experienced real estate attorney can assist the tenant by spotting issues, explaining alternatives, and negotiating with the landlord to help the tenant accomplish its business objectives.

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Assignment of commercial leases

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If your business needs to exit its current leasehold unit and you have lined up a willing assignee to take over your space, you will need to ensure that your landlord is happy to consent to the change of occupant.

However, your liabilities relating to that lease will generally not come to an end upon assignment.

On assigning a lease and exiting a commercial unit you will wish to reduce the risk of being pursued by your former landlord in regard to any breaches in the lease terms by your successor.

However, landlords may be able to pursue you, dependent upon the age of your lease and whether there is an authorised guarantee agreement:

• if your lease was granted pre-1996, then landlords can look to any former tenants to be liable for a breach by the current tenant. It might be that the lease has been assigned several times since you were the tenant. That does not matter, the landlord can still pursue you for breaches by the current tenant.
• if your lease was granted post-1996, then landlords are more restricted in who they can pursue. Normally they will require that you provide an authorised guarantee agreement on assignment of the lease. The advantage of this agreement is that the liability to guarantee your successors’ obligations comes to an end when your immediate successor assigns.

What is an authorised guarantee agreement?

This is a special form of guarantee that specifically applies to leases granted from 1996 onwards. They were created by statute and are frequently imposed as a condition of a landlord giving consent to the assignment of a lease.

Your landlord’s solicitors will generally present you with their standard form of document. Sometimes this can be negotiated to create a slightly more preferential position for you.

An authorised guarantee agreement requires you to guarantee the performance of the lease obligations by the assignee. Following assignment, if the assignee breaches a lease covenant, then the landlord will be entitled to look to you, or the relevant successor, to make good that breach.

Most leases entered into after 1996 make the landlord’s consent to assign the lease conditional upon the assignor providing an authorised guarantee agreement. You will not receive your landlord’s licence to assign unless you enter into an authorised guarantee agreement.

The agreement lasts until your assignee in turn assigns the lease. If the assignee does not assign, then you will remain liable until the expiry of the lease.

For example, a lease for 15 years is granted to company A, who assigns to company B after 5 years. At the point of assignment, company A grants an authorised guarantee agreement for company B’s liabilities to the landlord as a condition of obtaining landlord’s consent. Company A’s liability under the agreement is limited to company B’s breaches alone. After 10 years, if company B then assigns to company C (in accordance with the terms of the lease,) then company A’s liability automatically comes to an end.

In very limited circumstances the authorised guarantee agreement lasts beyond a second assignment, for example if company B did not obtain the landlord’s consent before assigning to company C. In this case, company A’s liability under the agreement would last until the next assignment authorised by the landlord.

In certain limited circumstances the agreement can be discharged before the usual expiry date. The actions of a landlord can sometimes result in the discharge of an authorised guarantee agreement, for example the material variation of a lease without the guarantor being a party to it.

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This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.

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Personal Guarantees in Commercial Leases: What You Should Know

Matthew Harrison

When you’re preparing to sign a lease on a commercial property as a business owner, don’t be surprised if the landlord demands that you also sign a personal guarantee for the commercial lease. Signing a personal guarantee for a business contract may appear counterintuitive, since business owners create and maintain corporate structures (such as Limited Liability Companies) to protect individual assets from business liabilities. However, most commercial landlords will not proceed without one in place. This requirement has become more common since the 2008 recession, especially for startup businesses that can’t yet demonstrate a successful business plan and consistent revenue. A guarantee asks that you put your personal finances at risk so that if the business defaults on the lease terms, those personal assets can be tapped in compensation.

As common as personal guarantees are, they should not be taken lightly as just another dotted line to sign. The significant risks are very real – but you can claim a certain amount of control over them by negotiating sensible terms beforehand.

Understanding Your Personal Guarantee

Personal guarantees are often required from small business owners seeking property for an LLC or other corporate structure – a common option for small businesses in Arizona. These structures protect their members from personal financial liability if the business fails. This may spell trouble for the landlord, who cannot collect on an unpaid commercial lease and cannot ordinarily hold anyone at the company personally liable to pay the balance. (The same protection doesn’t exist for a sole proprietorship, in which personal and business liability are considered one and the same under the law.)  The fact that most commercial leases can extend (and can also be renewed) for a significant period of time, along with the substantial monthly lease obligations, can expose the parties to potential losses in the tens if not hundreds of thousands of dollars.  In addition, finding a business to quickly reoccupy a location after a lease has ended is often a long process.  Commercial landlords are wary of taking on this substantial financial risk without additional assurances if the business fails.

By requiring a business owner or representative to sign a personal guarantee, the landlord has a potential financial option of collecting on a delinquent or broken lease. Meanwhile, the business owner gets the desired lease without having to show established business financials. It sounds like a win-win scenario, but there is an obvious dark side to the proceedings – the potential consequences for lease holders who can’t meet their obligations.

The Potential Dangers of Personal Guarantees

If you sign a personal guarantee on a commercial lease that the business ultimately cannot pay, then you are liable for the unpaid balance of that lease. In addition, you may also lose access to the property itself. Under Arizona law, the landlord may have the right to evict you, lock you out of the property, and later put the business property sized within the location up for auction as payment of the delinquent lease. If you and your spouse both signed the personal guarantee, then your community property may be exposed in a financial judgement against your business.  If only one spouse signed the lease, then the landlord may be limited to collecting from that spouse’s sole and separate property – which is why both spouses are commonly asked to sign.

Smart Strategies for Reducing Your Risk

The prospect of putting your personal finances on the line for a commercial lease may make you understandably uncomfortable. Fortunately, there are some strategies a business can employ that may reduce aspects of personal risk. It is important to understand the actual terms of the commercial lease and, if necessary, modify them to give you a bit more protection. These strategies may include:

• Limiting the guarantee term – Do you have to guarantee the entire term of the lease? You might be able to secure a guarantee term shorter than the term of the lease itself – for example, negotiating a 3-year personal guarantee for a 5-10 year lease.
• Limiting the post-lease financial obligation – You and your landlord might agree to a limited period of personal financial obligation (say, the first 6 months’ rent after default) if you won’t be able to maintain the entire lease.
• Including an “early break” or surrender clause – You might add a clause that allows you to break your lease early at specific, pre-agreed milestones, assuming that the business has consistently paid on time up that point.
• Allowing for lease assignment or sub-letting – Will your landlord let you assign your lease or sub-let the property if you run into financial challenges? It may be worth your while to get this option added to your lease agreement.

While personal guarantees for commercial leases for non-established businesses have become commonplace, it does not stop the negotiation process of the business or its attorney concerning the nature and extent of any personal guarantee.

© 2018 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved

This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.

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Out-Law Guide 3 min. read

Guarantees on lease assignment: implications for tenants

25 Aug 2011, 4:54 pm

The Court of Appeal has confirmed that, when a lease is assigned to a third party, the outgoing tenant's guarantor can guarantee the outgoing tenant's liabilities under an authorised guarantee agreement (AGA). In doing so, the guarantor can indirectly guarantee the incoming tenant's obligations.

This guide considers the implications of a recent case for tenants. For the implications for landlords and their lenders, please see our separate Out-Law guide .

What is an authorised guarantee agreement?

Authorised guarantee agreements (AGAs) were created by the Landlord and Tenant (Covenants) Act, and their content is strictly regulated by statute.

Tenants and their guarantors are automatically released from liability to the landlord when a lease is lawfully assigned to a third party. Landlords can, however, require outgoing tenants to enter into AGAs guaranteeing the liabilities of the new tenant under a lease. There are no provisions allowing guarantors to do so as well.

The Landlord and Tenant (Covenants) Act applies to leases granted on or after 1 January 1996, unless the lease was granted under an agreement or court order made before that date. It includes anti-avoidance provisions which invalidate contractual provisions designed to work around it.

Recent case law

There were heated debates about the validity of guarantees of leasehold liabilities following the High Court's decision in the Good Harvest case in 2010 that a guarantee of an assignee given by the outgoing tenant's guarantor was void. This was considered again later that same year in a case between landlord K/S Victoria Street and House of Fraser (Store Management) Ltd.

In January 2006 K/S Victoria Street agreed to the sale and leaseback of a property in Wolverhampton to a company in the House of Fraser group. Under the agreement, the store management company was to take a lease guaranteed by the group holding company. The Agreement for Lease also required it to assign the lease to another group company by April 2006, but no assignment ever took place. In March 2010, the landlord brought proceedings against all three of the House of Fraser companies seeking to enforce the assignment.

House of Fraser relied on the Good Harvest decision to argue that the agreement was unenforceable. The High Court agreed, deciding that the guarantee to be given by the parent company as the outgoing guarantor in respect of the new tenant's liabilities under the lease was invalid. It also doubted whether sub-guarantees - that is, guarantees by outgoing guarantors in respect of outgoing tenants' liabilities under AGAs - were effective. The decision caused difficulties for landlords and tenants, and meant that in many cases groups of companies could no longer make assignments between themselves.

The Court of Appeal clarified the law and upheld the validity of sub-guarantees. The decision confirms that:

• an outgoing tenant's guarantor can guarantee an outgoing tenant's liabilities under an AGA – but not the liabilities of the incoming tenant to which the lease was assigned;
• once released from liability by an assignment, guarantors can provide fresh guarantees in respect of subsequent assignees.

Grant of a lease

During negotiations, it is going to be more difficult for a tenant to object to a landlord's requirement for a guarantor to guarantee its AGA now that the Court of Appeal has confirmed that such arrangements are valid.

Assignment of a lease

A guarantor cannot guarantee the obligations of the new tenant to which the lease is assigned even if it wants to. This poses a particular problem for intra-group assignments. A tenant should anticipate that it will be a common condition on assignment that a guarantor is asked to guarantee its obligations in an AGA.

There is a suggestion that a tenant may not be able to assign its lease to its guarantor. It may be advisable to avoid this scenario until the position is clarified.

Intra-group assignments

The Court of Appeal confirmed that an outgoing tenant's guarantor cannot directly guarantee the liabilities of the incoming tenant when a lease is assigned.

This has important consequences for alienation provisions which allow the landlord to control the assignment by a tenant of its lease. Corporate tenants often request provisions in leases which will allow assignments between companies in the same group without the landlord's permission. Landlords often agree to these arrangements, subject to a condition that the tenant's guarantor continues to guarantee the incoming tenant's liabilities under the lease. The decisions in the Good Harvest and K/S Victoria Street cases prevent this because:

• it will be impossible to obtain a further guarantee from the same guarantor for the incoming tenant;
• the Landlord and Tenant (Covenants) Act provides that it is only possible to obtain an AGA from an outgoing tenant, for which the outgoing guarantor can then be a guarantor, if the lease prevents the tenant from assigning the premises without the landlord's consent.

As a result of this, landlords may seek to prevent assignments between companies in the same group without their consent in order to obtain a sub-guarantee from an existing guarantor. Alternatively, landlords may attempt to impose some other form of control – for example, a financial test – to ensure that an assignee is suitable.

Note too that the Court of Appeal did not say whether tenants can validly offer the same guarantor through a string of intra-group assignments using a series of guarantees and sub-guarantees, or more complex arrangements, in order to provide a fresh guarantee from an outgoing guarantor.

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Assignment of Lease and Authorised Guarantee Agreement (“AGA”)

A tenant who wants to assign (transfer) a lease must check its terms to see whether or not this is permitted.

Usually the assignment of the whole of the property let under a lease is permitted provided the tenant obtains the landlord’s consent.

A lease will usually contain a provision that such consent should not be unreasonably withheld or delayed but will also set the conditions which need to be met before the consent is provided to assign a lease.

One of the main conditions, which a landlord will require prior to granting the tenant consent to assign a lease, is that the tenant guarantees the future performance of the new tenant by giving an AGA to the Landlord.

This means that the tenant must guarantee that the assignee will comply with the covenants in the lease. This will include all covenants to pay rent and to keep the property in repair.

Risks of Transferring a Lease

As a tenant it is important to understand the risks in agreeing to provide an AGA when you assign a lease. It is always worth asking the landlord to dispose of this requirement, in particular where the covenant strength of the assignee is greater than the tenant’s or where the landlord is collecting a rent deposit from the assignee.

If the tenant is assigning to an assignee with a weaker covenant strength, a landlord will insist on an AGA being entered into. The risk to the tenant is that the assignee may fail to comply with the covenants, which means the landlord can pursue the tenant for compliance. This could mean the Tenant is forced to pay rent, repair the demised premises and anything else under the lease, which could become rather costly for a tenant.

In the event the lease is disclaimed after the insolvency of the assignee, the landlord can request the tenant to enter into a new lease. This would of course defeat the purpose of the tenant disposing of the lease in the first place.

The final point is that in the event the lease benefits from security of tenure under the Landlord and Tenant Act 1954, the AGA may continue beyond the end of the contractual term. The tenant could potentially be guaranteeing the assignee’s compliance with the covenants for an indefinite period of time. It is therefore suggested that the tenant seeks to limit its obligation under the AGA only until the end of the contractual term, and not any “holding over” period.

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