Many landlords of commercial property require that the obligations of the tenant be guaranteed by an individual or affiliated entity. Most tenants of commercial leases are an entity, such as a corporation or limited liability company, whose only asset is the business engaged in the leased premises. If the entity tenant cannot perform its lease obligations or leaves before the end of the lease, the landlord has no remedy besides renting the premises to a new tenant. For this reason, most landlords require that an individual or entity closely affiliated with the tenant guaranty the tenant’s requirements. That way, other assets of the guarantor may be available to the landlord if the tenant defaults under the lease. This post will examine the various types of guaranties that may be requested by a landlord.
A full guaranty is the most broad, wherein the guarantor covers all of the tenant’s obligations under the lease. Such obligations would include paying rent, real estate tax escalations, utility payments, common area maintenance payments, maintaining proper insurance, repair obligations and the like. Landlords prefer this type of guaranty because there is no limit on the amount or extent of the obligation covered. Also, the landlord does not need to meet any condition before enforcing the guaranty against the guarantor.
A partial guaranty is more limited. Perhaps the obligations covered are only those that are monetary in nature or up to a certain amount. Other limited guaranties may cover lease obligations such as keeping up with maintenance and repair obligations. Partial guaranties could also “burn down” or “sunset” over time. For instance, after a certain period of perfect performance by the tenant, the amount guaranteed reduces or the partial guaranty terminates entirely. In partial guaranties, the landlord may need to meet certain conditions before it is enforced against the guarantor.
A “good guy” guaranty is the best possible type of guaranty from a tenant’s perspective. In a classic good guy guaranty, the guarantor’s liability is terminated once the tenant surrenders the premises, delivers the key and pays rent through the date of surrender. Your attorney should be mindful that a good guy guaranty may still present certain unacceptable terms to the tenant, such as extending the guarantor’s obligations for several months after the premises has been vacated or requiring conditions be met upon vacating like restoring the premises to its original condition. Also, a tenant will want to limit the definition of rent in a good guy guaranty to the pure monthly rent charged, without additional items being included in the definition of rent, such as real estate tax escalations, administrative expenses and the like.
Tenant’s attorneys should request that guaranty obligations are not triggered until the landlord has sought performance from the tenant first and that the guaranty terminate if the lease is assigned to another tenant. In addition, a guarantor may want to request that the landlord seek reimbursement from the security deposit before pursuing the guarantor for payments due from the tenant. Also, landlords should be required to notify the guarantor of a default and provide the guarantor with an additional time to cure the default, beyond that afforded to the tenant. That way, the guarantor may be able to help the tenant by paying a few months’ back rent, instead of potentially being required to pay all sums due if the lease is accelerated.
Commercial leases tend to be long term situations, perhaps a ten year initial term with options to renew for additional five year terms. It is prudent for a tenant’s attorney to request that a guarantor’s obligations do not apply to amendments or extensions of the lease unless specifically agreed by the guarantor. The rationale for this is that the guarantor was aware of the original terms when the lease was signed and agreed to back them up. It is unfair to automatically bind the guarantor to lease amendment and extensions that may increase the amount of rent charged and impose other burdens on the tenant that the guarantor needs to support.
We are well-equipped to negotiate lease guaranties as a landlord may demand and as most preferential to a tenant as possible.
Our firm is routinely involved in commercial lease negotiations. This post will address the “give and take” that takes place in such negotiations, while discussing the legal issues that commonly arise. For convenience sake, let’s assume that our attorney is negotiating on behalf of a retail store tenant engaged in a food business in a suburban strip center.
Commercial leases typically span several decades and are not rent-regulated. Both landlord and tenant cannot envision business conditions or pricing over such a timeframe. Most leases will run for an initial term, potentially for ten years. The parties may wish to include a renewal provision, potentially for another five years. Is such a renewal term to be a requirement for the landlord to offer or an option to renew on behalf of the landlord or tenant? If the option to renew is for the tenant, one may find provisions as to the timeframe in which to exercise the option, so that the landlord can make the space available to another tenant without a vacant period of time.
The determination of rent to be charged during the renewal period is tricky. The parties could state in the current lease that the renewal period rent will be a certain percentage above that charged in the last year of the lease. This provides certainty but may be too high or too low for market conditions at the time of renewal. The other option is for the renewal rent to be determined by an appraiser to be mutually selected by the landlord and tenant. The inherent problems in this formula are that there may be a disagreement on the selection of the appraiser and the rent to be charged would be uncertain.
During such a long term lease, it is not unlikely that the property will be sold by the landlord. The lease should provide that the landlord is required to deliver the security deposit to the new owner, who will also need to recognize the lease with the tenant.
The use of the premises will be stated in the lease. From a tenant’s perspective, the less specific the better. Use as a general grocery store is more favorable to a tenant than an ethnic grocery store, because if the ability to assign or sublet the lease is tied to keeping the same use, it will be more difficult for the tenant to locate a replacement tenant if the use is too specific. The tenant may wish for a non-compete clause in the lease. Her attorney may request to exclude other food businesses from the strip center, so that another tenant with a similar business does not pull customers from its client.
Physical alterations to the premises are another topic of contention. A tenant should be obligated to pay rent until landlord-agreed alterations are made. A landlord will not permit alterations by the tenant without his written approval if such alterations are structural, rather than cosmetic only. Landlords are also mindful that any alterations be done in compliance with local law and do not have an adverse environmental effect.
Guaranties are highly significant to the tenant. Most tenants lease spaces under the name of an entity, such as a corporation or limited liability company. Most landlords require a personal guaranty of some sort from the principal of the entity, so that if the entity has financial problems, the landlord can pursue the individual and other assets owned by the individual for the satisfaction of lease obligations. Some guaranties are broad and without condition. Other guaranties are more limited, such as a “good guy” guaranty, which means that the obligations under the guaranty end once the tenant has delivered the keys and possession of the space to the landlord.
Assignment and subletting are of particular concern to the tenant, because they provide an exit strategy in case the tenant wants to end a long-term lease. Assignment means that the tenant finds a replacement tenant and does not intend to return to the premises. Subletting is similar, but the tenant intends to return after a particular period of time. Tenants need to be careful as to the standards for the replacement tenant, so that the landlord will not have a valid reason to refuse a particular replacement tenant. Landlords want control over the replacement tenant, potentially requiring the same use of the premises, that the financials be as strong or better than the current tenant, that the same type of guaranty be provided and that he have the ability to deny a replacement tenant for any reason. Tenants want the landlord not to unreasonably withhold or delay approval of a replacement tenant.
Commercial leases involve a landlord attempting to transfer the obligation to pay common area building and property charges to a tenant and do not involve the tenant only paying rent. For instance, a tenant commonly pays a percentage of the increase in real estate taxes over the base year, reflective of the percentage that the premises comprises of the entire building. Let’s say that the store is twenty percent of the property by agreement and that the real estate taxes in the first year of the lease are $1,000 and the second year $2,000. The tenant would pay twenty percent of the increase or $200. Landlords try to include other taxes within the definition of real estate taxes such as inheritance taxes. Tenants should resist this. Other charges which are attempted to be passed on to the tenant, such as paving of the parking lot and building-wide improvements. The potential for reductions should not be ignored. For instance, if the landlord achieves a tax reduction, the tenant should receive a corresponding reduction in the portion of taxes paid.
Default provisions should be carefully negotiated. While we cannot help our clients keep up with lease obligations, we do attempt to negotiate grace and notice periods before the tenant is deemed to be in default and additional cure periods. Should there be a default, we request notification to our attorneys , so that we can assist in the evaluation of the alleged default and negotiate on the tenant’s behalf.
Our firm is well-versed in the standard commercial lease clauses and stands ready to negotiate a favorable lease on behalf of our readers.