Lease Guarantees: What Landlords Should Know When Negotiating

While landlords prefer tenants with the strongest financial positions to sign leases, they may sometimes accept a “shell” entity — created solely to operate the business at the leased premises — provided that an upper-tier entity with substantial assets or the tenant’s principals sign a lease guarantee. A lease guarantee, if enforceable and signed by a party with sufficient assets to cover the tenant’s obligations, can provide a landlord with greater assurance that a tenant’s monetary obligations under the lease will be satisfied. Outlined below are a few key considerations in negotiating lease guarantees.

Types of Guarantees

The scope of a lease guarantee often depends on the financial condition and negotiating leverage of the tenant. If a tenant is in a relatively weaker bargaining position, the landlord can insist on a full guarantee. In a full guarantee, the guarantor promises to pay and perform all of the tenant’s obligations under the lease — both monetary obligations (such as payment of base rent and additional rent) and performance obligations (such as performing repairs and maintaining insurance). In other words, the guarantor will be equally liable as the tenant if the tenant fails to meet its lease obligations. In addition, the guarantor is typically also responsible for the landlord’s costs in enforcing the guarantee as well as the amortized cost of broker’s commissions and any tenant improvements.

Alternatively, a landlord may allow for a limited guarantee. Some common examples of limitations in lease guarantees include:

• Capping the guarantor’s monetary obligations to a certain amount;
• Containing a “rolling” maximum amount of guarantor liability based on tenant’s monetary obligations over a period of months or years starting from the date of tenant’s default;
• Having the guarantee “burn off” (be decreased over time) and/or “sunset” (terminate after a period of time);
• Requiring certain triggering events for the guarantee to become enforceable (e.g., defaults related to tenant financial condition or various enumerated tenant “bad acts”);
• Releasing the guarantee when the tenant entity achieves certain financial milestones;
• Having most of the guarantor’s obligations terminate upon tenant’s surrender of the premises and payment of all rent due through the date of surrender;
• Limiting the guarantee to tenant’s monetary obligations only; or
• Requiring landlord to pursue certain remedies against the tenant before enforcing the guarantee.

Landlords and tenants often agree to various combinations of these options. For example, a guarantor might provide a full guarantee for the first few years of the lease while tenant proves its ability to perform. Thereafter, the guarantee might convert to a form of limited guarantee. The type of guarantee agreed upon will depend on the relative bargaining power of landlord and tenant.

In most cases, a lease guarantee will remain in effect following an assignment of the lease (unless landlord otherwise agrees in the lease or in landlord’s sole discretion when consenting to an assignment of the lease). However, in some circumstances the parties might agree to a release of the guarantor upon assignment, if certain financial metrics are achieved (e.g., assignee creditworthiness and/or provision of an acceptable replacement guarantor).

Enforceability of Guarantees

While guarantees are important and common tools for mitigating risk, enforcement of a guarantee can be challenging. There exists a risk that the guarantor will be financially unstable and have insufficient assets to pay the amounts owed to the landlord (or that the guarantor’s assets are exempt from seizure under applicable state law). In addition, guarantors can challenge the enforcement of a lease guarantee, with enforceability sometimes varying depending on jurisdiction.

A guarantor can argue that a lease guarantee is unenforceable due to a lease modification that materially changes the tenant’s obligations. For this reason, a landlord will usually expressly state in the guarantee that the guarantee continues in full force and effect notwithstanding any renewal, amendment or extension of the lease. However, even with this language, it is best practice for a landlord to give a guarantor notice of a lease amendment and have the guarantor expressly consent to the terms and conditions of the lease amendment and reaffirm their obligations under the guarantee.

Landlords often draft guarantees to expressly waive certain other jurisdiction-specific defenses to enforcement. For example, it is common for landlords to require waiver of presentment, demand, protest and certain notices. It is also common for guarantors to waive any obligation for the landlord to first pursue the tenant for payment or performance of the obligation. There are many other defenses to enforcement that are commonly raised in litigation, including, among other things: disputing that any lease default has occurred, claiming that the guarantee is too vague to enforce (i.e., that there is no “meeting of the minds” to create a contractual obligation), that the signatory to the guarantee lacked authority to bind the guarantor, lack of consideration for the guarantee, fraud, and duress.

Conclusion

Below are a few practical tips to keep in mind when negotiating lease guarantees:

• Discuss the tenant entity and the forms of lease security (including any guarantees) early in the lease negotiation process, ideally before the letter of intent is signed.
• Lease guarantees are prerequisites for the landlords entering into the lease (and, to help demonstrate adequate consideration for a guarantee, the lease should expressly state this fact and require delivery of the guarantee to landlord). A landlord may also want to include in the “Events of Default” provision of the lease certain defaults that relate to the guarantor (e.g., guarantor insolvency or death/dissolution or guarantor default under the guarantee).
• Have guarantors reaffirm their obligations under their guarantees when the applicable leases are amended, extended or replaced.
• Provide for ongoing financial reporting and receipt of estoppel certificates from guarantors from time to time upon request. Consider net worth or liquidity covenants.

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