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Most of the commercial leases that we provide a lease synopsis for are on behalf of small business owners (more flower shops and karate schools than corporate office leases). A common thread in these leases is a personal guarantee or guaranty associated with the lease. The simple reason is that the landlords tend to be small and they are leasing to small, often start up businesses and they want to ensure that the business owner will stand behind and indemnify the obligation of the lease personally.
In other words, if you default on the lease, you still owe the rent.
What you will get out of this blog post – answers to the following:
Landlords do carry risk when they lease commercial space. Often they are required to do some landlord’s work, provide a leasehold improvement allowance, and pay real estate commissions.
Even in cases when they do not have much cash outlay, they still want to find credit-worthy tenants to lease their space and not have to worry about always marketing their vacant properties.
They would love to have both your business and you personally on the lease.
If you default on your lease and have a personal guarantee, you are now personally liable for the remaining balance of the rent.
So not only did your business not succeed, but now you owe the remaining balance of the rent. Boo!
In one case, we pointed this out to a Lease Ref customer in their commercial lease overview and they had no idea that this was in their lease, and the total rent obligation over the term was $2.4 million.
Unfortunately personal guarantees only show up in about 50% of the letters of intent (LOIs), so you have to be on the look out for the personal guaranty when it arrives in the lease.
Also, since it is often a surprise when the lease arrives, you may have already spent the time and energy to move forward with your space plan and construction budget and now feel committed to moving forward.
Not at all. This really just comes down to leverage. Personal guarantees are rare in office and industrial leasing.
For instance, a 3 person accounting firm start up would typically find space without a commercial real estate broker, only lease space that is already built out and would not require the landlord to make any leasehold improvements.
In this case the risk is low for the landlord. The space is sitting vacant, so a deposit and a tenant paying rent is better than nothing, and there is no personal guarantee.
Owners of office buildings tend to be larger and have stronger financing as well, so they can take some bigger risks.
Now let’s take the case of a beauty salon owner. The premises is probably in a smaller building, with a smaller landlord. The tenant build out is custom and the business is going to be sensitive to location and walk-by traffic. Somebody has to pay for the leasehold improvements and if the tenant goes out of business the landlord likely has to demolish the space to repurpose it for the next retail tenant.
In this case, the risk is higher and the landlord likely will want more security.
Ultimately the question of whether or not you have to sign the guarantee comes down to leverage. Who has it? Is the market a landlord’s market or a tenant’s market?
Have you explored other spaces in other buildings? Do those buildings require a personal guarantee?
It is important to ask the personal guarantee question prior to negotiating the letter of intent – it could determine whether you go to one building or another.
Be sure the landlord you are negotiating with knows that you have found other landlords that are willing to NOT have a personal guarantee.
Ok, so you found the space you want, but the landlord is insisting on the personal guarantee.
There are compromise positions you can offer instead of just signing the landlord’s template.
Higher deposit – most leases call for the tenant to provide first and last months’ rent, or first and a security deposit. You could improve that so that the landlord has more of your cash on hand in the event you default.
Letter of credit – similarly, a letter of credit can be drawn upon if you abandon the property or default on the lease. I would recommend that whether you use an increased security deposit or a letter of credit that it decline over time. Ask your bank about a declining letter of credit (for example, 6 months of rent, but it applies to rent every 6 months and therefore it is exhausted after 36 months).
Limit the personal amount – how much time does the landlord require to find a new tenant? Rather than owing the balance of rent, you could have a hard cap on the amount. For instance, if you pick 6 months’ worth of rent, then if you default at the one-year mark of a 5 year lease, then you owe the following 6 months’ worth of rent, not 4 years’ worth.
Declining balance – similarly with the hard cap approach above, you could do a percentage of remaining balance. For example, if you default at the 2 year mark of a 3 year lease, and you owe 50% of the remaining rent, then your obligation is 6 months’ worth, not the entire last year.
No obligation if the landlord finds another tenant. Let’s say you default on your lease but you were paying under market rent and the landlord is able to fill your space with a new tenant immediately at a higher net rent. The landlord is actually better off, and you should not have to be personally liable for the balance of rent that you owe from your lease. Sample wording in this scenario could look like this:
The personal guarantee is null and void if the Landlord is able to lease the Premises within sixty (60) days following default to another tenant and that tenant’s net rental rate for the balance of Tenant’s term exceeds what is owed by Tenant. For further clarity, since the Landlord in this scenario receives more net rent than if Tenant had not defaulted, the personal guarantee shall not apply.
Expiry date – in addition to any combination of the above, a personal guarantee should not be for the full length of the term, especially for longer leases. For example, on a 5 year lease in which the landlord did not provide a tenant improvement allowance, did not pay real estate commissions, did not provide any free rent, and did not have to contribute any renovations, your personal guarantee should not have to last 5 years. It being null and void after 12 months I think is fair.
In case you are wondering what a personal guarantee clause looks like, below is a sample clause:
WHEREAS, the Landlord under said Lease requires as a condition to its execution that the undersigned guarantees the full performance of all of the obligations of the Tenant under said Lease; and
WHEREAS, Tenant ABC, LLC hereinafter referred to jointly and severally as “Guarantor”, is desirous that Landlord enter into said Lease with Tenant;
NOW, THEREFORE, in consideration of the execution of said Lease by said Landlord, Guarantor hereby unconditionally guarantees and promises to Landlord, its successors and assigns, the full performance of each and every term, covenant, and condition of said Lease to be kept and performed by said Tenant, including the payment of any and all rentals and other charges to accrue thereunder, and the performance of any and all requirements of said Lease.
If default shall at any time be made by Tenant in the prompt and timely payment of the rent or other sums to be paid thereunder, or in the performance of any and all other covenants, conditions, and/or requirements contained therein, at the times and in the manner provided therein, the undersigned, for himself, his heirs, successors, and assigns, agrees, on demand made as more fully set forth hereinafter, to pay said rent, and any and all other sums that Tenant may be liable for thereunder, together with any and all damages that may arise in consequence of the nonperformance by Tenant of any of said covenants, conditions, and requirements, and fully to perform and carry out all other covenants, conditions, and requirements of said Lease on the part of Tenant to be performed.
All of the obligations of Tenant secured hereby are intended to be construed in the most comprehensive sense and shall include all obligations of Tenant under said Lease, whether to pay or deposit money or perform some other act, whether due or not due, absolute or contingent, liquidated or unliquidated, and whether Tenant may be liable individually or jointly with others, and whether recovery on such obligations of tenant may be or hereafter becomes barred by any statute of limitations or be or hereafter becomes otherwise unenforceable.
Upon written notice by Landlord of Tenant’s default, delivered in person or by United States Mail, postage prepaid, Guarantor agrees to cure any monetary default within ten (10) days of receipt of such notice and Guarantor agrees to cure any nonmonetary default within thirty (30) days of receipt of such written notice. All such notices, if mailed, are to be mailed to Guarantor at the following address: <Tenant Address goes in here> (Premises). For the purposes of this Guarantee, receipt of notice mailed to Guarantor within the State of California, will be deemed to have occurred upon the fifth (5th) day after mailing of such notice by Landlord, and if made outside the State of California, will be deemed to have been made upon the tenth (10) day after such mailing by Landlord. Except as otherwise provided for herein. Guarantor hereby waives (1) demand, protest, notice of protest, notice of Tenant’s default, notice of nonpayment of nonperformance, notice of acceptance hereof and of default hereunder; (2) the right, if any, to the benefit of, or to direct the application of, any security hypothecated to Tenant or its successors or assigns until all obligations of Tenant to Landlord, howsoever arising, shall have been paid or performed; and, (3) the right to require Landlord, or its successors or assigns, to proceed against Tenant, or other guarantor, or any security, or insurance, or to pursue any other remedy in Landlord’s power. Landlord may proceed against the undersigned directly and independently of tenant, and other persons, and each other.
No modification, amendment, extension, renewal, or holdover of, nor any waiver of excuse of any default under said Lease, nor the termination of said Lease, nor the death, disability or incapacity of Tenant, the undersigned, or any of them, shall release the undersigned, the undersigned hereby consenting thereto and waiving notice of any such transaction of event. The covenants hereof shall survive the redelivery of the Leased Premises under said Lease, or the acceptance thereof, and the termination of said Lease, and the undersigned waives, to the maximum extent allowed by law, the benefit of any statue of limitations affecting his liability hereunder.
Landlord may, without affecting the liability of the undersigned hereunder, (1) take and hold other security for the performance of said Lease or for the payment of this Guarantee; (2) exchange, enforce, waive, or release any such security; or, (3) release or substitute any one or more endorsers or guarantors, and Landlord may, without notice to the undersigned, assign this Guarantee of Lease in whole or in part.
Guarantor does hereby further agree that this Guarantee of Lease shall continue in favor of Landlord, notwithstanding any extension, modification, or alteration of said Lease entered into by and between the parties thereto, or their successors or assigns, and/or notwithstanding any assignment of said Lease with or without the consent of Landlord and/or Guarantor.
No extension, modification, alteration, assignment, or sublease of the above referenced Lease shall in any manner release or discharge the obligations of Guarantor, and Guarantor does hereby consent thereto.
The undersigned agrees to pay any and all attorney’s fees, court costs, and any and all other costs and expenses incurred by Landlord or its successors or assignees in the enforcement of the Lease or this Guarantee of Lease.
Where there is more than one (1) Guarantor under this Guarantee of Lease, the obligations of each of the undersigned hereunder shall be, and are, primary and independent of the obligations of each other, of Tenant and of all other persons. Proceedings against each of the undersigned maybe brought and maintained hereunder whether or not any other person is a party thereto.
The use of the singular herein shall include the plural. The obligation of two (2) or more parties shall be joint and several.
This Guarantee of Lease contains all of the agreements of the parties hereto with respect to any matter covered or mentioned in this Guarantee of Lease and no prior agreements or understanding pertaining to any such matters shall be effective for any purpose. No provision of this Guarantee of Lease may be amended or added to except by an agreement in writing signed by the parties hereto or their respective successors in interest. It is understood that there are no oral agreements between the parties hereto, or their agents, affecting this Guarantee of Lease and this Guarantee of Lease supersedes and cancels any and all previous promises, negotiations, arrangements, brochures, agreements and understandings, if any, between the parties hereto or displayed by Landlord or its agents to Guarantor with respect to the subject matter hereof, and none thereof shall be used to interpret or construe this Guarantee of Lease. This Guarantee of Lease is and shall be construed to be the only agreement between the parties hereto and their representatives and agents. All negotiations and oral agreements acceptable to both parties have been merged into and are included herein. There are no other representations or warranties between the parties and all reliance with respect to representations is safely upon the representations and agreements contained in this document.
The terms and provisions of this Guarantee of Lease shall be governed and construed by and under the laws of the State of California.
In the event that any of the terms, conditions, provisions, and/or covenants of this Guarantee of Lease are deemed to be either invalid or unconstitutional for whatever reason, such invalidity or unconstitutionality shall not affect the validity and/or constitutionality of the remaining provisions, terms, covenants, and conditions of this Guarantee of Lease.
The terms and provisions of this Guarantee of Lease shall be binding upon and inure to the benefit of the respective heirs, representatives, agents, successors, and assigns of all the parties herein named.
Notwithstanding anything to the contrary in this Guarantee of Lease, after the first year of the Primary Lease Term are complete, the personal guarantee for the remainder of the Primary Lease Term and any Option Terms shall be on a rolling six (6) month basis. This means that after the first year of the Primary Lease Term is complete, Tenant ABC, LLC personal liability will be limited to six (6) months of Lease liabilities. The Guarantee of the Lease shall be null and void and of no further effect after the eighteenth (18th) month of the Term.
Let me know if you have any questions.