Five Important Issues to Consider When Parties Negotiate a Lease Guaranty
By Rick Angel, Angel Law Offices
Landlords often require a personal or corporate lease guaranty, 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 guaranty. Landlords want an unconditional and unlimited guaranty, holding the guarantor liable for all of the tenant’s defaults. Guarantors, on the other hand, want a conditional, less sweeping guaranty. Below are several bottom line issues to consider when negotiating a limited guaranty.
Set a Maximum Dollar Cap
The parties can set a maximum dollar cap on the guarantor’s liability. The amount generally bears some relationship to the landlord’s potential losses and the tenant’s creditworthiness, or lack thereof.
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 a period of time. For example, if the guarantor’s maximum liability is set at $360,000 for a 10-year lease, the parties can agree that the guarantor’s maximum liability will decrease by one-tenth ($36,000) with the passage of each default-free year. Similarly, the parties could work out a formula on a monthly basis, agreeing that the maximum liability will decrease by one-one hundred twentieth ($3,000) with the passage of each default-free month.
Set a Formula-Based Liability Cap
You can also 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. Unlike a set dollar cap, with a formula-based cap the guarantor does not know the exact dollar amount of his financial exposure when the lease is executed. Common categories of losses include 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,
- costs to restore the premises to the condition required under the lease, and
- attorney fees and costs incurred in evicting the tenant.
Good Guy Liability
Under a “Good Guy Guaranty” The guarantor is liable for rent from the date on which the tenant defaults until the date on which the tenant turns over possession of the premises to the landlord. Since the guarantor is liable for rent until the tenant vacates the premises, a Good Guy Guaranty creates an incentive for the guarantor to make sure the tenant vacates the premises and delivers possession to the landlord as soon as possible.
A Good Guy Guaranty does not cover all of the losses that a landlord may suffer as a result of a tenant’s default. Therefore, it is often used in conjunction with a dollar or formula-based cap on the guarantor’s liability.
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 guaranty.
Guaranty Termination, Tenant’s Benchmarks
A guaranty can terminate with the passage of time or if tenant hits a financial benchmark. Landlords want a guaranty 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 guaranty.
Guaranty Termination at a Point in Time
Under this approach, if the tenant has not defaulted after a prearranged period of time, the guaranty terminates. For example, the parties can agree that the guaranty 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 guaranty. Examples of benchmarks are:
- an agreed-upon net worth,
- an agreed-upon level of gross sales, or
- any other financial target the parties establish.
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 joint and several liability–and potential limitations on such liability–and 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 guaranty.
Rick Angel is the founding partner of Angel Law Offices, a real estate transactions firm, with offices in Los Angeles and Boulder, Colo. Prior to forming Angel Law Offices, he was a partner and chair of the commercial real estate department at Buchalter Nemer in Los Angeles.
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