Summary and implications
A rent guarantee is a term of a property sale contract which requires the seller to make payments to the buyer equal to the rents which would otherwise be generated from empty premises if they were let (e.g. vacant units in a shopping centre). The seller will receive a higher headline price on the sale (since, in effect, the buyer will receive income from the vacant premises), but will be required to make payments during the guarantee period.
Rent guarantees are complicated:
- They require a large number of issues to be considered;
- These issues need to be addressed at the heads of terms stage;
- The inherent tensions between the seller and the buyer in dealing with the vacant premises are difficult to resolve; and
- The parties should consider whether the guarantee is sufficiently important to warrant the negotiations and need for ongoing monitoring.
Why give a guarantee?
Often such arrangements are agreed where there are vacant premises which either:
- The seller believes the buyer will be able to let soon after completion; or
- Were let at the time the buyer made its offer, but have since become vacant or the tenant has entered into some form of insolvency (which may or may not mean that it is still paying the rent at the time the sale contract is exchanged).
The heads of terms are vital
We regularly find that heads of terms contain little or no detail as to the precise terms of the guarantee. If (in the heads of terms) the parties address as many of the issues as possible, the time required to negotiate the guarantee should be vastly reduced. The converse is also true – where these issues are not considered at an early stage, negotiations can become protracted, delaying completion of the sale. However, when thinking about these issues, the parties should also bear in mind how much work will be necessitated in operating the guarantee, and properly monitoring it. The big question for all concerned will be “is it worth it”?
Think about the following when agreeing heads of terms
- Does the guarantee include rent, service charge, insurance and rates liabilities? If the buyer is to be placed in the position it would have been in if the premises were let then it should.
- If service charge is included, does the seller need to consider including a cap on the amount recoverable? This would be a particular concern if the guarantee covers a large proportion of the sale property and/or major works are envisaged during the guarantee period.
- How long does the guarantee last? Is it until the premises are let, or until they are let at a rent equal to or higher than the amount payable under the guarantee? Almost certainly it will be the latter.
- Does the guarantee fall away upon re-letting at a sufficient level of rent, or is it merely suspended while the new tenant pays the rent? The buyer will be keen to ensure that the seller starts picking up the tab once more if the new tenant stops paying rent/exercises a break option/becomes insolvent. The seller will argue that if it is the buyer selecting the new tenant then the buyer should bear that risk. In that case, the buyer will be even more cautious about the identity of any new tenant for the premises, potentially prolonging the guarantee. The seller may prefer to agree more buyer-friendly “re-activation” provisions in the guarantee and taking on these risks.
- If the guarantee falls away to the extent a new tenant is liable to pay rent, is this judged by reference to rents paid or payable?
- What happens if the new tenant pays some or all of its rent on a turnover basis?
- If a capital contribution is required to bring in a new tenant, who pays for this?
- On what terms can or must the buyer let the empty premises? The seller will be keen to see as short a rent-free period as possible. The buyer will on the other hand be happy with a rent-free period equal to the length of the guarantee, if this secures a higher rent immediately after.
- Does the seller want to use the premises whilst it is making payments? This is more likely where the guarantee relates to office premises. It might even consider taking a lease itself and then seeking to assign or underlet.
Tension between the seller and the buyer
What the above table demonstrates (and it is by no means a comprehensive list of all issues which arise), is the inherent tension between the interests of the seller and the buyer, particularly in relation to letting the empty space – this is probably the main reason why negotiating rent guarantees can be a challenge.
Once all of these issues have been considered, it often becomes apparent that the seller and the buyer have very different expectations as to how the guarantee should actually operate, particularly in connection with the circumstances in which the seller will be released.
The seller wants the guarantee to fall away at the earliest possible date and on terms which are as easy as possible to satisfy. The buyer wants to keep the seller on the hook until it has found a tenant it is completely happy with and on terms which represent the best deal available to it. In addition, the buyer may feel that since (from completion) it is the owner of the property, no-one (including the seller) should have the ability to force it to agree new leases on any terms other than those with which the buyer is completely happy.
A possible solution to this issue is the appointment of an independent adviser (e.g. a letting agent) who owes a duty of care to both the seller and the buyer. The buyer could be obliged to seek to let the property on terms which the agent certifies are reasonable market terms. Obviously, what “reasonable market terms” means in this context is another point for negotiation…
In our experience it is sometimes preferable (depending on the level of rent being guaranteed, length of the guarantee and likelihood of the premises being let) to agree an adjustment to the price than to enter into lengthy negotiations which, once concluded, may require the seller to monitor the ongoing management of the property when their efforts could be put to better use elsewhere within their business.
If a guarantee is to be put in place, it must address all possible scenarios which might arise in connection with its operation, the release of the seller, and the letting of the empty premises, in order to achieve certainty for the parties and avoid future disputes.