Many commercial landlords require that a guarantor secure the obligations and liabilities of a tenant as a prerequisite for entering into a lease. A lease guaranty is a contract between an individual or entity (guarantor) that is typically related to the tenant. The guarantor promises to pay the landlord any and all payments due under the lease in the event the tenant defaults under its lease obligations and otherwise cure the tenant's defaults.
Today, most commercial leases are entered into by an entity as the tenant, such as a limited liability company or corporation. That entity is often a shell company that is created solely to engage in the business at the leased premises and may be part of a multilayered corporate structure designed to provide maximum liability protection for the tenant's principals. This creates significant hurdles for the landlord in the event the tenant defaults under the lease. Even if the landlord is ultimately successful in securing a court judgment against the tenant, it may be a hollow victory as the tenant may have little or no assets to collect against. To mitigate this risk, landlords now routinely require either a personal or corporate guaranty to secure a tenant's obligations under the lease.
Depending on the financial condition and bargaining position of the tenant and guarantor, the parties may enter into various types of lease guarantees, which are outlined below:
- Full or Absolute Guaranty. This is the gold standard for most landlords, as this guaranty provides the landlord the most comprehensive coverage. It requires the guarantor to cover all of the tenant's obligations under the lease, without limitation. This can include payment of all monetary obligations under the lease (i.e., payment of rent, tenant's share of operating expenses and utility charges), as well as non-monetary obligations (i.e., maintenance of insurance coverage, repairs, licenses and permits). Another benefit for landlords is that a full guaranty does not impose any conditions upon the landlord before it may pursue the guarantor. Thus, the landlord can move quickly to enforce the guaranty following a default by the tenant to be made whole.
- Partial or Limited Guaranty. Sometimes referred to as "rolling" or "floating" guarantees, partial guarantees provide more protections for tenants before they may be enforced. A partial guaranty may be limited to just a tenant's monetary obligations under the lease, and the guarantor's liability may be capped at a specific dollar amount. A partial guaranty may begin as a full guaranty, then transition to a partial guaranty following a certain period of time. In addition, a partial guaranty may include a "burn off" or "sunset" provision whereby the amount of guarantor's financial liability is decreased over a period of time before terminating completely. A partial guaranty may also impose certain conditions on a landlord such as requiring the landlord to pursue or exhaust its remedies against the tenant before it can enforce its rights under the guaranty.
- Springing or Bad Acts Guaranty. This is a form of partial guaranty that becomes enforceable only upon the occurrence of a specified event. The triggering event is typically an event of default by tenant under the lease, which can include the tenant entering bankruptcy or insolvency proceedings or the tenant's net worth falling below a certain threshold. The triggering event may also be a result of tenant's "bad acts." These include fraud, damage to the premises resulting from tenant's actions or negligence, contamination of the premises by hazardous substances or criminal prosecution of the tenant or guarantor.
- Good Guy Guaranty. This is a form of limited guaranty and that is attractive for many tenants. Under a traditional Good Guy Guaranty, which is common in New York City, the guarantor's liability is terminated upon the tenant's surrender of the premises. The tenant must pay all lease payments through the date of surrender and return the keys to the landlord. Most Good Guy Guarantees require the tenant to provide the landlord reasonable advance notice of the intended surrender date, and the tenant must surrender the premises in good condition. However, a Good Guy Guaranty may also impose certain requirements on the guarantor that may survive the tenant's surrender of the premises, such as requiring the guarantor to remove the tenant's alterations and restore the premises to its condition upon commencement of the lease term.
Most limited guarantees are subject to the tenant being in good standing under the terms and conditions of the lease. The parties may agree to some combination of a standard guaranty with full liability against the guarantor that may convert into a rolling guaranty provided that no event of default has occurred under the lease. Further, any limit on a guarantor's liability may be subject to reimbursing the landlord the amortized cost of any improvements that were constructed for the tenant or tenant improvement allowance, brokerage commissions, and for all costs and expenses incurred by the landlord in enforcing and collecting under the lease and the guaranty.
Ultimately, these are general concepts, and there is room for negotiation between the parties depending on many factors – including financial condition of the tenant and/or guarantor, desirability of the location, lender requirements, etc. Landlords, tenants and guarantors should carefully consider these and other factors when negotiating a guaranty of a commercial lease.