In an uncertain market where landlords face the difficult balance between the need to offer favorable leasing terms to prospective tenants while protecting against the growing number of tenants experiencing economic hardship causing them to wind down their businesses, the concept of a “good guy” guarantee has become far more prevalent in leasing transactions, and thus the focus of much more scrutiny and discussion during lease negotiations.
In an effort to protect landlords against a breach by a tenant of its obligations or undertakings in a lease, it is a well-established practice in commercial leasing transactions that a landlord require (i) tenant to post a security deposit (in cash or by letter of credit) and (ii) a principal of tenant (or any other creditworthy affiliate/individual) to guarantee tenant’s performance under the lease. Generally, these guarantees are known as “payment and performance” guarantees in which the guarantor guarantees the payment of all rent and other amounts due by tenant under the lease and the performance of all of tenant’s obligations and undertakings thereunder. While the two aforementioned constructs protect a landlord against financial losses related to a lease, they fall short in two important areas of concern for landlords. First, neither prevents a tenant from engaging in a drawnout and costly dispute or litigation during which the tenant may remain in possession of the premises. Second, neither provides a tenant with a true incentive to vacate the space and deliver the premises to landlord as soon as possible after tenant determines that it is no longer practical for it to remain in the space. Thus, the “good guy” guarantee was devised by landlords to motivate tenants to vacate the space and surrender possession of the premises to landlord to avoid arduous and costly landlord-tenant litigation and so that the space may be shown and a new tenant found more easily.
A typical “good guy” guarantee requires one or more of the tenant’s principals (or creditworthy affiliates) to guarantee the rent (and often other payment) obligations under the lease through the date tenant surrenders the leased premises to landlord, even if that occurs prior to the lease expiration date. Usually cast in the form of a “payment and performance” guarantee, the basic “good guy” guarantee contains a specifically negotiated set of limitations or conditions that, if satisfied, releases the guarantor from personal liability thereunder. The basic rationale for such a guarantee is to help satisfy the landlord’s overriding concern that if the lease is terminated prior to its scheduled expiration as a result of a tenant default, the premises will be surrendered to landlord in the same condition in which they would have been had the lease expired in accordance with its terms (e.g., vacant, broom clean and with all amounts due and owing by tenant paid up to the date of expiration, etc.).
Over the past few years, the nature and scope of the “good guy” guarantee has evolved and the agreement itself has become a much more sophisticated document, with landlords seeking to impose upon guarantors more stringent requirements and restrictions before releasing such guarantors from liability thereunder. Key business terms that require much thought/negotiation include, without limitation:
- Scope of Liability: Will guaranteed obligations be limited to payment of fixed rent or will it include additional rent such as operating expenses and taxes? Will guaranteed obligations include performance obligations like repairs, improvements, etc., or other reimbursement obligations of tenant?
- Condition of the Premises: Will guaranteed obligations include removal of tenant’s property and leasehold improvements?
- Notice Requirements: A “good guy” guarantee requires tenant to provide advance notice of surrender (with a range of anywhere from three to 18 or more months) before a guarantor will be released. Landlords generally seek to require as much notice as possible so that they will have ample time to show the space and find a new tenant(s).
- Security Deposit: Will the security deposit, if any, held by landlord be applied to offset all of any portion of the guaranteed obligations?
- Tail/Lump Sum Payment Clause: Some “good guy” guarantees contain provisions requiring the payment of a negotiated lump sum at the time of surrender.
- Net Worth/Financial Covenants of Guarantor: Will the “good guy” nature of guarantee be conditioned upon guarantor maintaining a minimum net worth or satisfying other financial covenants?
Given the complexities of the “good guy” guarantee, we urge both parties to discuss specific terms and conditions early in the “business” discussion stage and preferably prior to the execution of the letter of intent for the lease. Further, as there are a wide range of guarantee structures and a plethora of critical business terms that could have a material effect on landlords, tenants, and guarantors alike, guarantees of any kind in a commercial leasing transaction should always be carefully reviewed by legal counsel before they are signed.