WHY ARE PERSONAL GUARANTEES REQUIRED IN A RETAIL LEASE?
What are some of the issues of a personal guaranty in a retail lease? Most landlords nationwide today require a personal guaranty from all tenants who are entering into a retail lease. The landlord had very bad experiences during the recession of 2008-2010 and found that they had many retail tenants close their doors without any notice. Since most retail tenants execute a lease under their legal entity (corporation or LLC) (see our business formation page and our blog on choosing a proper entity), without a personal guaranty, the retail landlord has no recourse to go after the owners of the tenant. If the tenant corporation or LLC has no assets, then the landlord has nothing from which to recover the rental fees due. Today, having learned their lessons, retail landlords require the shareholders or members of the tenant entity to sign a personal guaranty. What does this personal guarantee mean?
WHAT ARE THE TYPES OF PERSONAL GUARANTEES?
Personal guarantees can be limited or unlimited.
- Unlimited. An unlimited personal guaranty is one that means that the guarantors (people who are guaranteeing the obligations of the tenant entity [typically the owners of the tenant entity]) fully and unconditionally guaranty the full term of the lease. This means that if a tenant defaults in year 2 of a 10-year lease, the owners of the tenant could be liable for 8 or 9 years of rent and additional rent. This could be hundreds of thousands of dollars.
- Limited. There are a few types of limited personal guarantees:
- rolling guaranty: this can be a 12 month, 24 month or some other number of months, rolling guaranty. It means that the total exposure is the number of months regardless of how many months are remaining in the lease (unless the remaining months are less than the rolling months. For example, in a 12-month rolling guaranty, a default in year 7 of a 10-year lease will mean that 12 months of rent and additional rent will be due personally, not 3 years.
- rolling guaranty after 5 years: this is the same as the rolling guaranty defined above, but only kicks in after 5 years. In the first 5 years of the lease the guaranty is the same as an unlimited guaranty, meaning you are liable for the full remaining term for rent and additional rent. In other words, if the default happens in year 2 of a 10-year lease with a 12-month rolling guaranty that kicks in after 5 years, then the individual owners of the tenant are liable for 8 years of rent and additional rent, not 3 years. This is a common misunderstanding that a retail tenant has.
ARE RETAIL TENANTS AUTOMATICALLY RELEASED FROM A GUARANTEE OF THE LEASE IF ASSIGNED WHEN A BUSINESS IS SOLD?
Retail tenants and the guarantors of a lease are not automatically released from the guaranty that they signed if the lease is assigned because a business is sold (or any other reason). When a lease is negotiated it is critical (to me one of the only “drop dead” issues in a lease) that upon an approved assignment of the lease to a buyer of the tenant’s business, the personal guarantees of the owners of tenant should be released from the guarantees. Since the recession, many landlords would like to keep as many personal guarantors on the lease as possible. However, if the personal guarantees are not released when the business is sold, those guarantors are guaranteeing the financial obligations of the buyer of the business. If the buyer fails to pay rent or any other financial obligation to the landlord, the landlord can look to the seller’s owner’s guaranty and go after the individual for those obligations. The indemnification/hold harmless clause in the Asset Purchase Agreement that was signed between the Buyer and the Seller at the time of the sale, will likely have no significant effect or be of any real help since it is likely that neither the buyer of the business, nor the buyer’s owners, will be able to reimburse these costs to the seller. Presumably the buyer does not have the funds or would have paid the rent in the first place.
JOINT AND SEVERAL LIABILITY OF THE PERSONAL GUARANTORS
What is joint and several liability? This is a legal term that means that each guarantor is liable for the entire amount (not 50% if there are two guarantors) and a landlord may go after a guarantor before pursuing action against the tenant in the lease. This is a serious issue in that a guarantor of the lease may not realize that the landlord can look to that guarantor for rental payments if there is a default before pursuing any remedies against the tenant that signed the lease. Since most people enter into a retail lease as the entity they have formed for the purpose of protecting their personal assets, it is important to realize that in a commercial lease the personal guaranty will expose those personal assets to liabilities of the tenant entity for financial obligations to the landlord (but typically protect the individuals from 3rd party liability [customers, vendors, etc.]).
Retail leases are complex legal documents that should not be entered into without the advice of competent legal counsel to negotiate important legal clauses in the lease such as the personal guaranty. Personal guarantees should be limited and should always be released upon an assignment to a qualified assignee of the lease. The attorneys at Lanard and Associates can review and negotiate the retail lease for your business with these and many other important clausesin mind. Our attorneys understand the commercial lease and the most important legal issues that should be negotiated.