Last week we ruminated over some of the legal aspects of lease guaranties. Characterizing them as “legal” issues doesn’t do proper justice to the subject because all legal issues are, in fact, business issues as well – they are a proxy for talking about allocating risk. Nonetheless, lease guaranties implicate an even more obvious business issue – will there be limits on the guarantor’s liability, and if so, what will they be? This posting will explore some of the possibilities. On the other hand, the relative bargaining power of the parties will determine how useful the following ideas will be.
It shouldn’t go unsaid that some tenants don’t care about “business” limits in a guaranty, just “legal” limits. An example is a national tenant who would sign a lease in its own name but for tax or internal business structuring reasons. Often, such a tenant will agree that it shouldn’t be able to get a “free” lease termination option by signing as a single location, otherwise asset-less, tenant. And, these tenants know that if their actual signing entities can’t pay the rent, they and those signing entities are all going into the same bankruptcy.
To Ruminations, there are three categories of limitations – scope, amount, and duration.
As to scope, the question is – will or will not the guarantor stand behind all of the tenant’s obligations, or just some of them? Landlords start by asking guarantors to be as liable as the tenant would be, just as if the guarantor were the tenant itself. However, that’s not the end of the story. Perhaps the guarantor can negotiate to stand only behind the fixed rent obligations. If not that limited, perhaps pass-throughs as well or maybe also percentage rent obligations? A somewhat reluctant, but willing, landlord might ask for coverage of environmental obligations. What would such compromises leave out? For a short list, try maintenance and indemnification (and insurance) obligations. You get the idea. Tenants start low; landlords start high. Bargaining power makes the deal.
As to amount, there are also a number of approaches. Since all translate to a dollar limit, you can work with a fixed amount or an amount that gets calculated by a formula. The formula may not be obvious, and sometimes its gets calculated “after the fact” but, at the end of the day, it is a formula. So, you can say that the guarantor’s maximum liability is $X. That’s the “fixed” amount approach. (No great display of wisdom there). Or, you can say that the limitation is “Y” months’ (or years’) rent. Be careful to define “rent,” because if you don’t, you could argue for years to come as to whether the deal called for additional rent as well. Now, a limitation on “amount” doesn’t preclude a hybrid approach. For example, the limitation could be $X plus the cost to cover the tenant’s environmental liability or somesuch (for future reference, take that to mean “or something like that).
As to duration, we can talk of a lot more than guarantying “the first two years” or all obligations first accruing before until XX/YY/ZZ. A time limit can be conditioned on there never having been any rent delinquencies beyond “N” days. Or, it can be conditioned on there never having been a prior “event of default.” Another approach is dropping the guaranty when the tenant passes a certain financial test such as an agreed-upon quick ratio. [Look that up, if you need to.] The guaranty doesn’t have to disappear altogether; it can “burn down,” just as some security deposits “burn down.” Yes the longer the tenant “behaves,” the lower the amount the guarantor will need to stand behind. A guaranty can be limited to only the initial lease term or through the first (or later) renewal term. Perhaps, the guarantor can take advantage of the landlord’s willingness to release the guarantor (whose financial standing may not be AAA+) for a solid guaranty of lesser amount, but from a much better “credit” in the form of a letter of credit. You can be creative. There are no rules, only a principle. That principle is that the more confidence a tenant can engender in its landlord, the less concern there is for a guaranty. So, when it comes to negotiating for a limitation on a lease guaranty’s duration, the key is to focus on how to find the point where the landlord is somewhat comfortable that the tenant can be trusted to stand on its own.
It’s now time to talk about a form of guaranty that is getting increased exposure – the “Good Guy” guaranty. Before we explain that term, we’re going to take a detour and lay out an unsupportable theory about how this infection has spread. [Note: not all infections are “bad,” some bacteria are needed for a healthy life.] Ruminations thinks this started in New York City, perhaps 10 years ago. Evicting a tenant in New York City, even a commercial tenant, can be a life-long endeavor. OK, we exaggerate, but you get the idea. So, someone got the idea that it would be more valuable to get a defaulting tenant (usually, a non-rent paying one) out of the space than to chase its guarantor (also, for seemingly forever). The solution was to tell the guarantor that if the tenant gave up the space voluntarily, i.e., surrendered the space, the guarantor’s liability would end with whatever the “tab” was at that point in time. That didn’t mean that the tenant would be off the hook for unpaid “future” rent, only that the guarantor would not be liable for “future” rent. A little more about that later, but back to the history.
Now, there is an overlap in brokerage coverage, especially in the retail brokerage community, between New York City proper and the “suburbs,” even into New Jersey. So, brokers started to suggest the use of Good Guy guaranties when tenants balked at giving one at all, and landlords balked at signing a lease without a guaranty. Now, in the New York suburbs, where eviction can be a moderately lengthy process, this style of guaranty could still make sense. But, in New Jersey, where commercial evictions (especially for non-payment of rent) move pretty quickly (like, three weeks) and where there are no “hardship” extensions, the “reasoning” behind the Good Guy guaranty “kind of” disappears. That didn’t matter much to the brokers because most of the brokers didn’t know why the Good Guy Guaranty had been “invented,” they only knew that they could be used to get the parties to sign leases. That’s not so bad. So what if the legal maxim, “Fortior et potentior est dispositio legis quam hominis” went out the window! (OK, it means: “where the reason for a law ceases, the law itself also ceases.) Some big judge, whose name we can’t remember, even said: “so, we just invent new reasons.”
Once the Good Guy guaranty crept out of New York City to New Jersey, it was only a hop, skip, and jump to elsewhere. And so, according to speculation by Ruminations, that’s its history. Now, back to some nuts and bolts.
Once the basic bargain is struck, i.e., the guarantor, acting as a “good guy,” gets its related tenant to surrender the premises, we’re left with some details, a few of which are often overlooked by landlords. The most important one is that a landlord should want both possession of the premises as well as a terminated lease. What a landlord doesn’t want is an empty space and a question as to whether the tenant can return or exercise any rights under the lease. Imagine a bankruptcy trustee asserting that the lease is still in effect and that she or he controls the space. So, the “good guy” should assure that the landlord gets a written surrender agreement taking care of both issues. To preserve the damage claims against the tenant (after all, you’re only letting the guarantor off the hook), the surrender should be denominated as a default under the lease specifically allowing the landlord to seek damages just as if an eviction had taken place.
A Good Guy guaranty doesn’t have to absolve a guarantor of all potential future damages. For example, especially where the “possibility” is a real one, perhaps the guarantor should remain on the hook for environmental contamination. What about for the failure of the tenant to return the premises in the condition called for by the lease had the lease term come to its natural end, generally in good repair, broom clean, and free of occupants and tenancies? After all, “be a good guy,” get the tenant out of the space just as if the lease had ended.
What about the security deposit? Should it be applied to the unpaid rent and other obligations that accrued before the “surrender” and thus reduce the guarantor’s liability, or should it only be applied to offset damages attributable to lost “future” rent?
Another possibility is to require, as a condition of releasing the “good guy,” that the guarantor pay the “back rent” and other obligations at the time of surrender.
Now, some landlords may be concerned about waking up one morning with an asset-less tenant whose rent is paid to date and who can surrender the space in the proper condition on one day’s notice. In such a case, the landlord will have the space back, but will not yet have started to find a replacement tenant. One way to address this fear is to either require a minimum notice from the tenant or to make the “good guy” liable for up to, say, six months of “future” rent.
Some might say: Ruminations, you’ve taken a pretty simple “I want a guaranty; I don’t want to give a guaranty” solution, and junked it up with conditions and exceptions. Guilty. But, so what? Everything is subject to negotiation and once you’ve forgotten why the Good Guy Guaranty was invented for New York City, there is no reason not to tweak the concept for its new environment. After all, just Get the Deal Done!
There’s probably a lot more to say on the subject, but the sun is setting and the other werewolves are gathering.