Tenant Lease Guarantee: 6 tips to minimise your risks
The terms of a tenant lease guarantee are negotiable.
You’re probably thinking that you have to sign the lease guarantee to enable your company to lease the premises. Its expected.
After all, the standard lease template that the agent or solicitor is using to document your offer to lease the premises has a standard clause for you to personally guarantee your company’s (the tenant) obligations under the lease.
A lease guarantee is just another item to negotiate on when you are negotiating the commercial terms of your proposed lease.
Just because the standard lease template has a standard clause for you to guarantee your company’s obligations under the lease, does not mean that you should automatically offer a lease guarantee when negotiating the commercial terms of your lease.
What is a Lease Guarantee?
A lease guarantee is a contract within a lease where you as the business owner / shareholder / director (the guarantor) personally guarantee your company’s (the tenant) obligations under the lease.
These obligations include payment of rental and opex, maintenance and repairs, and reinstatement. Depending on the wording of the guarantee, the lease obligations are for the term of the lease, regardless of whether the lease is assigned to another party or not.
Why do Landlords ask for a Lease Guarantee?
The reason that Landlords ask for a lease guarantee is to protect against your company as tenant defaulting on its payments under the lease.
Start up companies and small companies make Landlords especially nervous.
The key concern in the Landlord’s mind is the tenant default risk – the likelihood that your company will fail to meet its lease payments, or, disappear and do a runner.
Obviously, the risk of tenant default will vary between tenants and is tenant / lease specific. For example, a listed public company would have a lower risk of tenant default than a private company start up.
From a tenant’s perspective, when negotiating the commercial terms of the lease, you should consider:
- Is a lease guarantee necessary for this transaction?
- If so, what can I do to limit or reduce my guarantee?
Tips for minimising Tenant Lease Guarantee risks during lease negotiation
1. Eliminate: Negate the need for a Lease Guarantee by demonstrating your reduced default risk.
The lower the perceived default risk the less likely a Landlord will require a Lease Guarantee.
We have successfully waived Landlord’s requests for a lease guarantee by addressing the perceived tenant default risk.
This is easier where:
- The tenant (even private unlisted corporates) can demonstrate longevity in business, scale, value;
- The tenant is making an investment in the premises;
- The tenant has the backing of a proven franchisor or business system;
- The ease with which the premises may be relet.
If you are not able to eliminate the need for a Lease Guarantee, the following tips focus on reducing your risks.
2. Quantum: Limit the quantum of the personal guarantee.
For example, negotiate to limit the personal guarantee to a maximum financial limit referenced to either X months rental and opex, or, a specified dollar amount.
3. Timeframe: Limit the personal guarantee to a certain timeframe.
For example, negotiate to limit the personal guarantee for the first 12 months, or the first term of the lease (where tenant default may be highest).
4. Benchmark: Limit the personal guarantee to a certain benchmark.
For example, negotiate to limit your guarantee once your business reaches a certain financial benchmark, such as a turnover target, monthly revenues, trade sale etc, where the Landlord’s risk of tenant default reduces.
5. Tenant: Limit the personal guarantee to the period that your business is the tenant.
For example, negotiate to limit the continuing nature of the personal guarantee to the period that your company is the tenant. So that when you sell the business and assign the lease, or, shares in the company and exit, your personal guarantee ends.
6. Bond: Limit your personal guarantee by substituting your personal guarantee for a cash bond or limited bank guarantee.
For example, instead of providing a personal guarantee offer a cash bond (3 months rental) or a limited bank guarantee (limited to 3 months rental or a dollar value).
A cash bond is simply a deposit paid preferably to a third party which holds the deposit in the event of tenant default. The terms of the cash bond can be negotiated eg interest, repayment etc.
The cost of the cash bond is the opportunity cost of your equity.
A bank guarantee is simply an agreement by a bank to pay a certain sum to the landlord when demanded. The bank does not get involved in whether the “demand” is fair or right.
The cost of a bank guarantee is the establishment fee and ongoing service fee. The bank will also require security from you in the form of a mortgage over property or over a cash deposit.
In my opinion, a limited cash bond or bank guarantee is worth more to a Landlord than an unlimited personal guarantee due to the ease and certainty of recovery under the guarantee.
Also negotiate when the bank guarantee or cash bond is to be released. Australian Landlords have a tendency to require cash bonds / bank guarantees to be in place beyond the term of the lease.
We know of one client who considers his limited 6 month bank bond on a 6 year lease a cheap exit payment option. It depends on your perspective.
- Notification: Limit your liability by requiring the Landlord to notify you of any tenant defaults.
For example, if you are not involved in the day to day running of the company, ensure there is an obligation on the Landlord to bring early default to your attention. This enables you to take steps to reduce the potential guarantee claim against you. Otherwise, the Landlord could make a claim after 6 months of default, whereas, if you had known about it sooner, you could have limited the default to 1 month.
So remember, everything is negotiable.
Lease Guarantees are negotiable. If you must provide a Lease Guarantee, negotiate on its limits and agree its terms upfront
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