Guaranty of Leases

As a condition to entering into a new lease, landlords often require a guaranty of lease from a personal or corporate guarantor in connection with those tenant entities that do not have either a high enough net worth or annual revenue, or for whatever other reasons do not meet the landlord's financial criteria. A guaranty of lease is a covenant by the guarantor to be responsible for the obligations of the tenant. For example, for a tenant business set up as a new limited liability company that has one or two principal owners, the landlord will likely require that the owners personally guaranty the tenant's obligations under the lease because the limited liability company would have little or no assets and no track record. Or for a tenant entity that is a wholly owned subsidiary of a parent corporation, the landlord will likely require that the parent corporation serve as the guarantor. In these examples, a selective landlord would not enter into the lease without the tenant offering a creditworthy guarantor.

This article briefly describes the typical provisions of a guaranty, outlines the competing interests of the landlord and guarantor when negotiating the guaranty, and offers some suggested compromise language to be used when negotiating and drafting the guaranty as ways to protect both parties.

The Basics

What exactly is a guaranty and how would the landlord enforce one? In a lending context, guaranties are similar to sureties, indemnities and hold harmless agreements: One party agrees by contract to be responsible for the obligations or actions of another. In a real estate leasing context, guaranties are instead consistently and typically structured as unconditional guaranties of payment. A guaranty of payment is more than a guaranty of collection. That is, if the tenant does not perform its obligations under the lease, then the guarantor will be equally as liable as the tenant. Beyond this basic starting point, the guarantor usually is also liable for the landlord's costs in enforcing the guaranty and the guarantor typically also remains liable even if the tenant is discharged of its obligations through the actions of a bankruptcy court.

Waivers

The guarantor form required by most landlords will also typically contain a long laundry list of defenses waived by the guarantor, including waiving defenses of presentment and protest, defenses based on the tenant's lack of capacity and defenses based on the tenant's insolvency. These typical waivers are usually considered reasonable requests from the landlord considering that the landlord's expectation is for the guarantor to stand fully behind the tenant. The landlord's form guaranties normally attempt to go even further, and often provide that:

• The guarantor guaranty the lease, even if the lease were materially modified or extended;
• The guarantor waive notice of a default by the tenant, and
• The guarantor waive any right of subrogation.

The careful attorney representing a guarantor should closely review these further waivers, and consider adding language to protect the guarantor. For instance, it may be unreasonable for the guaranty to remain enforceable if the lease were to be subsequently amended without the guarantor's consent (especially amendments extending the term beyond the agreed upon initial term). Similarly, the guarantor should request that the landlord be obligated to send copies of notices of tenant's default to the guarantor. In response, landlords will likely resist these requests for revisions in situations where the guarantor is a close affiliate or owner of the tenant because the landlord will not want an extra layer of unnecessary administrative burden.

A good compromise would be to require the guarantor's consent to amendments to the lease and provide copies of notices of default to the guarantor in situations where the original tenant has assigned the lease to an unrelated third party so that the guarantor is no longer a close affiliate of the tenant.

Note also that form guaranties often include the guarantor's waiver of a right to seek subsequent reimbursement from the tenant after the guarantor has made payment to the landlord. The guarantor should review these provisions in a bankruptcy context. The landlord may agree to reasonable revisions provided any efforts by the guarantor to seek reimbursement from the unaffiliated tenant do not adversely affect the interests of the landlord in any bankruptcy proceeding.

The guarantor needs to closely review any waivers in the guaranty that go beyond the typical laundry list set forth above. Landlords sometimes try to expand the guaranties beyond the limitations agreed to in the lease. That is, the guarantor should only be liable for tenant's obligations after the tenant has exercised any of its remedies or defenses, and only after the applicable notice and cure period made available to the tenant under the lease.

Limiting the Guaranty

Recognizing that the guaranty is a condition to entering into the lease, and its leverage is limited, the guarantor would still like to limit its exposure under a long-term lease. At the same time, the landlord wants the security of an unlimited and unconditional guaranty, at least until such time as the tenant has a track record of success or can provide better financials. Because these competing interests are critical business terms, any attempts at limiting the guaranty need to be raised early in the lease negotiation process by tenant and preferably at the time of the negotiation of the letter of intent.

There are many ways for creative parties to agree to limit the guaranty. The tenant could agree to replace the guaranty with a letter of credit after a certain number of lease years. Or the parties could agree that, after the first five lease years, if there is no current or past event of default by tenant, the guarantor will either be released or the guarantor's exposure will be limited to one years' rent. Another approach would be to limit the exposure under the guaranty to the landlord's unamortized tenant improvement costs and brokerage fees.

As you can see, the possibilities are only limited by the imagination of the landlord and tenant. Another common solution that might work in the retail context is for both parties to negotiate a termination of the guaranty that only becomes effective after the tenant has reached certain financial milestones. For example, the parties could provide in the guaranty that the guarantor is released at such time when the tenant has reached a net worth of $5 million or gross sales of $10 million, based on financial reporting satisfactory to landlord. The dollar amount of any financial testing or the minimum length of time needed before the landlord will consider a release is often dependent on the amount of cash the landlord spent in procuring the lease. If the landlord had a very expensive build-out for the tenant's benefit, or provided a very high tenant allowance, then it will be much less willing to release the guarantor until such time as it has recouped its investment.

Below are three sample provisions that could be inserted into most form guaranties to limit the guarantor's exposure, while hopefully still giving the landlord enough protection to satisfy its lenders and investors. The first is a simple provision that terminates the guaranty after a finite period of time. The second is a rolling limitation based on the year of the lease. The third provision caps the guarantor's exposure if there have been no defaults during the first five lease years. A guaranty of lease is a critical document that can offer tremendous protection to a landlord and expose the guarantor to devastating liability. Guaranties of leases are treated differently in various states, so please consult with your local real estate attorney.

Example #1: Terminates After a Period of Time

Notwithstanding anything herein to the contrary, and provided that Tenant is not in default under the Lease, then as of the first day of the sixth (6th) Lease Year, Guarantor shall have no further liability thereafter accruing under this Guaranty; provided, however, Guarantor shall be responsible for all liabilities accruing during the first five (5) Lease Years and any expenses incurred by Landlord in collecting the same, including attorneys' fees and interest.

Example #2: Rolling Guaranty Limitation

Notwithstanding anything to the contrary contained herein, Guarantor's liability for Tenant's Rent obligations under the Lease during Lease Years 1 through 3 pursuant hereto shall not exceed an amount equal to the sum of (i) all Rent due and payable, or which has accrued but as yet has not been billed, under the Lease through the date upon which Tenant has vacated or Landlord has obtained possession of the Premises in the condition required under the Lease (the “Vacate Date”), and (ii) an amount equal to the Rent due and payable during the twenty-four (24) month period following the Vacate Date; and (iii) all costs and expenses incurred by Landlord in collecting such sum or any part thereof or of otherwise enforcing this Guaranty, including reasonable attorneys' fees and court costs. Provided no Tenant Default existed during the first three (3) Lease Years, then Guarantor's liability for Tenant's Rent obligations under the Lease during Lease Years 4 and 5 shall not exceed an amount equal to the sum of (i) all Rent due and payable, or which has accrued but as yet has not been billed, under the Lease through the Vacate Date; (ii) all costs and expenses incurred by Landlord in collecting such sum or any part thereof or of otherwise enforcing this Guaranty, including reasonable attorneys' fees and court costs. Provided Tenant was not in default at any time during the first five (5) Lease Years, then as of the first day of the sixth (6th) Lease Year, Guarantor shall have no further liability thereafter accruing under this Guaranty. No limitation of the Guarantor's liability hereunder shall be deemed to limit Tenant's liability under the Lease.

Example #3: Capping the Exposure

Notwithstanding anything to the contrary contained in this Guaranty, if no Event of Default (beyond any applicable notice and cure period) shall have occurred under the terms of the Lease from the Effective Date through the fifth (5th) anniversary of the Commencement Date, then the liability of Guarantors under this Guaranty shall automatically be limited thereafter to an amount equal to the sum of (a) six (6) months of Base Rent at the rate then in effect as of the date of the Event of Default by Tenant under the Lease upon which Landlord is seeking to enforce its rights under this Guaranty, plus (b) six (6) months of Tenant's Pro Rata Share of Common Area Maintenance Costs, Insurance Costs and Taxes for the calendar year in which the Event of Default by Tenant under the Lease upon which Landlord is seeking to enforce its rights under this Guaranty occurs, plus (c) any and all costs and expenses, including actual and reasonable attorneys' fees and expenses, actually incurred by Landlord in connection with the collection of the amounts payable by Guarantors pursuant to (a) and (b) above. For avoidance of doubt, the amount calculated in subsection (c) shall not be increased by any costs and expenses incurred by Landlord in connection with the Landlord's efforts to collect monies due or to bring any action for any relief against Tenant, declaratory or otherwise, arising out of the Lease, it being understood that subsection (c) shall be limited to costs of collection of the amounts otherwise payable by Guarantors under this Guaranty.

John G. Kelly, a member of this newsletter's Board of Editors, is a partner with Bean Kinney & Korman, PC in Arlington, VA. Reach him at [email protected].

As a condition to entering into a new lease, landlords often require a guaranty of lease from a personal or corporate guarantor in connection with those tenant entities that do not have either a high enough net worth or annual revenue, or for whatever other reasons do not meet the landlord's financial criteria. A guaranty of lease is a covenant by the guarantor to be responsible for the obligations of the tenant. For example, for a tenant business set up as a new limited liability company that has one or two principal owners, the landlord will likely require that the owners personally guaranty the tenant's obligations under the lease because the limited liability company would have little or no assets and no track record. Or for a tenant entity that is a wholly owned subsidiary of a parent corporation, the landlord will likely require that the parent corporation serve as the guarantor. In these examples, a selective landlord would not enter into the lease without the tenant offering a creditworthy guarantor.

This article briefly describes the typical provisions of a guaranty, outlines the competing interests of the landlord and guarantor when negotiating the guaranty, and offers some suggested compromise language to be used when negotiating and drafting the guaranty as ways to protect both parties.

The Basics

What exactly is a guaranty and how would the landlord enforce one? In a lending context, guaranties are similar to sureties, indemnities and hold harmless agreements: One party agrees by contract to be responsible for the obligations or actions of another. In a real estate leasing context, guaranties are instead consistently and typically structured as unconditional guaranties of payment. A guaranty of payment is more than a guaranty of collection. That is, if the tenant does not perform its obligations under the lease, then the guarantor will be equally as liable as the tenant. Beyond this basic starting point, the guarantor usually is also liable for the landlord's costs in enforcing the guaranty and the guarantor typically also remains liable even if the tenant is discharged of its obligations through the actions of a bankruptcy court.

Waivers

The guarantor form required by most landlords will also typically contain a long laundry list of defenses waived by the guarantor, including waiving defenses of presentment and protest, defenses based on the tenant's lack of capacity and defenses based on the tenant's insolvency. These typical waivers are usually considered reasonable requests from the landlord considering that the landlord's expectation is for the guarantor to stand fully behind the tenant. The landlord's form guaranties normally attempt to go even further, and often provide that:

• The guarantor guaranty the lease, even if the lease were materially modified or extended;
• The guarantor waive notice of a default by the tenant, and
• The guarantor waive any right of subrogation.

The careful attorney representing a guarantor should closely review these further waivers, and consider adding language to protect the guarantor. For instance, it may be unreasonable for the guaranty to remain enforceable if the lease were to be subsequently amended without the guarantor's consent (especially amendments extending the term beyond the agreed upon initial term). Similarly, the guarantor should request that the landlord be obligated to send copies of notices of tenant's default to the guarantor. In response, landlords will likely resist these requests for revisions in situations where the guarantor is a close affiliate or owner of the tenant because the landlord will not want an extra layer of unnecessary administrative burden.

A good compromise would be to require the guarantor's consent to amendments to the lease and provide copies of notices of default to the guarantor in situations where the original tenant has assigned the lease to an unrelated third party so that the guarantor is no longer a close affiliate of the tenant.

Note also that form guaranties often include the guarantor's waiver of a right to seek subsequent reimbursement from the tenant after the guarantor has made payment to the landlord. The guarantor should review these provisions in a bankruptcy context. The landlord may agree to reasonable revisions provided any efforts by the guarantor to seek reimbursement from the unaffiliated tenant do not adversely affect the interests of the landlord in any bankruptcy proceeding.

The guarantor needs to closely review any waivers in the guaranty that go beyond the typical laundry list set forth above. Landlords sometimes try to expand the guaranties beyond the limitations agreed to in the lease. That is, the guarantor should only be liable for tenant's obligations after the tenant has exercised any of its remedies or defenses, and only after the applicable notice and cure period made available to the tenant under the lease.

Limiting the Guaranty

Recognizing that the guaranty is a condition to entering into the lease, and its leverage is limited, the guarantor would still like to limit its exposure under a long-term lease. At the same time, the landlord wants the security of an unlimited and unconditional guaranty, at least until such time as the tenant has a track record of success or can provide better financials. Because these competing interests are critical business terms, any attempts at limiting the guaranty need to be raised early in the lease negotiation process by tenant and preferably at the time of the negotiation of the letter of intent.

There are many ways for creative parties to agree to limit the guaranty. The tenant could agree to replace the guaranty with a letter of credit after a certain number of lease years. Or the parties could agree that, after the first five lease years, if there is no current or past event of default by tenant, the guarantor will either be released or the guarantor's exposure will be limited to one years' rent. Another approach would be to limit the exposure under the guaranty to the landlord's unamortized tenant improvement costs and brokerage fees.

As you can see, the possibilities are only limited by the imagination of the landlord and tenant. Another common solution that might work in the retail context is for both parties to negotiate a termination of the guaranty that only becomes effective after the tenant has reached certain financial milestones. For example, the parties could provide in the guaranty that the guarantor is released at such time when the tenant has reached a net worth of $5 million or gross sales of $10 million, based on financial reporting satisfactory to landlord. The dollar amount of any financial testing or the minimum length of time needed before the landlord will consider a release is often dependent on the amount of cash the landlord spent in procuring the lease. If the landlord had a very expensive build-out for the tenant's benefit, or provided a very high tenant allowance, then it will be much less willing to release the guarantor until such time as it has recouped its investment.

Below are three sample provisions that could be inserted into most form guaranties to limit the guarantor's exposure, while hopefully still giving the landlord enough protection to satisfy its lenders and investors. The first is a simple provision that terminates the guaranty after a finite period of time. The second is a rolling limitation based on the year of the lease. The third provision caps the guarantor's exposure if there have been no defaults during the first five lease years. A guaranty of lease is a critical document that can offer tremendous protection to a landlord and expose the guarantor to devastating liability. Guaranties of leases are treated differently in various states, so please consult with your local real estate attorney.

Example #1: Terminates After a Period of Time

Notwithstanding anything herein to the contrary, and provided that Tenant is not in default under the Lease, then as of the first day of the sixth (6th) Lease Year, Guarantor shall have no further liability thereafter accruing under this Guaranty; provided, however, Guarantor shall be responsible for all liabilities accruing during the first five (5) Lease Years and any expenses incurred by Landlord in collecting the same, including attorneys' fees and interest.

Example #2: Rolling Guaranty Limitation

Notwithstanding anything to the contrary contained herein, Guarantor's liability for Tenant's Rent obligations under the Lease during Lease Years 1 through 3 pursuant hereto shall not exceed an amount equal to the sum of (i) all Rent due and payable, or which has accrued but as yet has not been billed, under the Lease through the date upon which Tenant has vacated or Landlord has obtained possession of the Premises in the condition required under the Lease (the “Vacate Date”), and (ii) an amount equal to the Rent due and payable during the twenty-four (24) month period following the Vacate Date; and (iii) all costs and expenses incurred by Landlord in collecting such sum or any part thereof or of otherwise enforcing this Guaranty, including reasonable attorneys' fees and court costs. Provided no Tenant Default existed during the first three (3) Lease Years, then Guarantor's liability for Tenant's Rent obligations under the Lease during Lease Years 4 and 5 shall not exceed an amount equal to the sum of (i) all Rent due and payable, or which has accrued but as yet has not been billed, under the Lease through the Vacate Date; (ii) all costs and expenses incurred by Landlord in collecting such sum or any part thereof or of otherwise enforcing this Guaranty, including reasonable attorneys' fees and court costs. Provided Tenant was not in default at any time during the first five (5) Lease Years, then as of the first day of the sixth (6th) Lease Year, Guarantor shall have no further liability thereafter accruing under this Guaranty. No limitation of the Guarantor's liability hereunder shall be deemed to limit Tenant's liability under the Lease.

Example #3: Capping the Exposure

Notwithstanding anything to the contrary contained in this Guaranty, if no Event of Default (beyond any applicable notice and cure period) shall have occurred under the terms of the Lease from the Effective Date through the fifth (5th) anniversary of the Commencement Date, then the liability of Guarantors under this Guaranty shall automatically be limited thereafter to an amount equal to the sum of (a) six (6) months of Base Rent at the rate then in effect as of the date of the Event of Default by Tenant under the Lease upon which Landlord is seeking to enforce its rights under this Guaranty, plus (b) six (6) months of Tenant's Pro Rata Share of Common Area Maintenance Costs, Insurance Costs and Taxes for the calendar year in which the Event of Default by Tenant under the Lease upon which Landlord is seeking to enforce its rights under this Guaranty occurs, plus (c) any and all costs and expenses, including actual and reasonable attorneys' fees and expenses, actually incurred by Landlord in connection with the collection of the amounts payable by Guarantors pursuant to (a) and (b) above. For avoidance of doubt, the amount calculated in subsection (c) shall not be increased by any costs and expenses incurred by Landlord in connection with the Landlord's efforts to collect monies due or to bring any action for any relief against Tenant, declaratory or otherwise, arising out of the Lease, it being understood that subsection (c) shall be limited to costs of collection of the amounts otherwise payable by Guarantors under this Guaranty.

John G. Kelly, a member of this newsletter's Board of Editors, is a partner with Bean Kinney & Korman, PC in Arlington, VA. Reach him at [email protected].