Landlord Solutions For Avoiding Uncertainty

The most traditional form of commercial lease guarantee — and the one that affords a landlord the greatest level of security and protection — is a “full” guarantee of payment and performance. Here, the guarantor, often a principal of the tenant, a corporate parent or an affiliate, pledges to perform all of the tenant's monetary and non-monetary obligations under its lease for the entire lease term (and potentially renewals, extensions and modifications). In the past, full guarantees were much more prevalent than they are today. The relative expense of rent and other costs associated with commercial leases have risen, and landlords by-and-large do not command the same level of control in the negotiation process, as consumer markets have shifted demand away from physical storefronts.

In lieu of a full guarantee, there are also a variety of limited guarantees with different degrees of protection. Such guarantees are diverse in the obligations that the guarantor is obligated to perform on behalf of a tenant that defaults. For example, the limited guarantor obligations:

• may be monetary (base rent, utility expenses, common area maintenance costs, real estate taxes, insurance and other passthrough expenses);
• may be non-monetary (specific tenant maintenance repairs and improvements as mandated under the lease, continuous operation requirements, and end-of-lease-term restoration and removal obligations);
• may include caps on total guarantor payments;
• may provide for conversion of the guarantee from “full” to “limited” (for example, after the tenant survives the first five years of its lease without triggering any defaults);
• may be temporal (either “rolling” or for a static, fixed period of time); and
• may be “good guy” guarantees.

We now focus on the nuances of the latter of these categories: 1) guarantees limited in time; and 2) good guy guarantees.

Temporally Limited Lease Guarantees

There are essentially two types of lease guarantees that are limited from a timing perspective: static (based upon a fixed period starting at lease commencement), and rolling (commencing from the date of the tenant's initial default). Commercial landlords and their tenants' obligors each have both potential upsides and downsides with each form of limited guarantee. To highlight how these work in practice, we offer a hypothetical …

Let's assume that a commercial landlord and its prospective retail tenant are contemplating a 10-year lease commencing Jan. 1, 2017. The landlord is demanding a three-year personal guarantee from the tenant's principal. If the guarantee is static (or fixed), it will require the obligor to guarantee the tenant's performance under the lease for the first three years, or until Jan. 1, 2020. In this scenario, if the tenant defaults in the payment of rent during the first year, the guarantor will need to pay the rent next coming due in order to satisfy the three-year static term. If, on the other hand, the tenant does not default until sometime during year five, for example, the guarantor is under no performance obligation whatsoever.

Landlords may be reluctant to agree to static guarantees because of this potential situation. This is even more poignant in circumstances where the tenant is teetering on the verge of default, but barely hangs on to life through year three for the sole purpose of avoiding the guarantee. Under our hypothetical, if the tenant can run on fumes before failing to pay rent on Feb. 1, 2020 — only a month after the three-year guarantee obligation expires — there is no guarantor liability.

In contrast to a static guarantee, landlords will often enjoy greater security under a rolling guarantee. Here, the guarantor's obligations “roll” along with the lease and will not kick in until the date that the tenant first defaults under the lease. The rolling guarantee provides the landlord with much greater protection and helps to prevent a tenant from “gaming” the system under a static guarantee, as in the last example. With a rolling guarantee, the guarantor's obligations last until the earlier of when: 1) the tenant has actually defaulted on three years' rent payments; or 2) the lease term expires.

'Good Guy' Guarantees

Another option with commercial leases is the “good guy” guarantee. As its name suggests, it rewards a defaulting tenant that acts like a “good guy” in promptly vacating the demised premises and voluntarily surrendering possession to the landlord in the condition required at the scheduled expiration of the term. Here, the guarantor's exposure will be limited to the rent and/or other lease obligations of the tenant that accrue from the date of default until the tenant surrenders possession, however long that might be. In this way, the landlord provides a strong incentive for a guarantor to cause a defaulted tenant to quickly vacate, surrender its keys and pay all accrued rent. Ideally, the landlord also benefits from avoiding legal action to recover possession and being able to quickly show and re-let the space while avoiding a dark storefront over a protracted period.

From a negotiation standpoint, good-guy guarantees vary significantly in scope. The guarantor's obligations, as highlighted above, may include base rent, triple-net lease pass-through payments, physical performance obligations, or some combination thereof. While there is no one-size-fits-all approach, good-guy guarantees will include a specific “surrender declaration” whereby the tenant explicitly agrees to surrender and vacate the premises upon the landlord giving notice of the tenant's default. On the other hand, the tenant might be required to give its own advance notice (often anywhere from three to 18 months) to the landlord about its intent to surrender the property, so that the landlord can get a jump on locating a new tenant. Generally, good-guy guarantees carve out the tenant's security deposit made to the landlord at the outset of the lease so it is not used to offset the guarantor's ultimate payment obligations.

Another key point when negotiating good-guy guarantees involves the physical appearance and condition of the leased space upon surrender. Vacant and “broom-clean” condition is most typically required when a tenant turns over its keys. However, this can become more complicated when the tenant is a franchise restaurant or other food purveyor that prepares food on-site. These tenants generally do not own their equipment (ovens, stoves, refrigerators, coolers), and instead lease them through installment contracts subject to equipment liens. Keeping in mind that the goal for a landlord utilizing a good-guy guarantee is quick access to and possession of the premises, having this equipment potentially lingering at the property until the equipment lessor reclaims possession can be a problem. To avoid that result, the landlord will want to include language in the guarantee that holds the guarantor personally liable for the prompt removal and/or safekeeping of this equipment.

Negotiating Personal Guarantees That Work

Personal guarantees for commercial retail leases come in a wide variety of shapes and sizes. Landlords must understand their ultimate goals compared with the particular circumstances of a prospective lessee, its business and the strength of its financial backers. Negotiating personal guarantees is a matter of preparing for the worst and hoping for the best. Of course, landlords want their tenants to flourish — successful tenants provide them with a steady stream of rent without the headaches of litigation. But if a tenant ultimately defaults under its lease, the landlord that negotiates the strongest personal guarantee at the outset will be in the greatest position to protect itself and reduce its damages.

*****
Mitchell W. Abrahams is a member in the Real Estate Department of Cole Schotz, in Hackensack, NJ. Jason R. Finkelstein is an associate in the firm's Litigation Department. This article also appeared in the New Jersey Law Journal, an ALM sibling publication of this newsletter.

In today's commercial real estate market, uncertainty is about the only real thing that is certain. Between ever-changing consumer tastes, increased Internet shopping in lieu of customers traveling to brick-and-mortar retail stores, greater competition between national franchises and mom-and-pop shops, tighter availability of lender financing, and the uncertainty of what will happen under a new government administration, the road ahead begs many questions without clear answers for commercial landlords. In this period of flux, where landlords no longer enjoy the same position of strength and leverage they once had over prospective tenants, it is critical to try and negotiate independent guarantees that best suit each particular deal and (hopefully) hedge against the downside of a potential tenant default and resulting litigation.

As with any other contract, lease negotiations are a process of give and take. In the world of personal guarantees, landlords have many options at their disposal, including a variety of full and limited guarantees that range in scope, coverage and duration. Herein, we briefly highlight some of the particularities and nuances of guarantees that commercial landlords and their attorneys should bear in mind during lease negotiations.

Full vs. Limited Guarantees

The most traditional form of commercial lease guarantee — and the one that affords a landlord the greatest level of security and protection — is a “full” guarantee of payment and performance. Here, the guarantor, often a principal of the tenant, a corporate parent or an affiliate, pledges to perform all of the tenant's monetary and non-monetary obligations under its lease for the entire lease term (and potentially renewals, extensions and modifications). In the past, full guarantees were much more prevalent than they are today. The relative expense of rent and other costs associated with commercial leases have risen, and landlords by-and-large do not command the same level of control in the negotiation process, as consumer markets have shifted demand away from physical storefronts.

In lieu of a full guarantee, there are also a variety of limited guarantees with different degrees of protection. Such guarantees are diverse in the obligations that the guarantor is obligated to perform on behalf of a tenant that defaults. For example, the limited guarantor obligations:

• may be monetary (base rent, utility expenses, common area maintenance costs, real estate taxes, insurance and other passthrough expenses);
• may be non-monetary (specific tenant maintenance repairs and improvements as mandated under the lease, continuous operation requirements, and end-of-lease-term restoration and removal obligations);
• may include caps on total guarantor payments;
• may provide for conversion of the guarantee from “full” to “limited” (for example, after the tenant survives the first five years of its lease without triggering any defaults);
• may be temporal (either “rolling” or for a static, fixed period of time); and
• may be “good guy” guarantees.

We now focus on the nuances of the latter of these categories: 1) guarantees limited in time; and 2) good guy guarantees.

Temporally Limited Lease Guarantees

There are essentially two types of lease guarantees that are limited from a timing perspective: static (based upon a fixed period starting at lease commencement), and rolling (commencing from the date of the tenant's initial default). Commercial landlords and their tenants' obligors each have both potential upsides and downsides with each form of limited guarantee. To highlight how these work in practice, we offer a hypothetical …

Let's assume that a commercial landlord and its prospective retail tenant are contemplating a 10-year lease commencing Jan. 1, 2017. The landlord is demanding a three-year personal guarantee from the tenant's principal. If the guarantee is static (or fixed), it will require the obligor to guarantee the tenant's performance under the lease for the first three years, or until Jan. 1, 2020. In this scenario, if the tenant defaults in the payment of rent during the first year, the guarantor will need to pay the rent next coming due in order to satisfy the three-year static term. If, on the other hand, the tenant does not default until sometime during year five, for example, the guarantor is under no performance obligation whatsoever.

Landlords may be reluctant to agree to static guarantees because of this potential situation. This is even more poignant in circumstances where the tenant is teetering on the verge of default, but barely hangs on to life through year three for the sole purpose of avoiding the guarantee. Under our hypothetical, if the tenant can run on fumes before failing to pay rent on Feb. 1, 2020 — only a month after the three-year guarantee obligation expires — there is no guarantor liability.

In contrast to a static guarantee, landlords will often enjoy greater security under a rolling guarantee. Here, the guarantor's obligations “roll” along with the lease and will not kick in until the date that the tenant first defaults under the lease. The rolling guarantee provides the landlord with much greater protection and helps to prevent a tenant from “gaming” the system under a static guarantee, as in the last example. With a rolling guarantee, the guarantor's obligations last until the earlier of when: 1) the tenant has actually defaulted on three years' rent payments; or 2) the lease term expires.

'Good Guy' Guarantees

Another option with commercial leases is the “good guy” guarantee. As its name suggests, it rewards a defaulting tenant that acts like a “good guy” in promptly vacating the demised premises and voluntarily surrendering possession to the landlord in the condition required at the scheduled expiration of the term. Here, the guarantor's exposure will be limited to the rent and/or other lease obligations of the tenant that accrue from the date of default until the tenant surrenders possession, however long that might be. In this way, the landlord provides a strong incentive for a guarantor to cause a defaulted tenant to quickly vacate, surrender its keys and pay all accrued rent. Ideally, the landlord also benefits from avoiding legal action to recover possession and being able to quickly show and re-let the space while avoiding a dark storefront over a protracted period.

From a negotiation standpoint, good-guy guarantees vary significantly in scope. The guarantor's obligations, as highlighted above, may include base rent, triple-net lease pass-through payments, physical performance obligations, or some combination thereof. While there is no one-size-fits-all approach, good-guy guarantees will include a specific “surrender declaration” whereby the tenant explicitly agrees to surrender and vacate the premises upon the landlord giving notice of the tenant's default. On the other hand, the tenant might be required to give its own advance notice (often anywhere from three to 18 months) to the landlord about its intent to surrender the property, so that the landlord can get a jump on locating a new tenant. Generally, good-guy guarantees carve out the tenant's security deposit made to the landlord at the outset of the lease so it is not used to offset the guarantor's ultimate payment obligations.

Another key point when negotiating good-guy guarantees involves the physical appearance and condition of the leased space upon surrender. Vacant and “broom-clean” condition is most typically required when a tenant turns over its keys. However, this can become more complicated when the tenant is a franchise restaurant or other food purveyor that prepares food on-site. These tenants generally do not own their equipment (ovens, stoves, refrigerators, coolers), and instead lease them through installment contracts subject to equipment liens. Keeping in mind that the goal for a landlord utilizing a good-guy guarantee is quick access to and possession of the premises, having this equipment potentially lingering at the property until the equipment lessor reclaims possession can be a problem. To avoid that result, the landlord will want to include language in the guarantee that holds the guarantor personally liable for the prompt removal and/or safekeeping of this equipment.

Negotiating Personal Guarantees That Work

Personal guarantees for commercial retail leases come in a wide variety of shapes and sizes. Landlords must understand their ultimate goals compared with the particular circumstances of a prospective lessee, its business and the strength of its financial backers. Negotiating personal guarantees is a matter of preparing for the worst and hoping for the best. Of course, landlords want their tenants to flourish — successful tenants provide them with a steady stream of rent without the headaches of litigation. But if a tenant ultimately defaults under its lease, the landlord that negotiates the strongest personal guarantee at the outset will be in the greatest position to protect itself and reduce its damages.

*****
Mitchell W. Abrahams is a member in the Real Estate Department of Cole Schotz, in Hackensack, NJ. Jason R. Finkelstein is an associate in the firm's Litigation Department. This article also appeared in the New Jersey Law Journal, an ALM sibling publication of this newsletter.