A commercial tenant’s negotiation to avoid personal liability
Consider a commercial tenant who intends to enter into an agreement to lease an office building to be occupied by an incorporated business operation.
The commercial landlord requests the corporation’s president to sign a commercial lease agreement on behalf of the corporation, acting in an agency capacity as authorized by the board of directors. Thus, the corporation is liable for performance of the lease agreement. [See RPI Form 552]
The landlord also requests for a separate agreement, a lease guarantee, to be signed. The lease guarantee is an agreement committing another person other than the tenant to pay all monies due the landlord under the lease agreement in the event the tenant does not. [See RPI Form 553-1]
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In the event of a default on the lease agreement — for example, the commercial tenant’s business files for bankruptcy and cannot remain in occupancy or afford to make payments to the landlord — the lease guarantee provides a method for the landlord to continue receiving payment throughout the duration of the lease, as specified in the commercial lease agreement. [See RPI Form 552 §2]
However, a lease guarantee agreement favors the landlord since it personally binds the individual who signs the agreement to pay, not just the president or owner of the business. [See RPI e-book Real Estate Property Management Chapter 23]
For example, a vice president who signs the agreement agrees to personally guarantee as an individual the corporation’s promised performance under its lease agreement with the landlord. The guarantee agreement signed by the vice president identifies the guarantor as an individual, not the vice president of the corporation. The guarantee agreement does not contain a description of the guarantor’s relationship to the corporation as a corporate officer. The vice president also supplies the landlord with a financial statement itemizing their personal assets.
The nature of the guarantee agreement identifying the individual and the inclusion of their personal financial statement indicated the vice president was binding themselves personally as an individual. [Sebastian International, Inc. v. Peck (1987) 195 CA3d 803]
Thus, a commercial tenant will often refuse to commit themselves to be personally liable for their company’s financial wellbeing.
In this case, an alternative negotiation tactic the commercial tenant can employ to avoid committing themselves to the lease guarantee agreement is to submit to the landlord a financial package to demonstrate their corporation’s creditworthiness and ultimate financial health, eliminating the need for a personal guarantee.
Analyzing the guarantee agreement
A guarantee is an independent promise. It is an obligation of one person, a third party, to pay the entire debt owed and promised to another, such as a landlord or property manager. [See RPI Form 553-1]
With third-party assurances, the landlord will receive full performance on the lease agreement from a third party when the tenant defaults on their rent or otherwise causes the landlord to incur a loss exceeding the security deposit.
On a default by the tenant, the landlord may hold the co-signer liable, or collect their losses from the guarantor.
The assurance the landlord will receive from this arrangement offsets the risk often associated with startups and new businesses. When new startups form and make their initial debut into the market, their sustainability is not guaranteed. There’s a chance they may be overly optimistic in their lease terms, space requirements and financial conditions, and will need to scale down. There’s also the chance the new business may simply not be sustainable and need to fold prior to the end of the lease term.
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A leasing agent, property manager or landlord uses the Guarantee Agreement For Rental or Lease form published by RPI (Realty Publications, Inc.) when entering into a rental or lease agreement with a prospective tenant in reliance on a guarantee. The form allows the leasing agent, property manager or landlord to document a third-party’s guarantee for the payment of rent or other monetary obligation arising out of a default in an underlying rental or lease agreement. [See RPI Form 553-1]
The Guarantee Agreement For Rental or Lease form provides:
- the general facts identifying the rental or lease terms [See RPI Form 553-1 §1];
- landlord agreement provisions [See RPI Form 553-1 §2];
- general provisions controlling the guarantee agreement’s use [See RPI Form 553-1 §3];
- guarantor agreement provisions [See RPI Form 553-1 §4];
- the rights the guarantor agrees to waive by signing and executing the guarantee [See RPI Form 553-1 §5]; and
- a blank space to fill with other provisions and agreements as deemed necessary. [See RPI Form 553-1 §6]
The landlord and guarantor sign and date the form, binding them to perform as agreed.
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A financial package demonstrating profitability
An individual tenant who signs the guarantee agreement is personally liable to pay the landlord for the duration of the rental or lease, even when the tenant’s business is no longer viable and can no longer operate. Since this carries a significant personal financial risk, a commercial tenant may want to seek alternative negotiation tactics to get around signing the personal guarantee when demanded by the landlord.
As an alternative for a personal guarantee, a tenant may instead negotiate with the landlord to provide documentation to the landlord which verifies their business is financially solvent, profitable and ultimately stable. With this documentation in hand, the landlord’s concerns about the tenant’s solvency are cured.
The tenant may provide the landlord with proof their corporation or business is financially healthy by submitting to the landlord:
- the corporation’s balance sheet;
- the prior two years of the corporation’s profit and loss statements; and
- the tenant’s credit report.
The corporate balance sheet and profit and loss statements are generally pulled from the tenant’s bookkeeping software.
The credit report is pulled by the tenant on themselves. These materials are part of the financial package handed to the landlord to provide evidence of the tenant’s propensity to pay their debts.
The financial package indicates to the landlord that the tenant will be capable of making rental payments throughout the duration of the rental or lease term in lieu of signing a personal guarantee.
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