It is common when granting or agreeing to the assignment of a commercial lease for the Landlord to require the tenant to provide a third party to guarantee the tenant’s obligations under the lease.
Here we explain how commercial lease guarantees are used, if a person or a company can be a guarantor, and what happens if a guarantor cannot pay.
What is a guarantee?
A guarantee is a promise given by one party ('the guarantor') that another party will meet its obligations. If the other party fails to meet its obligations, then the guarantor can be asked to meet the shortfall (if the payment of money is involved) or pay for the default to be rectified (or in the worst case be sued for damages). In some cases, the guarantor may have to step into the shoes of the other party if, for example, it ceases to exist.
When can a landlord require a guarantee to be given?
In lease transactions guarantees play a particularly important role by providing landlords with more confidence that the tenant will comply with its obligations under the lease.
Given that a tenant often commits to significant liabilities under a commercial lease (including, among others, the payment of rent and keeping the property in repair) but at the same time either has limited financial resources or is a limited company with few assets of its own (described as having 'poor covenant strength') a landlord will often be reluctant to grant a lease unless the tenant can provide some sort of guarantee. A guarantee provides the landlord with a form of security that the Landlord can turn to if the tenant defaults.
An effective guarantee will allow the landlord to recover monies from the guarantor and/or insist that the guarantor fulfils the tenant’s obligations.
A landlord can ask for a guarantee to be given in two particular cases:
- When the landlord grants a new lease;
- When an existing tenant needs to ask its landlord for permission to transfer its lease to a new tenant (known as “assigning the lease”).
Whether in either of these circumstances, the landlord can insist on the guarantee being given depends on all the surrounding circumstances. It is not unusual for a landlord to ask for a guarantee to be given even though it is unreasonable (and even unlawful) for them to do so. If you are a tenant, you should take advice before agreeing to give a guarantee just because the landlord demands it.
On an assignment, in addition to this type of third party guarantee, the lease may contain an obligation on the tenant to provide an authorised guarantee agreement (AGA) from the outgoing tenant that the new tenant will fulfil its obligations under the lease if the lease. The terms of the lease will govern when an AGA must be given so should be considered at the time the lease is granted. An AGA is different to a third-party guarantee because it simply requires that the outgoing tenant remains responsible for its obligations under the lease if the new tenant defaults but only (usually) until the new tenant itself assigns the lease to someone else. A landlord may require both a third-party guarantee and an AGA to be given.
For more information on the process of transferring a lease, read our guide: Assigning a commercial property lease to another business
How are guarantees used?
A landlord will usually seek to enforce the lease terms against the actual tenant. It is only if the tenant defaults that it will seek to enforce the obligation against the guarantor.
Depending on how the lease and guarantee are drafted, it is not ordinarily necessary for the landlord to be required to serve any form of ‘formal’ demand on the guarantor (the situation is slightly different in the cases of AGAs but that is outside the scope of this guide). As long as a demand has been made on the tenant if required pursuant to the terms of the lease (which creates the principal liability) the guarantor will be liable without the need for any further notice. In practice of course, if the tenant does default, the landlord will contact the guarantor and demand payment but this does not create the liability. The guarantor is just being notified of a liability that has already arisen.
Because the guarantor only has a secondary liability, if for any reason the tenant ceases to be liable to the landlord (e.g. because the landlord has forfeited the lease and brought it to an end) the guarantor will usually no longer be liable. A guarantee will therefore usually permit the landlord to require the guarantor to take a new lease (instead of the tenant) or make a payment to the landlord to meet the liabilities under the lease.
Who can be a guarantor for a commercial lease?
Any individual or any company with capacity can be a guarantor for a commercial lease. The term ‘with capacity’ is important. For example, if a company is giving a guarantee it should have specific powers to do so under its memorandum or articles of association the directors of a company giving a guarantee should be able to show that they are acting within their power in order to promote the success of the guarantor company as well as the tenant and that it has been properly approved under the company’s constitution.
A landlord should be cautious about who they accept as guarantors and of statutory protections offered to guarantors. This includes risks that some of the terms of the guarantee could be deemed ‘unfair’ and therefore not enforceable. Circumstances where a guarantee may not be enforceable include:
- The basic requirements of any contract (such as offer, acceptance, intention to create legal relations and consideration) have not been met. As it is possible that there is may be no consideration given by the landlord, a guarantee will usually be signed as a deed, as it does not require consideration to be given.
- Statutory requirements have not been complied with (the guarantee must be in writing and signed by the guarantor)
- Complexities owing to corporate structures (holding company, subsidiaries and other affiliates)
- Any legal limits on authority (company law prohibits or limits certain forms of financial assistance)
- Any duress, undue influence or misrepresentations. This is very likely if a person is being asked to stand guarantor for their spouse’s company’s obligations.
To avoid these difficulties guarantees should be drafted and entered into with care and often it is sensible for the landlord to require the guarantor to obtain independent legal advice on the terms of the guarantee so that the guarantor cannot claim that it was forced into signing something it did not understand.
Guaranteeing a commercial lease as an individual
If a guarantor is an individual, then they will take on personal liability for the obligations under the lease if the guarantee is called upon. A landlord will wish to ensure that the individual is of sufficient financial standing to meet its liabilities. A third-party guarantee can provide security in such circumstances.
As an individual does not have the limited liability that a limited liability company has, this means that when entering into a guarantee, that all of his or her personal assets are at risk in the event of the tenant defaulting. From the perspective of all the parties therefore, whether obtaining a guarantee from an individual is desirable depends on the financial standing of the proposed guarantor. An individual may be more inclined to ensure that the demands under the lease and the guarantee are met, in order to avoid losing their personal assets. On the other hand, if the individual is of limited means and can no more meet the obligations under the lease than the tenant, such a guarantor is of little benefit to the landlord.
What happens if a guarantor cannot pay rent?
If a tenant has defaulted on its obligations to pay rent and, the landlord having called in the guarantee, finds that the guarantor also fails to pay the rent then the landlord may wish to take the following steps against the guarantor:
- Commencing legal proceedings for the arrears may force either the tenant or the guarantor to pay the arrears
- Serving a statutory demand (which is a pre-curser to winding up or bankruptcy proceedings) may also have the same effect
- Commencing a bankruptcy or winding up petition may or may not result in a payment to creditors, of which the landlord will be one although probably not of the full amount of the debt
If it is clear that none of these steps are likely to result in a payment being made, then the landlord might:
- Use funds from a rent deposit if such an arrangement is in place. This will provide a quick source of funds to discharge the arrears.
- Seek to take possession of the tenant’s assets at the premises and either hold them until the debt is paid or sell them to pay off the debt.
- Regain control of the property by forfeiting the lease, either by peacefully re-entering the premises, changing the locks and taking back possession or by seeking an order from the court to the same effect.
- Enforce any other forms of security that are in place that could be called in (such as a charge on a third party property)
- Enforce an Aga against a previous tenant f there is one in place.
- Agree with the tenant and/or guarantor a repayment plan.
It should be understood that the landlord is not obliged to take any of these steps and its failure to do so does not release the tenant or the guarantor from its obligations.
What are the limits on a guarantee?
A guarantee is a secondary liability which means that it is linked to the principal liability given by the tenant direct to the landlord. This means that:
- The guarantee will only be valid if it is in writing and signed by the guarantor (or someone authorised on its behalf).
- A claim can be brought under a deed within 12 years (known as the limitation period). However, if the claim is for rent arrears, the limitation period is six years from the date the rent became due. This means that if an amount claimed by a landlord from a guarantor relates to rent under a lease, the limitation period will also be six years.
- As a guarantee is linked to the tenant’s obligations in the lease, if the lease is unenforceable in any respect or if for any reason the tenant is found not to be liable, then the guarantor will not be liable either.
Alternatives to guarantees
The tenant should consider offering the following as an alternative to a guarantee:
- A rent deposit deed. This is a sum paid by the tenant to the landlord that can be used if the rent is not paid or other obligations under the lease are not complied with. The advantage to the landlord is that funds are readily accessible if the tenant fails to meet its oblations. The landlord does not need to pursue a third party or begin legal proceedings to enforce the obligations under the lease. From a tenant’s point of view, however, it can mean that valuable funds (typically equivalent to 6 or 12 months rent) are tied up and cannot be used for the business.
- A charge over a property or other asset owned by the tenant or a third party. Depending on the length of term of the lease, the potential scale of liabilities and the ‘covenant strength’ of the tenant, it may be appropriate for the landlord to take a charge over a property in the same way that a bank takes security over a property as a mortgage. In the event that the tenant cannot meet its liabilities, the landlord would look to call in the security to pay the liabilities. The problem here is that most properties “owned” by individuals are in fact already mortgaged and the lender will have to consent to the grant of the additional charge and most lenders are most reluctant to do this.
- Including additional parties as joint tenants to the lease. Clearly it is better to have two people to sue rather than one but equally two tenants with no assets are no better than one tenant with no assets.