Recent statistics released by The Insolvency Service, which can be accessed here, show that company insolvencies are higher than at the same time last year. As businesses fall into financial difficulties, guarantees will no doubt continue to play an important role protecting landlords in the current uncertain market. In this new instalment of our Building Blocks series, we look at the role of guarantors in the context of commercial leases.
What is a lease guarantor?
Put simply, a lease guarantor is a party that is contractually bound to observe and perform the tenant covenants of a lease (including payment of rent), should the tenant fail to do so. Guarantors may be individuals or corporate entities.
Often, a guarantee imposes a "secondary" obligation, as the guarantor is not liable until the tenant defaults. However, it is common for lease guarantees to be drafted in such a way as to impose a "primary" liability on the guarantor, so guarantors are responsible for compliance whether or not the tenant defaults or continues to be liable.
A landlord may ask for a guarantor to be provided on the grant of a lease or on assignment. The landlord’s primary concern will be to ensure that the tenant is of sufficient financial standing to pay the rent and comply with the covenants in the lease.
In practice a guarantee is often sought where the tenant is an individual or a small/newly incorporated company. Where a newly incorporated company forms part of a group of companies, a landlord will most likely ask the parent company to provide the guarantee.
What are the guarantor’s obligations?
The contents of a guarantee are usually negotiated between the parties and a guarantor’s obligations can be extensive. This is especially the case where the guarantee is not limited in any way.
Often landlords will want the guarantee to cover all the tenant’s covenants in the lease, but the parties can negotiate a more limited scope. Some guarantees are limited to the payment of rent. There will usually be obligations to protect a landlord if the tenant becomes insolvent or falls into financial difficulties.
For example, where a lease is disclaimed by a liquidator, the landlord may, if the terms of the guarantee allow, require the guarantor to take a replacement lease of the premises on the same terms as the original tenant. Alternatively, the terms of the guarantee may require the guarantor to pay a sum of money, usually the equivalent of three to six months’ rent.
Traps for the unwary
Guarantees are subject to strict formalities, some dating back centuries. If a guarantee is in place the landlord should always proceed with care to ensure that it is not caught out.
Crucially a variation of a lease will release the guarantor unless either:
- The guarantor consented to the variation, or
- The variation is clearly insubstantial or incapable of adversely affecting the guarantor.
Another potential trap is that existing guarantees can be rendered unenforceable on an assignment of a lease as a matter of course. The landlord cannot insist on the incoming tenant providing a guarantor unless it is reasonable to do so or the lease expressly allows it. What is considered reasonable will always depend on the specific circumstances.
Further, there may be certain pre-conditions to enforcing the guarantee. For example, if the landlord wishes to make a claim against a former guarantor who remains liable under an authorised guarantee agreement (otherwise known as an AGA), the landlord must serve a statutory notice on the guarantor within a certain time limit informing the guarantor of its liability. We explored AGAs further in the first of our Building Blocks series, here.
Given these potential traps, landlords are encouraged to take legal advice at the earliest opportunity to avoid inadvertently releasing the guarantor or otherwise missing the opportunity to enforce the terms of a guarantee.
What are the alternatives to a guarantor?
The most common alternative form of security is a rent deposit. This is a sum of money paid to the landlord as security for non-payment of rent or non-performance of the tenant covenants in the lease. A rent deposit deed will be negotiated between the parties and its terms will dictate when the landlord is entitled to draw on the funds. Whether the tenant can provide a rent deposit will depend on its cash flow and not all businesses will be in a position to stump up a large sum of money.
Our comments
With many commercial tenants falling on hard times (for instance Paperchase and Cath Kidston, to name two recent high profile cases) guarantees are becoming more common place, even where the tenant is a big player in their market, as landlords understandably seek to protect their own position.
This is a complex area of law and this summary is intended to provide only a brief overview. Our real estate team regularly negotiates guarantee and rent deposit agreements and our real estate disputes team is experienced in enforcing the terms of existing guarantees against defaulting tenants.
Chloe Fisher