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Guaranty of Leases. How to Protect the Interests of Both Landlords and Tenants? Part 2

In Part 1 of this series, the definition of guaranty and the means for landlords to enforce guaranties was discussed.

Recognizing that the guaranty is a condition to entering into a 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, that the guaranty 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 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 which 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. That is, the parties could provide in the guaranty that the guarantor is released at such time when the tenant has reached a net worth of $5,000,000 or gross sales of $10,000,000, for example, 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 landlord’s cash spent in procuring the lease. If the landlord had a very expensive build-out for tenant’s benefit, or provided a very high tenant allowance, then they will be much less willing to release the guarantor until such time as they have recouped their investment.

Below are three sample provisions that could be inserted into most form guaranties as ways to limit the guarantor’s exposure while hopefully still giving the landlord enough protection to satisfy their 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 insert 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 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.

This article first appeared in Commercial Leasing Law & Strategy, and is republished with their permission. John serves a contributor and a member of their Board of Editors.

  • Shareholder

    John Kelly is a shareholder of Bean, Kinney & Korman and focuses his practice on general corporate law and real property law, including commercial real estate leasing, financing and acquisitions, and business mergers and ...