The downturn in the economy, has seen a dramatic increase in clients coming to us for advice on their rights and obligations under commercial leases and brought a renewed focus on lease guarantees. This article explores the practical benefit and effect of lease guarantees and the main commercial and legal considerations which apply both to their negotiation and their enforcement.
Purpose of Lease Guarantee
A landlord's primary commercial consideration in granting a lease is whether the tenant has the means necessary to pay the rent and perform its obligations for the duration of the tenancy. Of course it's simply not possible for either party to predict this with any certainty into the future and so in entering into a lease both parties do take on the risk of non-performance. This risk is inherent in the landlord and tenant relationship as it is in all contracts. But there is a level of risk beyond which it is institutionally recognised that landlords should not reasonably be expected to accept. And so for example where the tenant does not have a proven trading record, or is in a volatile industry, or its audited accounts highlight potential future trading concerns, landlords, being then effectively "on notice" of particular risk will generally and reasonably require that the tenant's covenant is supported in a way which offsets that additional identified risk.
The purpose of the guarantee is therefore to offset the particular risk identified at the outset as attaching to the particular tenant and is not intended to, nor could it possibly, remove the risk for the landlord inherent in the contract itself.
Key Elements for Commercial and Legal Agreement
It is often the case that the requirement for a guarantee is established after the commercial terms for the letting are agreed so that no specific commercial consideration is given to the terms of the guarantee. This effectively results in the landlord's solicitor having a blank canvas to put in place the broadest guarantee and indemnity possible in protection of the landlord's interests.
In principle a guarantee is enforceable on its express terms and so to balance this, ideally from the guarantor's perspective, it would have commercially agreed up front any limitations on liability appropriate to the particular circumstances of the letting.
The most usual limitations are:
- for the guarantee to be limited to rent and other payments only;
- for it to be released after a specific period, sometimes linked to the tenant meeting the standard institutional "profits test" or other trading milestone and sometimes not;
- overall caps on liability (for example, that liability would not exceed two years rent and outgoings under the lease); and
- for personal guarantors, express exclusion of recourse to the family home.
Also of particular concern to a guarantor are the terms for the release of the guarantee. Often the only circumstance in which a landlord will openly offer release of the guarantee is on a permitted assignment of the Lease but there are other circumstances in which a guarantor would be likely to seek to be released and for which the guarantee might provide some flexibility, most notably, where the guarantor is an individual, upon his/her death; or where a guarantor, whether personal or corporate, severs their relationship with or disposes of their interest in the tenant. In the absence of some provision for release of the guarantee in these circumstances the guarantor (including his or her estate in the case of a deceased individual) has no legal right to be released.
Enforcement
When faced with significant tenant default on the lease terms, the first step for both parties will be to review the express terms of the guarantee, to see what options are provided for.
The landlord will be focussed on two things:
- recovering the property; and
- recovering the arrears and losses (including potentially the loss of the bargain depending on whether the guarantee provides for it).
Clearly the ability of the guarantor to pay arrears and otherwise perform the obligations under the lease at the point of enforcement will be critical in the consideration of the enforcement options and ultimately to recovery of any arrears and losses. The existence of a guarantee will increase the landlord's options in dealing with the lease and arrears under it, but whether the guarantor has the means at that time to pay the rent and is worth pursuing in an action for recovery of arrears or specific performance will need to be assessed at the time by the landlord. If the guarantor does not have the means at that time to pay the rent, it will simply not be worth pursuing the guarantor and the landlord will instead have to focus on recovering the property (by agreed surrender or forfeiture of the lease) and minimising its loss.
Bankruptcy of a tenant or more usually the appointment or potential appointment of a liquidator, receiver or examiner to the tenant will also have a real practical bearing on decisions taken by both parties in relation to the lease and the guarantee and, importantly, can impose a timeframe for the taking of those decisions, which the parties need to be aware of. Crucially from both the perspective of the landlord and guarantor, the disclaimer of a lease by a liquidator to a tenant company, or by the official assignee to a personal tenant in bankruptcy, does not impact on liabilities of third parties, including the guarantor's liability pursuant to a guarantee. However the statutory framework for examinerships imposes particularly onerous obligations on landlords who wish to rely on lease guarantees. Significantly, if a landlord, who receives notice of a meeting of creditors to vote on a scheme of arrangement for the tenant company in examinership, does not immediately and most commonly at least within 48 hours, serve notice on the guarantor of the meeting so as to allow the guarantor to vote instead, the landlord loses its entitlement to rely on the guarantee.
Where the guarantor is solvent and remains a real mark for enforcement the options open to the landlord will include: in the short term, maintaining the status quo i.e. not taking any action in respect of the lease but demanding the rent from the guarantor; and exercising a right, if it is an express term of the guarantee, to require the guarantor to take on the lease for the remainder of the term.
As enforcement of these options is however potentially both time consuming and costly (and Courts lean against ordering specific performance of obligations where damages would be an adequate remedy) it is most often the case that the real practical benefit and effect of these options, and the strength and scope of the guarantee in general, is in bringing the guarantor to the table to negotiate a surrender of the lease and settlement of liabilities (and thereby achieving the landlord's objectives of (1) recovery of possession of the premises and (2) recovery of arrears and losses, to the extent possible). The benefit of negotiating to both parties is of course that the time and cost in achieving a negotiated agreement will be much less than if the issues are litigated.
Recovery through the Courts
In the absence of an agreed settlement the most common course of action for recovery of arrears or losses is to bring proceedings for judgment for the amount of the debt. (This action may of course be taken against the tenant and/or the guarantor depending on the particular facts and can be coupled with an action for recovery of possession if this is also being resisted.)
If and once judgment is obtained, the usual methods of debt recovery are available against the guarantor including:
- having a judgment mortgage registered against land and buildings owned by the guarantor;
- the sheriff seizing the guarantor's personal property and assets for auctioning off in discharge of the debt; and
- taking "garnishee" proceedings against the guarantor where it is known or likely that the guarantor is to receive a sum of monies so that those monies are effectively diverted to the landlord towards satisfaction of the debt.
Where the sheriff has found no goods available to discharge the debt, a further process of examination by the Court of a personal guarantor's means, to assess and agree payment of the debt by instalments is open to the landlord.
If the instalment order is not complied with, the landlord can apply to the Court for a committal order, which is an order for arrest and imprisonment. The maximum imprisonment period is three months, but notably, the imprisonment does not extinguish the debt.
Summary
In summary, lease guarantees do not eliminate the normal risk inherent in a landlord and tenant relationship but, while not a safety net for landlords in all circumstances, do have a clear benefit in offering options in difficult circumstances. They can also very clearly place significant and potentially very onerous obligations on guarantors which need to be carefully considered.
On a very practical level landlords, tenants and guarantors are all particularly well advised to build and work on their relationships as best they can from the outset and to be and stay informed of issues affecting each other at all times to the extent possible. Being informed (both at the commercial level and also on the legal issues) and being confident in the accuracy of that information ensures that arrears don't build and takes a lot of the pain out of ensuring that the right action is taken in the particular circumstances in the most cost effective way.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.
