Leasing: Should You Require A Personal Guarantee?

When a commercial property is leased to a corporate entity (such as a company), or an individual with few assets, it is common practice to require a personal guarantee from a director or shareholder of the tenant company, or another third party in the case of an individual.  Exceptions to this might be if the tenant company is publicly listed or the landlord is satisfied that the company is financially solvent enough not to require any further security. 

What is a Personal Guarantee?

A personal guarantee is a promise by the person providing the guarantee (the “guarantor”) to honour all obligations of the tenant contained in the lease.  This includes payment of all rent and outgoings.  The guarantor effectively becomes a principal party to the lease and the landlord may enforce the lease obligations against the guarantor if the tenant defaults or otherwise breaches the lease.  The landlord is not required to take action against the tenant before it takes action against the guarantor.

The problem is that a savvy guarantor will structure their affairs so that they do not have any significant assets in their personal name.  Family trusts are extremely popular in New Zealand and it is common for business owners to form a trust for asset protection purposes.  The consequence of this sort of structuring is that the landlord may find that the guarantee is essentially worthless.  This can be incredibly frustrating for a landlord when they think they have taken steps to protect themselves in the event of the tenant’s insolvency.

If a guarantor does not have any significant personal assets, there are still options open to the landlord:

• The landlord can threaten bankruptcy proceedings.  The stigma of bankruptcy, and its repercussions, acts as a strong motivator for a guarantor to find funds from other sources to meet their obligations.

• If the guarantor receives a salary or wage, the landlord can seek to obtain an ‘attachment order’ through the courts.  An attachment order requires the guarantor’s employer to deduct a specified sum from the guarantor’s wage/salary and to pay that sum directly to the landlord in satisfaction of any outstanding debt/damages.

• If the guarantor has disposed of assets in order to avoid having to pay any debt owing to the landlord, it may be possible to claw back such dispositions.

Bank Guarantees: are they the Answer?

‘Bank guarantees’ are often preferred by landlords over personal guarantees and are a more secure way for landlords to protect against the risk of a tenant becoming insolvent.  A bank guarantee is provided by the tenant’s bank and is a confirmation in writing that the bank is holding a sum of money, usually equal to 6 or 12 months’ rental, in case of default by the tenant under the lease. 

A bank guarantee should provide that the landlord can, upon demand, recover from the funds held any costs incurred by the landlord resulting from a breach of the lease (such as legal fees).  But there is a catch: bank guarantees can be difficult to obtain because the tenant must have sufficient assets and equity in order for the bank to be prepared to provide security.

How do I Avoid a Worthless Guarantee?

The key when accepting a personal guarantee is to make sure that the guarantor has sufficient assets in their personal name to cover any potential default by the tenant.  There are some basic steps that you can undertake to try and mitigate the risk of a worthless guarantee:

• Search the Insolvency Register to see whether the proposed guarantor has been adjudged bankrupt before.

• Undertake a title search to see if the proposed guarantor owns any property in their personal name.

• Search the Company Register to see whether the proposed guarantor is a director or shareholder of any companies other than the tenant company.

Summary

Obtaining legal advice prior to entering into a lease is critical.  It is more cost-effective to ensure appropriate structures are in place to try and minimise the effect of an insolvent tenant, rather than trying to clean up after the mess. 

If you are considering leasing your commercial property, please contact Nick Strettell on (03) 377-4470 for a no obligation chat to discuss these matters in further detail.

The above information is of a general nature only. You should contact our firm for advice relating to your specific circumstances.