It is becoming increasingly important for landlord’s to explore the securities available for their commercial tenancies. Landlords do not want to be out of pocket from missed payments or damages and need assurances in place. Securities can be available through different means with rent deposit deeds and guarantees popular options in the current commercial property market.
This article explores the securities available and how they work within commercial property.
What is a guarantor?
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. As businesses fall into financial difficulties, guarantees will continue to play an important role protecting landlords in the current market. A landlord may ask for a guarantor to be provided on the grant of a lease or on assignment, referred to as an authorised guarantee agreement (AGA). The landlord’s primary concern will be to ensure that the tenant has sufficient financial standing to pay the rent and comply with the covenants in the lease.
The role of a guarantor in lease agreements
In a commercial lease, a guarantor, whether an individual or a company, plays a critical role in ensuring the fulfilment of lease obligations. They can be asked to step in if the tenant fails to meet the lease requirements, providing landlords extra security.
Often a guarantee imposes a “secondary” obligation, the guarantor does not incur liability 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.
The contents of a guarantee are usually negotiated between the parties and 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.
How rent deposit deeds work
One form of security that a landlord may seek from a tenant is a rent deposit and if this is agreed then the level of such a deposit can typically be the equivalent of 3 or 6 months’ rent. The rent deposit by its nature results in the landlord having ‘money in hand’ accessible immediately should the landlord need to recover any monies properly due to them. Although providing a rent deposit may create short-term cashflow issues for a potential tenant who may require those additional funds to make good the premises.
In addition to or as an alternative to having a rent deposit, the landlord may require the tenant to provide a guarantor.
Key differences between a guarantor and rent deposit deed
The most common alternative form of security to that of a guarantor, 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 position, not all businesses will be in a position to stump up a large sum of money at the outset of a new letting.
Amount of security provided
The benefit of a landlord insisting on a tenant’s guarantor, is as we have already mentioned, the landlord can insist upon how much or how little the guarantor is ‘on the hook’ for under a lease and when, for example, the insurance rent and service charge payments in addition to all other sums due for the duration of the lease, will be for far more than the monies due under a rent deposit deed.
The downside is that unlike a rent deposit which is readily realisable, a guarantor would have to be pursued for sums owed, which in turn comes with its own complexities and costs.
Risk exposure for landlords
There are broader benefits than that of a rent deposit deed, for a landlord to insist upon a lease to be guaranteed. A guarantor, whether they be individuals or a company, are guaranteeing to the landlord that the tenant will perform the obligations under the lease and where the tenant fails to do so, then the landlord may require the guarantor to perform such obligations and make good the default of the tenant.
It is not necessary for the landlord to first pursue the default with the tenant, only to then turn to the guarantor. If they choose to, a landlord can pursue the guarantor even where the landlord has not first pursued the defaulting tenant. In the event of a lease to the tenant being disclaimed as a result of insolvency, the landlord may require the guarantor to take on a lease of the premises on the same terms as the disclaimed lease for the unexpired term left of the lease.
Ease of enforcement
For a landlord to rely on the enforceability of a guarantee, they should first ensure that the guarantee is in writing and signed by the guarantor or by some other person lawfully authorised by the guarantor. In addition, the document is to be executed as a deed.
It is also the case that the value of the guarantee to the landlord is that the guarantor may remain liable even if the landlord’s claim against the tenant is unenforceable.
The benefit of insisting on a lease to be guaranteed is that a landlord can bring a claim under a deed within 12 years (known as the limitation period) against a guarantor, as long as it does not relate to rent arrears. To bring a successful claim for this, the limitation period is six years from the date the rent became due. This will also be true under a rent deposit deed.
If a tenant has defaulted on their 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 steps against the guarantor by commencing legal proceedings for the arrears; serve a statutory demand (winding up or bankruptcy proceedings); or commence a bankruptcy or winding up petition, which may or may not result in a payment to creditors of which the landlord will be one.
Appeal to tenants
It may be appealing for a tenant’s lease to have a guarantor, as this may negate the need for a landlord to insist on the use of a rent deposit deed.. The decision of course will ultimately rest with the landlord whether to insist upon a lease being guaranteed and/or a rent deposit.. In some cases, a landlord may insist on both, depending on the covenant strength of the tenant.
How to choose the right lease security option
The landlord may have to finely balance its options regarding the letting of premises which may primarily be dictated by location, market and demand as to which conditions can be imposed. In relation to a rent deposit and guarantor, the landlord may consider a rent deposit is worthwhile on the basis that a ‘bird in hand is worth two in the bush’. It is important for the position regarding the landlord’s security to be formalised by way of deed and appropriate legal advice being obtained.
How Goughs can help
Our Commercial Property Solicitors at Goughs appreciate that every lease is different and every business is unique. We can guide you through the implications of choosing a lease that requires a guarantor,, a rent deposit deed, or both, so as to ensure you are aware of your options from the outset.
