Part II of the Small Business Real Estate Series focused on commercial lease negotiations. As indicated in the blog, commercial leases are typically extensive, including dozens of pages of terms with numerous exhibits, addenda, rules and regulations. One of the most important, yet least understood, attachments to a commercial lease is the personal guarantee.
A personal guarantee holds the business owner personally responsible for payment on a commercial loan or lease in the event of a default by the business. Prospective tenants entering into a commercial lease should be aware that landlords may require the business owner to sign a personal guarantee. Business owners that have incorporated their businesses as a Limited Liability Company, C Corporation, or S Corporation are protected from personal liabilities for contractual issues related to the business; however, signing a personal guarantee negates the business owner’s personal liability protection.
If presented with a personal guarantee by a landlord, the business owner should negotiate the terms. For example, the landlord may be willing to waive the personal guarantee if the space is in a building, complex, or industrial park with a high vacancy rate. Also, if the landlord has not incurred expenses for improvements on the space for lease, he or she may be willing to waive the requirement of a personal guarantee, especially if the business has a strong balance sheet with a good fiscal track record.
Even if the landlord has invested in tenant improvements, it may be possible to negotiate the personal guarantee to only include the cost of the improvements. In addition, the landlord may be agreeable to adding a provision to the personal guarantee that provides for its termination once the tenant has met all of its obligations under the lease for a predetermined period of time. If the terms are nonnegotiable, the business owner may want to consider whether it is in its best interest to sign the personal guarantee, or whether it should explore space in a complex that does not require a personal guarantee.
Small businesses that have multiple owners present unique opportunities to negotiate the terms of a personal guarantee. They may be able to negotiate provisions that permit an owner to terminate his or her guarantee upon withdrawing from, or being bought out of, the business. The landlord might consider permitting provisions for such terminations in exchange for payment of a predetermined price by the withdrawing party.
There are other potential issues that should be considered and addressed when negotiating a personal guarantee in relation to a commercial lease. For example, the personal guarantee should contain a provision that terminates the liability of the original guarantor(s) when the business is sold. The landlord would be more open to including this provision if the guarantor paid a predetermined price in exchange for a release from the personal guarantee.
Another issue that arises is when the space is sublet or assigned. Typically, the lease will state that the landlord must consent before there can be an assignment or sublease. If approved, the original tenant should negotiate a provision in the personal guarantee that terminates its personal guarantee upon the assignment or subletting of the premises. Again, the tenant should consider including the payment of the termination fee in the personal guarantee so that the landlord is more inclined to negotiate a mutually beneficial agreement.
Renewal options should also be considered when negotiating a personal guarantee. Most commercial leases contain some type of renewal option. A “continuing” personal guarantee means that the original guarantor is personally liable for all obligations under the lease, even if the business was sold and the buyer assumed the lease and, subsequently, exercises the renewal option. Regardless of how many years have passed, the original guarantor can be called upon to perform under the original personal guarantee if a subsequent purchaser of the business defaults during the option term of the lease.
Lastly, it is important to understand that the personal guarantee obligates the guarantor for not only the base rent, common area maintenance, and taxes, but also for all of the company’s indemnity obligations under the lease. Personal liability for indemnity obligations can be substantially greater than the rents due under the lease.
These are just some of the reasons business owners should be aware of and negotiate the terms of a personal guarantee before signing a commercial lease. It is recommended that prospective tenants seek the advice of legal counsel to assist in the negotiations of commercial leases, particularly those that require a personal guarantee.
David Brnilovich is a member with the law firm of Jennings, Strouss & Salmon, PLC. His practice includes real estate, construction, corporate governance, small business formation, dissolution, purchases and asset sales, estate planning and estate planning litigation. Mr. Brnilovich can be contacted at email@example.com or 602.262.5898.