Every month we feature a CRE Expert who answers some questions about topics related to commercial real estate. This month Justin Oeth of Reinhart Law in Madison, Wis., discusses legal aspects of leases with us.
Should a guaranty be required as part of a lease?
Oftentimes tenants wish to protect themselves from personal liability by creating a separate entity to operate business operations at a particular leased premises and serve as the named tenant under a lease. In such cases, the named tenant will most likely not be sufficiently capitalized to protect the landlord in the event of a breach of the lease by the tenant. Landlords need to consider obtaining personal or corporate guarantees from third-parties affiliated with the named tenant (i.e. parent companies or individual owners) that have the necessary financial capacity to cover the tenant’s obligations under the lease. If a landlord requires a separate guaranty from a particular tenant because of its financial uncertainty, from the tenant’s perspective, there are a number of provisions that can be added to the guaranty document to limit the liability of the third-party guarantor, such as:
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- Limit the guaranty to a specific duration within the lease term.
- Limit the obligations of the tenant covered in the guaranty, such as those obligations relating to construction, maintenance and repairs, rent or other payments, lease representations and warranties, or certain bad acts by the tenant.
- Limit the guaranty to a specific dollar amount, and possibly reduce the initial dollar amount throughout the lease term. Further, if there or more than one guarantors, the aggregate liability of each could be limited to a specific dollar amount or percentage.
- Release of the guaranty upon the occurrence of certain events, such as an assignment of the lease by the tenant, the sale of the assets or ownership interests of tenant, or upon finding another replacement guarantor with a similar net worth or creditworthiness.
- Replace the guaranty with a security deposit or bank letter-of-credit that is payable upon a default by the tenant.
How to protect a landlord from a tenant’s early termination right?
A tenant will sometimes want to include an early termination option into a lease that allows the tenant to unilaterally terminate the lease prior to its expiration. A tenant will want such a right for any number of reasons, but primarily to protect itself from unforeseen market conditions that directly impacts the tenant’s ability to remain financially viable at the leased premises. If this topic arises in lease negotiations, a landlord can protect itself by considering the following conditions to the tenant’s exercise of the early termination:
- Payment of an early termination fee. This payment should include, at a minimum, reimbursement of all costs incurred by the landlord arising from the lease and/or its termination (i.e. tenant improvements, broker commissions, legal costs, financing prepayment penalties, etc.).
- Sufficient Advanced Notice of Termination. The amount of time between the notice of termination and the actual termination date should provide the landlord with adequate time to locate another tenant. Rent should be due and payable through the actual lease termination date.
- Early Termination Period. The tenant should not have a free right to exercise the early termination right at any time during the lease term. Rather, the time period in which the tenant is permitted to exercise the early termination right should be limited to a specific date, month or other relatively short period of time within the lease term.
- From a retail perspective, if the tenant is concerned about sales at a given location, the termination right should only be permitted if the tenant’s sales fall below a pre-determined and agreed upon figure. The lease should require the tenant to provide evidence of sales to the landlord, and clearly define what is (and what is not) included within sales.