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What is the significance of a personal guaranty in a lease?

| Dec 9, 2020 | Leases

A commercial lease can be an essential part of getting your business to the next level. Whether you are looking for your first brick-and-mortar location or you need to expand your footprint, leasing commercial property can help you develop your business.

Often, a commercial lease will require a personal guaranty to protect them if you are unable to fulfill your obligations under the lease.

Before you sign a commercial lease, here’s what you should know about the personal guaranty and how it could impact your personal finances.

Where did the personal guaranty come from?

Before 2008, the personal guaranty was not as prevalent as it is today. During the recession, commercial landlords learned a difficult lesson about what can happen when their tenants cannot pay the rent.

To create a safeguard against businesses that did not make it, more commercial landlords added the personal guaranty for greater financial protection.

What does a personal guaranty do?

When you create an entity for your business (corporation or limited liability company), if set up and managed properly, a court of law will usually consider that a “corporate veil” exists that will shield your personal assets if your company defaults in the financial obligations to the landlord or has legal issues. The protection of the corporate veil gave commercial landlords virtually no recourse if a tenant could not pay the remainder of their lease.

A personal guaranty is a separate legal document from the commercial lease. While the commercial lease is signed by the owner or an officer of the business on behalf of the corporation, a personal guarantee is signed by the business owner or owners personally.

If the tenant does not pay all rent and fees under the lease, and their business has no assets, the personal guaranty gives the landlord a way to collect the money that was owed. Depending on the type of personal guaranty, the landlord could go after assets such as the tenant’s owner’s house and/or vehicles.

Limited vs. unlimited

There are many variations to the terms of a personal guaranty. In general, personal guarantees are either limited or unlimited. In an unlimited personal guaranty, you promise to personally guaranty the full financial obligations of the lease unconditionally. While you may have every intention of fulfilling all of the obligations of the lease, agreeing to an unlimited personal guaranty could be a substantial risk. For example, if you are only a few years into a 10-year lease, you could be liable for all unpaid rent and additional rent through the agreement’s end.

As the name suggests, a limited personal guaranty has more boundaries. In many cases, limited guaranties are either rolling or rolling after a period.

When a personal guaranty states that it is “rolling,” it means that there is a shorter-term for which you are promising to be responsible. For example, if you default on an 18-month rolling guaranty, regardless of what year of the lease you are in, the maximum you would personally owe is 18 months of rent plus additional rent, not the years you may have left on the lease.

A personal guaranty that is limited after a period follows a similar concept, but the “rolling” benefit does not kick in until the end of the initial period. During the initial period of years, the personal guaranty would have the same effect as an unlimited guaranty. For instance, if you default before the initial period, you could be personally liable for the entire lease (not just the initial period).

When have I defaulted?

For a commercial lease, a default is not always monetary. It is crucial to understand when your landlord will consider an action (or lack of action) default. Commercial lease default can include actions or omissions such as:

  • Not paying rent
  • Neglecting to make required repairs
  • Not paying required additional charges, such as triple net rent
  • Violating health and safety regulations

You should know what your lease says regarding defaults and what notice you will receive if there is a suspected default. You should also know what options you have to remedy the situation before your personal guaranty would take effect.

Before you agree to a personal guaranty on your commercial lease, you should clearly understand the landlord’s remedies. Depending on your agreement, the lease could include remedies, such as:

  • Removing your personal property from the premises
  • Selling your personal property
  • Accelerating the rent that is due with or without terminating the lease

When a landlord accelerates rent, it typically means that you must pay any past due amount in addition to paying remaining rent on the lease term. This is one way the landlord has of ensuring they will have the rent that you owe.

What asset can I lose?

Knowing that a personal guaranty makes your personal assets vulnerable can be unnerving. Unfortunately, that is part of what helps the landlord feel more secure if your business fails or you otherwise default on the lease.

Since a tenant’s default could cost the landlord hundreds of thousands of dollars, any number of personal assets could be vulnerable, including:

  • Properties
  • Vehicles
  • Bank accounts

This is why it is essential to have a clear understanding of your liabilities in your commercial lease.

Are there alternatives?

In broad strokes, personal guarantees go along with most commercial leases. It is vital to negotiate the terms of the guaranty, but there is likely no way around having one in most cases.

However, in some cases, landlords are willing to discuss alternatives. There are a few options that help the landlord feel secure in the transaction while allowing you to avoid the liability of a personal guaranty. Some landlords may consider alternatives, such as:

  • Demonstration of business viability and solvency
  • Paying a larger portion of the lease ahead of time
  • High net worth
  • Significant business experience and accumen

These alternatives are rare and often the case only in situations where the landlord has a personal relationship with the tenant.

Before your commercial lease negotiation

Knowing and understanding the terms of both your commercial lease and the personal guaranty is essential to the negotiation. It is also critical to have a knowledgeable attorney to advocate for your interests.

As you prepare for your negotiation, you should talk to an experienced attorney about your lease agreement and what concerns there are. Your lawyer can help you understand the terms of the agreement, how those terms will impact your goals and what terms should be negotiated.