CREJ - Retail Properties Quarterly - August 2016
A lease usually represents a significant financial undertaking by the party signing the lease. When considering whether to enter into a retail lease, a landlord needs to carefully analyze whether the tenant has the ability to perform the obligations of the lease, especially if the tenant’s business turns out to be less successful than anticipated. Financials statements should be those of the tenant or guarantor. Perhaps the first step in analyzing a prospective tenant’s ability to perform the obligations under a lease is to review the tenant’s financial statements. These can vary widely depending on the sophistication of the proposed tenant. The landlord should confirm that any financial statements provided are, in fact, for the proposed person or entity that will be the tenant under the lease. Often, a proposed prospective tenant will be a subsidiary or location-specific entity, but the financial statements provided either will be those of a parent company or consolidated with a parent and other related entities. Guaranties. After analyzing a prospective tenant’s financial condition, if a landlord still feels additional financial strength is required, a guaranty from a related entity or an individual may be necessary. In this case, one possibility is to have the parent, whose financial statements have been provided, guarantee the lease. As a cautionary note, guaranties have many nuances and care should be taken in drafting and negotiating the guaranty. Sometimes, the parent is not willing to provide a full guarantee of the lease and, in that case, a limited guarantee may be the solution. These limitations could be based on time passed without a default. For instance, if the tenant has not had a default in the first five years of the lease term, the parent’s guaranty would be released. Another method is to limit the parent’s guaranty in terms of dollars. For instance, the parent might guarantee one year of rent (which may need to specify if any pass-through amounts are included), or the amortized amount of the tenant improvement allowance, leasing commissions and other lease costs. Other benefits of a guaranty. When the proposed tenant is a new business or franchisee with limited financial resources and is operated by one person or a couple, landlords should consider obtaining a personal guaranty from the individuals who will actually operate the tenant. First, this allows the landlord to collect from the financial resources of the individuals who operate the tenant. Second, it provides a strong incentive for the individuals to remain involved with the tenant if the business struggles. Although it is possible to have the individual operator named as the tenant, it may benefit the landlord to have the tenant be a limited liability company or corporation, as long as the landlord retains the ability to pursue the individual through a guaranty. (Note that it does not make sense to have the tenant also serve the guarantor.) This would protect the landlord’s ability to collect even if an accident or other occurrence involving the tenant’s business makes it difficult to collect from the tenant himself. Thus, the combination of a limited liability entity and a personal guaranty in favor of the landlord can be beneficial to both the tenant and landlord. Always have guarantors consent to lease amendments. Once a guaranty is in place, it is important to obtain the guarantor’s consent to any amendment. Absent language to the contrary in the guaranty itself, the modification of the underlying obligation can result in a full release of the guaranty. If the individual signing for the tenant and the guarantor are the same person, it is important that the person signs in the two different capacities as if there were two different people. If the guarantor is not the person signing for the tenant, it also is important to obtain the guarantor’s consent to be sure the guarantor is aware of the change in the lease and that the guarantor remains liable on the guaranty after the change. It is possible a properly worded guaranty can protect the landlord if it does not obtain the guarantor’s consent to an amendment. Many guaranties include waivers of a number of different defenses the guarantor may have to the landlord’s ability to enforce the guaranty. One of those waivers should be to future amendments, and it is worthwhile not only to have the guarantor waive any defense to an amendment, but also to consent to the amendment. However, even if a guaranty contains language to address future changes in the lease obligation, it is still advisable to have the guarantor consent in writing to amendments. When entering into a retail lease, it is important to consider the financial resources of the tenant. That involves both the review of financial statements and considerations as to whether a guaranty is necessary. If a guaranty is necessary, there are options available to both landlord and tenant to reach a reasonable compromise as to the extent of that guaranty. Once the guaranty is in place, care should be taken to avoid a loss of that guaranty through a modification of the guaranteed obligation.