Personal Guaranty Issues in a Commercial Lease
Updated: Jan 24
Landlords commonly request guarantees in commercial leases for restaurants and bars. Prospective tenants should always attempt to eliminate the requirements of a guaranty. If a guaranty is required, a tenant should negotiate with the landlord to limit the scope of the guaranty. The Texas Hospitality and Non-profit Law Center can assist with lease negotiations, including a personal guaranty.
Still, there are some guaranty basics that every prospective tenant should know.
What is a lease guaranty?
It is a third-party obligation to be liable for the payment or the performance of the tenant's obligations under a lease.
Ok, in English.
Generally, the tenant is the primary obligor under a lease. The guaranty provides the landlord with direct recourse against a third party if the tenant fails to pay or perform. Thus, a guaranty is generally considered secondary rather than a primary obligation.
Of course, I used the word "generally" because a guaranty can provide that the guarantor's obligation is primary. That would grant the landlord the right to first proceed against the guarantor without proceeding against the tenant. Don't worry; I'll explain this concept in greater detail below.
Why does a landlord want a guaranty?
Landlords are often concerned about whether the tenant will not honor its lease commitments. This concern grows when landlords have paid for substantial tenant improvements. A lease guaranty provides a third party to answer for the obligations and performance of the tenant in the event of the tenant's default. So a guaranty is an additional source of revenue if the tenant fails to perform under the lease. This other revenue source is a massive benefit to the landlord.
Restaurant leases generally include guarantees because restaurants are considered highly speculative businesses—especially new restaurants with no operational track record.
Also, most commercial tenants execute a lease under their legal entity (e.g., LLC). If a tenant LLC has no assets, then the landlord (who does not have a personal guaranty) has no recourse to go after the owners of the tenant when the tenant defaults. Landlords have learned this lesson the hard way, so they almost always require the owners or investors of the tenant to sign a personal guaranty. That way, the landlord can go after the guarantor's assets. YES, READ THAT AGAIN.
Can a guaranty benefit a tenant?
Suppose a landlord requires security as a condition to enter into the lease. In that case, the guaranty allows the tenant to enter into a lease that would not otherwise be available. That's a benefit to the tenant. But at what costs?
What is the benefit to the guarantor?
Often the guarantor is an individual owner of the tenant—e.g., the chef who opens their restaurant. So the benefit to the guarantor is the landlord entering into the lease.
If the tenant has investors, expect the landlord to request guarantees from the investors instead of the tenant. Landlords want guarantees from whoever has the deepest pockets. Still, a guaranty may benefit an investor since the investor benefits directly or indirectly from the tenant's business.
Conditional guaranty vs. Absolute guaranty.
An absolute guaranty is a guarantor’s unrestricted obligation to perform on the primary undertaking if the tenant fails to perform. Suppose a tenant defaults in year three of a 10-year lease, and the landlord holds an absolute guaranty. In that case, the guarantor could be liable for seven years of rent.
A conditional guarantee is a guarantor’s restricted obligation to perform on the primary undertaking; the guarantor's performance is conditioned on the happening of some event. Suppose a tenant defaults and the landlord holds a conditional guaranty. In that case, the landlord must expend time, money, and energy to satisfy the precondition.
Guaranty of collectability vs. Guaranty of payment.
A guarantee of payment is an absolute undertaking to pay the amounts due under a lease when the tenant does not. So the landlord can pursue the grantor instead of, or at the same time it pursues, the tenant.
A guaranty of collection requires the landlord first to pursue the tenant with due diligence to collect the sums due under the lease before proceeding against the guarantor.
Joint and several liability.
If there are multiple guarantors, a guaranty can be either “joint” or “joint and several.” A joint guaranty means a particular guarantor’s obligation is limited to a portion of the tenant’s obligation. The lease would state the specific amount. A joint and several guaranty means each guarantor is liable for the tenant’s entire obligation.
Good guy guaranty.
Under this type of guaranty, the guarantor promises the landlord that they will be liable for all rent payments that accrue until the tenant vacates the leased premises. Upon the tenant's surrender of the premises and the landlord's receipt of the payments, the personal liability of the guarantor ends. Landlords usually insist on a minimum advance notice period from which the guarantor must notify them of the surrender and the vacating of the premises. Tenants should attempt to minimize the length of the notice period.
Caps on the guarantor's obligations.
The parties can agree to cap a guaranty at a maximum amount. A cap would prevent the guarantor's liability from exceeding that amount. Alternatively, the parties can use a formula to create a cap on the guarantor's liability.
Limitation on duration.
A guaranty could expire after a certain period. For example, the guaranty could expire after the first two years of a ten-year lease. Or the cap of the guaranty may decrease in stages over time.
Release after assignment.
Most leases include a provision that requires the landlord to approve the lease assignment. Suppose a guarantor is not released when the lease is assigned. In that case, the guarantor is liable for the assignee's obligations (payment and performance). If the assignee defaults, the landlord can go after the assignor's guarantor for those obligations.
Other possible limitations.
the guarantors' obligations do not apply following any renewals; and
the guarantors' obligations cease if there is a transfer of the property by the landlord.
A personal guaranty provides a landlord with an additional way to collect payment or performance that the tenant owes because of its default. Depending on the type of personal guaranty, the landlord could go after the guarantor's assets. Again, the tenant's limited liability under an LLC or corporation will not shield the guarantor's assets. Thus, it is critical to understand a lease guaranty clearly. The Texas Hospitality and Non-profit Law Center can assist with lease negotiations, including personal guarantees.
The firm provides this material for informational purposes only. The firm does not intend for this material to constitute legal advice. Nor does this material create a client-attorney relationship between the Texas Hospitality and Non-profit Law Center, PLLC and any recipient.