Personal Guarantees, Bank Guarantees, Security Deposits.…

What does Security on Commercial Leases mean?

What are the risks?

Can I negotiate them out of my Lease?

 

Security on Commercial Leases: As a regular part of the work we do in representing Tenants in their commercial leasing matters and in getting to know our clients, one of the standard questions we ask is “Do you have a Personal Guarantee as part of your Lease”?  

If you don’t know what a Personal Guarantee is, don’t know if you have one in your Lease or have no idea how security on commercial leases work, then be assured, you are not alone!  This is quite a common situation; that we hear regularly!

It is not uncommon for a Tenant to just accept that a Personal Guarantee and / or a Bank Guarantee /  Security Deposit is a standard clause in all Leases.   It is not uncommon for a Tenant to agree to include these in their Lease, without really understanding the real implications and exposure they have, should the security need to be relied upon by the Landlord at some time in the future.  Landlords rely on this lack of understanding to extract more security than they really need.

Can guarantees be negotiated?

As is the case with most items in a Lease, guarantees are negotiable. We regularly negotiate them out of our clients leases entirely or alternatively, negotiate limitations or tight restrictions on the level of guarantee being provided, as part of our lease negotiations for Tenants.  Being able to achieve this, often depends on things like the stability of the business, how long the business has been operating, the Landlords level of desire to have the business as a Tenant, the amount of rent being paid and broader market conditions, but we achieve this all the time where appropriate.

What is a “Personal Guarantee” and what are the risks?

In relation to a commercial lease and as the heading suggests, a Personal Guarantee is the Tenant personally providing a legal promise to pay the Landlord for any liability in relation to the Lease.  If you have a 5 year Lease with an annual rent of $100,000, you are personally promising to cover the full 5 years rent or $500,000.  Items such as makegood expenses (returning the tenancy back to the condition it was in at the start of the Lease) as well as any other associated costs which relate to exiting a tenancy, can add up to tens of thousands of dollars, depending on the size of the tenancy and the circumstances surrounding the exit.  When you sign a Personal Guarantee, you are personally promising the Landlord that you will also cover all of these costs, in the event of an exit.

What if my Lease is in my personal name?

If a Tenant holds the Lease to their premises, in their own personal name, that means they are automatically providing the Landlord with a Personal Guarantee, meaning that any of their other personal assets, also held in their own personal name, such as the family home, are at risk of being sold by the Landlord to fulfill the financial obligations of the Lease, in the event of a default. These guarantees are often unlimited without an expiry date.

What if my Lease is in the name of a company entity?

If a Tenant holds the Lease to their premises, in a company entity, it is common for a Landlord to seek Personal Guarantees of the company directors, as the value of the company itself may be lower than the total value of the financial obligations of the Lease, over the full term.

What is a “Bank Guarantee?”

A Bank Guarantee is an amount of money which is held by the Tenants bank in the Tenants name, that must remain on deposit for the term of the Lease and must be accessible by the Landlord in the event of a default.  The value of the Bank Guarantee is usually 3 – 6 months rent, depending on what is negotiated at the time of entering the Lease. In the event of the rent not being paid, the Landlord has the ability to go to the bank and access the money secured by the Bank Guarantee to cover their loss. 

What is a “Security Deposit”?

A Security Deposit is an agreed amount of money paid to the Landlord by the Tenant, usually 3 – 6 months rent, that is held by the Landlord in one of their bank accounts. It can be accessed by the Landlord for the same purposes as a Bank Guarantee.  

The funds of a Security Deposit are held by the Landlord and the funds for a Bank Guarantee stay in the bank account of the Tenant, however, both are accessible by the Landlord when appropriate.

Can I negotiate Security on Commercial Leases: a Personal Guarantee, Bank Guarantees or Security Deposit?

Personal Guarantees

These can be negotiated out of a Lease completely, depending on the circumstances and the other items being negotiated at the same time. If a Personal Guarantee is a firm requirement of the Landlord, we will always try to limit the exposure of the guarantee to the value of the lease liability, rather than it being completely unlimited.

Bank Guarantees / Security Deposits

These can be negotiated too.  Typically a Landlord will seek 3 – 6 months rent for a Bank Guarantee or Security Deposit, but we are regularly negotiating these down to 2 – 3 months rent, depending on the other items being negotiated at the same time.

What is the best outcome I should be trying to achieve?

The best outcome is to negotiate a Lease that has no Personal Guarantees at all. However, there is sometimes a trade off in achieving this, in the form of a higher Bank Guarantee. For example, offering a Bank Guarantee or Security Deposit worth more than what the Landlord is seeking may be a strategy to remove the need for a Personal Guarantee.  Increasing the value of the Bank Guarantee or Security Deposit could be a good outcome, as it eliminates the exposure of the Tenants personal assets and limits the general exposure to a limited amount.  One of the strategies we often adopt is to offer a higher bank guarantee value at the start, with a programme for reducing it back to 2 – 3 months in value after an agreed period of time, for the balance of the Lease term.

If you are about to renew your Lease or enter into a new Lease, feel free to call us on our FREE phone hotline 1300 356 702 or email us to discuss the level of liability you have and the mix of security that you should be providing to your Landlord.