Blog - Commercial
COMMERCIAL LEASING: WHAT IS A GUARANTEE WORTH?
Landlords of commercial, industrial and retail premises will usually require some form of security from a Tenant, in order to protect themselves where a Tenant defaults under the lease.
Whilst the Landlord may not necessarily contemplate the worth of the Tenant’s security, as the presumption is that the Tenant is entering into the lease with the intention of honouring its commitments, it is important to make sure that the Landlord’s interests are protected. Indeed, this may work to the Tenants advantage as well, as a Landlord may be more willing to offer a grace period in order to deal with any issues, rather than looking to terminate the lease as soon as an issue arises (if the Landlord would otherwise be exposed, without any security).
Lease security will typically take the following forms:
1) A bank guarantee
Landlords generally favour a bank guarantee, because it is a third party undertaking from an entity of substance, and the bank is required to honour any draw down request without first checking with the Tenant.
Additionally, bank guarantees survive the Tenant’s insolvency, so there is limited risk to a Landlord that any draw down of a bank guarantee will be clawed-back as a “preference payment” in an insolvency situation.
The downside to the Tenant is that a bank guarantee generally requires a cash deposit or other minimum-balance facility with the bank, which ties up funds and generally costs the Tenant a premium to maintain. Other forms of third party security, such as insurance bonds and deposit bonds, are becoming more common these days, but Tenants should first check with their Landlord whether these are acceptable (because the lease document will usually mandate a bank guarantee issued by an Australian trading bank).
Tenants should also check whether their bank guarantee provider has a policy on expiry dates. Many banks these days require the bank guarantee to have an expiry date. Again, this is often resisted by Landlords or prohibited under the lease document.
Landlords of retail premises should note the recent changes to the Retail Leases Act which require them to return a bank guarantee to the Tenant within 2 months of the Tenant completing performance of its obligations under the lease.
2) Cash deposit
Cash deposits are not particularly popular with Landlords.
Aside from the administration required for the Landlord (or managing agent) to open and administer an account, the funds are actually held jointly on behalf of the Landlord and the Tenant. This means that in the event of the Tenant’s insolvency, an Administrator / Receiver / Liquidator may try to claim the funds back, even if the Landlord properly drew on the cash deposit (for lease breaches) prior to the Tenant becoming insolvent. Any pre- or post-insolvency payments out of cash security can be called into question as a preference payment, being a situation where the Landlord’s debt is being satisfied (at least to an extent) in preference to other creditors.
In a retail context, a cash deposit will need to be lodged with the NSW Small Business Commissioner (and note the specific time frame set down in the Retail Leases Act – this must be done within 20 days). In order to make a claim on a cash deposit lodged with the NSW Small Business Commissioner, the Landlord will need to have the Tenant sign the claim form. This may not always be possible if the Tenant is in dispute with the Landlord, or if the Tenant is insolvent.
3) Personal guarantee
Landlords sometimes require the directors and/or shareholders of a Tenant to personally guarantee the lease obligations of the Tenant. Whilst many Landlords view this as an added assurance of performance of those obligations, because the guarantor is personally committed (and potentially faces bankruptcy if they cannot honour the guarantee), Landlords need to realise that:
- The personal guarantee is only as valuable as the worth of the individual giving it – so if they own no assets of value, have assets that are not liquid or have assets that are heavily financed, the guarantee may not be worth enforcing.
- Unlike a bank guarantee, which can be called upon relatively simply by visiting a bank branch and making a request for a draw down, a personal guarantee needs to be enforced. This may involve a process of issuing a statutory demand against the guarantor and then bringing Court proceedings to pursue the guarantee as a debt. This will likely involve a time delay and an outlay of expenses (Court fees and legal costs), before any funds flow from the guarantor.
4) Parent company guarantee
Where the Tenant entity is a subsidiary of a parent or holding company (or a franchisee of a successful franchise business), a Landlord may feel more comfortable requiring a guarantee from the (higher) entity of substance.
Again, Landlords need to remember:
- For reasons of corporate separation or corporate governance, the parent company may not be in a position to give a guarantee on behalf of its operating company or franchisee.
- Parent company guarantees from foreign entities can be very difficult (and costly!) to enforce, and may require the Landlord to institute proceedings and pursue a judgment overseas in the parent company’s home jurisdiction.
- Where the parent company is listed on a stock exchange, this may give the Landlord additional comfort, however, listed companies can fail, and it is not beyond the realms of possibility that a Landlord may find that both the operating company and its listed parent suffer an insolvency event.