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.

Below is a summary of the types of security that a Landlord may typically request, and in Part 2, we summarise some common things to look out for when accepting a bank guarantee.

Part 1: Forms of commercial leasing guarantees

1) A bank guarantee

What is a bank guarantee?

A bank guarantee is a formal assurance by the bank that a sum of money will be paid to the vendor if the tenant (you) do not fulfil the specified obligations under the commercial leasing agreement.

Will a commercial landlord accept a bank guarantee?

When it comes to commercial leasing guarantees, landlords generally favour a bank guarantee. This is because it is a third party undertaking from an entity of substance, and the bank is required to honour any drawdown 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 drawdown 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

What is a cash deposit?

A cash deposit is an amount of cash that is held as a deposit in a bank account that is shared between the vendor and the tenant.

Will a commercial landlord accept a 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.

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3) Personal guarantee

What is a personal guarantee?

A personal guarantee is exactly that, a personal guarantee from directors and/or shareholders that stipulates that the obligations of the lease will be fulfilled by the incoming tenant. In the event of default, personal guarantees require the guarantors to pay back the defaulted amount.

Will a commercial landlord accept a personal guarantee?

Landlords will 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 drawdown, a personal guarantee needs to be enforced. This may involve a process of issuing a statutory demand against the guarantor and then be 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

What is a parent company guarantee?

In contrast to a personal guarantee, a parent company guarantee may occur where the Tenant entity is a subsidiary of a parent or holding company (or a franchisee of a successful franchise business). Here, a Landlord may feel more comfortable requiring a guarantee from the (higher) entity of substance.

Will a commercial landlord accept a parent company guarantee?

It is possible and, in some cases, this may be preferable to a personal guarantee. However, 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.

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Part 2: What should you look out for when it comes to bank guarantees?

The overwhelming preference for Landlords is security by way of a bank guarantee. However, Landlords and property managers who accept bank guarantees on behalf of Tenants need to be particularly careful when checking the terms of that document.

The bank guarantee is often handed over as a final step, potentially after a lengthy lease negotiation process. It can often be seen as a formality, but failure to properly check the terms can pose a significant problem.

Here are some helpful tips and some examples of common issues:

Beneficiary

• Describe the beneficiary with precision – Make sure that the party who is the beneficiary of the bank guarantee (i.e. the Landlord) is properly noted. The case of Simic v New South Wales Land and Housing Corporation [2016] HCA 47 is an example where the beneficiary was wrongly described and they had to go all the way to the High Court to pursue an enforcement of the bank guarantee. They did ultimately succeed (on a “rectification” argument) but think of all the time, cost and angst that went along with the initial application to the Supreme Court, followed by an appeal to the Court of Appeal and then an ultimate decision in the High Court.
• Re-draw existing bank guarantees in your favour – If you buy a property where bank guarantees are already in place, make sure you go through the process of having these re-drawn in your favour. Do not assume that you can draw on a bank guarantee that is made out to another beneficiary – the issuing bank is unlikely to simply accept it on the basis that you are now the Landlord of the property.

Purpose

• Do not skip the description – Check the description of the agreement that is referenced in the bank guarantee. It should generally be applicable to “all the obligations of [the Tenant] under a lease of [the Premises]”. A standard form checkbox option of “rental bond” should not be accepted by a Landlord – this suggests that the bank guarantee is security for rent only, when the Landlord may actually need to rely on it to rectify Tenant damage to the land or a failure to make good or some other default which is not rent related.
• Remember to reference other documents that the bank guarantee also covers – Consider what ancillary documents should also be referenced in the bank guarantee. It might properly refer to the lease, but is there an associated parking licence, seating licence or an agreement for lease?

Expiry Date

• Verify the expiry date – It is becoming more common for the mainstream banks to insist on an expiry date in the bank guarantee. Make sure you check and double-check the expiry or termination date – the bank is under no obligation whatsoever to honour a claim if the expiry date has passed. It is also advisable that the expiry date is not the same date as the lease end date so that it allows you some time after the lease ends to make sure that all lease requirements (including making good) have been satisfied. If the lease has an option, consider an expiry date which is after the end of the option term, otherwise, you need to be diligent in obtaining an updated bank guarantee before the expiry of the initial term so that it is still valid through the option term.

Drawing on the bank guarantee

• Consider the location of the bank – Be cautious with bank guarantees issued by non-mainstream banks. They may offer the same level of security (as they are issued by a regulated ADI), but in practical terms, the bank may have a limited number of branches/offices and you may need to go out of your way, or even interstate, to claim on it.  Even some of the big banks are now including specific conditions in their bank guarantees that dictate a specific trading hub or business centre where then bank guarantee must be presented, rather than at any branch location.

Remember, the reason you are holding a bank guarantee is that it is as good as cash, so you should treat it that way. Make sure that it satisfies your requirements and, once you have it, keep it secure.

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One final piece of advice

Never send a bank guarantee by regular untrackable post. If it is lost, the paperwork process (including multiple statutory declarations) to have it cancelled and re-issued is a nightmare. Or even more concerning, if it falls into the wrong hands, a fraudulent claim on the bank guarantee can have significant implications for the Landlord who lost it, and potential ramifications for the banking covenant of the Tenant.

Rob Jarvin is a property expert practising at Kardos Scanlan Corporate Lawyers, acting on acquisitions, disposals and real estate projects in all sectors (including commercial and residential).  Rob also has extensive experience with commercial leasing matters, acting for both commercial landlords and tenants. This includes complex development leasing and asset/portfolio leasing for commercial office buildings, industrial development sites and retail shopping centres.  

www.kardosscanlan.com.au

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