If you (or someone you know) are a director of a company entering into a commercial lease, then you may like to read on.
In commercial leasing arrangements landlords will routinely require a personal guarantee for a tenant company’s obligations under the lease. As such, a director or shareholder providing a personal guarantee needs to be aware of the extent of the guarantee which he or she is to provide.
Obtaining legal advice in relation to a commercial lease (including for a guarantor) before executing it ought to be viewed as good practice and not something to be avoided due to the perceived cost associated with that advice. If as a result of that advice your potential risk and exposure are subsequently limited by further negotiation with the landlord, then that advice could potentially pay for itself many times over and in some instances where the terms of the lease are then defaulted on down the track, be the difference between financial pain and financial ruin. This is because, amongst other reasons, on even a fairly modest lease, the potential exposure to landlord costs in the event of a default (which may be much more than simply the cost of the annual rental and outgoings payments) may be significant and could run to tens or hundreds of thousands of dollars.
Further, guarantors seeking to defend claims against their personal guarantee being called upon often face an uphill battle. Establishing a defence which would seek to render a formal lease (or an aspect of it) unenforceable despite the guarantor having voluntarily entered it can be an onerous task. In such cases the courts have generally expressed a reluctance to set aside formal lease arrangements and therefore compelling reasons (backed by evidence) will be needed for a guarantee to be set-aside or otherwise limited.
Furthermore, most commercial leases do not impose any obligation on the landlord to first exhaust all avenues to recoup losses from the tenant company. In simple terms the landlord will ordinarily be well-advised to pursue the guarantor if the guarantor has the capacity to pay. This means that the landlord may sue the guarantor without seeking to first recover from the tenant. As a result, if a director is contemplating providing a guarantee, then he or she ought to seek legal and accounting advice regarding an appropriate asset management structure to safeguard personal assets.
In summary, a guarantor of a commercial lease is at considerable risk of personal exposure if the tenant company defaults on the terms of the lease. Whilst a director may not be able to avoid providing a personal guarantee for a tenant company, the level of personal risk can usually be reduced. Common examples include negotiating for a larger bond or bank guarantee in exchange for limiting guarantor exposure.