Should you personally guarantee a commercial lease?

Entering into a commercial property lease is a significant commitment for any business, whether you're a startup or an established company.

One query that often arises is whether to provide a personal guarantee for the business’s obligations under the lease.  This article aims to shed light on the considerations and implications of providing a personal guarantee to a commercial lease.

Other alternatives may be available, including providing a “parent company” guarantee, rather than a personal one.  This article focuses on the ramifications of personal guarantees.

What is a commercial lease guarantee?

A commercial lease guarantee is a legal commitment where an individual, usually a director or major shareholder of the relevant business, agrees to be personally liable for the obligations of that business taking the lease. This means that if the business fails to meet its lease obligations, such as paying rent or maintaining the property, the guarantor may be called on to cover these costs.

Why do landlords require guarantees?

Landlords often require personal guarantees to mitigate the financial risk associated with leasing to a business, particularly if the business is newly established or has limited trading history.  A personal guarantee provides an additional layer of security for the landlord, and an alternative route for pursuing payment if the tenant business struggles financially.

Pros of providing a personal guarantee

1. Access to good quality premises:  Agreeing to a personal guarantee may open doors to leasing better quality commercial spaces that might otherwise be out of reach.  Landlords may be more willing to lease desirable properties to businesses that offer a personal guarantee.
2. Leverage in negotiations:  Offering a personal guarantee can give tenants more leverage in negotiating other terms of the lease, such as rent, break options, limited repairing obligations and lease duration.
3. Demonstrating commitment:  Providing a personal guarantee demonstrates to the landlord your confidence in the business and your commitment to meeting lease obligations.

Cons of providing a personal guarantee

1. Personal financial risk: The most significant drawback of providing a personal guarantee is the personal financial risk involved.  If the business cannot meet its lease obligations, the guarantor's personal assets, such as savings, investments, and personal property, may be at risk. 
2. Potential legal consequences:  In the event of default, the landlord can take legal action against the guarantor to recover unpaid rent or other costs. This can lead to court proceedings and potential damage to the guarantor's credit rating.
3. Limited flexibility:  Providing a personal guarantee can limit the guarantor's financial flexibility and ability to secure other forms of credit.  Lenders may view the guarantee as a liability, affecting the guarantor's personal borrowing capacity.

What happens if a landlord seeks to enforce a personal guarantee?

Should a landlord seek to enforce the terms of a guarantee after a tenant default, the guarantor is personally liable, and its personal assets are at risk. 

There are legal considerations and limits to consider prior to a landlord taking steps to enforce a personal guarantee, and advice should always be sought from a solicitor prior to doing so.   Equally, if a guarantor receives notice of enforcement action being taken by a landlord, it’s important that that guarantor seeks legal advice promptly.

What are alternatives to personal guarantees?

1. Rent deposit: Offering a larger rent deposit can provide landlords with security while avoiding the need for a personal guarantee.  Much will depend on whether or not the business has the cash available to pay a rent deposit up front.  Deposits are usually between three- and six-months’ rent, plus an amount equivalent to the VAT payable on that sum.
2. Bank guarantee: A bank guarantee involves the bank promising to cover the tenant's lease obligations if the tenant defaults.  This option may require collateral and comes with associated fees.
3. Corporate guarantee: If the business is part of a larger group, offering a corporate guarantee (for example, from a financially stable parent company) can be an alternative to a personal guarantee.

Conclusion

Deciding whether to personally guarantee a commercial lease requires careful consideration of the potential benefits and risks. While offering a personal guarantee can facilitate access to desirable properties and strengthen lease negotiations, it also involves significant personal financial risk. It's essential to weigh these factors and explore alternative options before making a decision.

Depending on the negotiating position of the parties, it may be possible for a guarantor to cap the amount guaranteed.  Alternatively, they may be able to negotiate “early release” provisions into the guarantee, so that they are released from their obligations after a particular time period has elapsed.

For businesses, it's advisable to seek legal and financial advice to fully understand the implications of providing a personal guarantee and to explore all available options.