• December 29, 2016

Negotiating Security Deposits & Good Guy Guarantees in a Commercial Lease

Negotiating Security Deposits & Good Guy Guarantees in a Commercial Lease

Short & Long Term Risk Mitigation Strategies for Landlords
and How Tenants Can Counteract Those Strategies

 

I. Introduction

A good guy guaranty (“GGG”) in its simplest form is not intended to be a straight personal guarantee. To most, the generally understood meaning is that one or more of the principals of a corporate or limited liability company (a “Guarantor”) will guarantee to the landlord that it pay all base and additional rent payments provided for under the lease up until the day the space is surrendered to the landlord – whether or not prior to the expiration of the lease term. Once the space is given to the landlord broom clean and vacant with all rent paid through the date of surrender, an event that the principals unilaterally control – there will no longer be a personal guarantee.

II. How Much Protection is Enough?

  • Landlords must ask themselves: “How much is enough?”
  • Tenant’s Perspective: Make your mantra “just a little is enough” when it comes to deciding upon:
    • How much security deposit; and
    • how many (or little) steroid laced legal and business points you are willing to agree to in the GGG.

III. Why You Should Include a Good Guy Guarantee in Your Lease

Landlord’s Perspective:

  • When the principals of a tenant hesitate to give a good guy guaranty:
    • It sends a message up front that you intend on being a “bad guy” if things go “south” for your business by not being a “good guy” and paying the landlord its rent while the corporate entity owned and controlled by the principal is occupying a landlord’s space.

Remember:

  • If the tenant doesn’t give some “love” to the landlord in the form of what many may perceive as merely giving the landlord “ice in winter,” it will be difficult for a landlord to give a tenant the “love it seeks” in the form of free rent, a tenant improvement allowance and other concessions then being negotiated.

IV. Factors Which Can Potentially Reduce (or Increase) a Tenant’s Security Deposit

  • The balance sheet and income statement of the prospective tenant;
  • the tenant’s historical track record;
  • the nature of the tenancy (retail, office or industrial);
  • the length of the lease term;
  • the amount money (a.k.a. “skin”) a tenant is putting into the space (and how much of that skin is considered “cosmetic” and how much of it is considered part of the infrastructure (e.g. HVAC, upgraded electric, etc.)); and
  • whether or not there will be a straight personal or good guy guaranty.

Only after a thorough analysis of the foregoing items will a landlord be able to determine just “how much is enough?”

V. The Reality

Example:

On a 10 year/10,000 RSF office lease renting at a $60 PSF with a $60 work letter allowance ($600,000) and 6 months of free rent ($300,000), and with brokers on both sides of the transaction (requiring in many markets a 150% commission to be paid), a landlord within the first 6 to 12 months of lease execution very well will be spending roughly $1.2 million (not including legal, architectural, and building department filing fees).

Given the vast delta between the aforesaid $1.2 million being laid out upfront, how a landlord underwrites its risk will go a long way in determining whether it requires 3, 6, 9 or even 12 months of security deposit.

VI. Sweet 16 Financial and Non-Financial Concerns of Landlords

Top 16 financial and non-financial factors thrown into a landlord’s analytical blender to arrive at the amount of security deposits it will require:

  • Will the tenant’s principal sign a GGG?
  • What is the strength of the tenant’s profit and loss statement and tenant’s balance sheet (and in many cases that of its principals)?
  • What is the tenant’s historical track record?
  • Is it an office or retail space? (Note: there is generally more outlay by a landlord on an office deal)
  • How long is the lease term? (Note: the longer the term, the longer a landlord has to recoup its initial costs)
  • The amount of tenant concessions/allowances (e.g., free rent and tenant improvement allowances)
  • Is tenant a non-profit or trade association? Think more security required given that a CEO of either type of entity cannot sign a GGG (given that such person does not truly “control” the non-profit or trade association).
  • Is tenant a shell entity?
  • Is tenant a foreign entity?
  • How much “skin” does tenant have in the game?
  • Are the payments of the brokerage commission and free rent concessions being spread out or paid at lease execution (in the case of commissions) or granted upfront (in the case of free rent concessions)?
  • Is the security deposit based on the 1st year, last year, or average monthly rent?
  • Does tenant have a “burn baby burn” mindset (by requesting a reduction of its security deposit a few years into the lease term)?
  • Is the security deposit in the form of a letter of credit (“LOC”) or cash? (Note: due to bankruptcy laws, a cash security deposit generally equates to greater landlord risk)
  • Will the tenant agree to deposit additional security as the base rent increases annually?
  • Will the tenant agree to allow landlord to co-mingle the security deposit? (Note: laws differ dramatically jurisdictionally speaking on this point)

VII. The Down & Dirty

The greater the concessions requested, the shorter the lease term to recapture the concessions granted, the less skin a tenant has in the game and the worse the financials and track record of the tenant… the larger the security deposit will be and the greater the dose of “legal and business steroids” a landlord should inject into its GGG.

VIII. Why is a GGG So Important?

It is imperative for a landlord to require a GGG:

  • Helps incentivize a tenant to pay its rent when occupying a space
  • Helps landlords cut its losses and get its space back in an expeditious manner if a tenant becomes non-paying
  • Keeps a tenant “honest”

Note: Generally stated, it is very rare when a GGG or corporate guaranty is required of a nationally or regionally recognized tenant or non-profit or trade association tenant.

An “Old School” GGG:

  • Generally states that while a corporate like entity occupies a space, the tenant’s principal or principals personally guarantee that rent will be paid
  • The guarantor controls its destiny in that it can unilaterally terminate this basic limited GGG by merely:
    • Paying all rent due and owing through the date of surrender of the space; and
    • delivering the space to landlord broom clean & vacant along with the keys to the space.

Tenant’s principals should strongly consider signing a GGG if requested as they are merely:

  • Agreeing to the most basic of covenants that a tenant makes (namely agreeing to pay rent while it occupies a landlord’s space, and as such an argument can be made that the Guarantor is merely giving the landlord “ice in winter”)
  • Incentivizing its landlord to grant a larger amount of concessions (and possibly require a lesser security deposit amount)

IX. The Power of a GGG

Good Guy Guarantees are NEVER Standard:

  • Over the past 20 years or so, landlords and attorneys have injected large doses of legal and business steroids into the once basic GGG – and as a consequence, certain provisions within a GGG are harsher to a guarantor than those found in a straight personal guaranty.

Landlord’s Perspective:

  • Not only do you want a tenant’s principals to be motivated to give back their space if they have gone from being good to bad (rent wise), but you also want to cover as much of your short-term and long-term risks and costs as possible.

X. Top 10 Landmines Injected into the Modern Day GGG (and Tenant Counteractions Thereto)

1) Guaranty of both base rent and additional rent:

  • Given that additional rent is defined broadly, tenant should attempt to limit its definitional scope within the GGG (e.g., for purposes of the GGG only, limit additional rent to real estate tax and sub-metered or rent inclusion electricity only)

2) Guaranty of performance of all non-monetary covenants contained in the lease:

  • Guarantors should attempt to delete this concept

3) Guarantor remaining “on the hook financially” after a lease assignment occurs:

  • As an “exit strategy” on behalf of guarantors, negotiate language that the guarantor is released from a Good Guy Guarantee upon assignment if:
    • The assignee’s principals sign a “replacement GGG”; or
    • The assignee’s net worth is above a certain monetary threshold.
  • If as a landlord you are willing to agree to either of the foregoing, consider adding both a net worth and credit score covenant (e.g., the replacement guarantor must have a (i) net worth equal to or greater than the current guarantor and (ii) credit score of 720 or greater).

4-7) Landlords should consider inserting language that the Good Guy Guarantee termination rights can’t be exercised until:

  • All tenant work has been completed lien free;
  • the 1 year anniversary of the lease commencement date has passed;
  • landlord has been given 90-180 days prior written notice of the surrender date;
  • the premises are returned not only broom clean and vacant but “in the condition otherwise required under the Lease”; and
  • landlord has received a surrender affidavit.
  • Tenants/Guarantors:
    • As to the straight personal guarantee for the first lease year, guarantors should attempt to delete the language;
    • as to the advance notice, 60-90 days is a more palatable time period; and
    • unless the removal and restoration clauses have been negotiated carefully within the lease, tenants should delete the not so innocent “condition required under the Lease” language.

8) Landlords: Insert language that the full amount of security deposit required under the lease must be intact (and given that the landlord will still have “damages” against the tenant as a consequence of the early surrender, have the guarantor affirm that as to such security deposit, the tenant can kiss that baby good-bye)!

9) Insertions of provisions by the landlord for reimbursement of the landlord’s unamortized costs incurred in connection with the lease (e.g., for free rent concessions, improvement allowances, landlord’s work and legal, brokerage, architectural and filing fees):

  • Guarantors should tone down such a request by:
    • Deleting it;
    • limiting the costs to merely commissions and free rent concessions at most; and/or
    • inserting a sunset provision of 24-36 months where the requirement fades away.

10) If there is more than one (1) guarantor:

  • Request that if one of the two guarantors is no longer part of the tenant’s business, as long as the remaining partner agrees and reaffirms its obligations, the departing shareholder or member will be released from the Good Guy Guarantee.

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