When you’re preparing to sign a lease on a commercial property as a business owner, don’t be surprised if the landlord demands that you also sign a personal guarantee for the commercial lease. Signing a personal guarantee for a business contract may appear counterintuitive, since business owners create and maintain corporate structures (such as Limited Liability Companies) to protect individual assets from business liabilities. However, most commercial landlords will not proceed without one in place. This requirement has become more common since the 2008 recession, especially for startup businesses that can’t yet demonstrate a successful business plan and consistent revenue. A guarantee asks that you put your personal finances at risk so that if the business defaults on the lease terms, those personal assets can be tapped in compensation.
As common as personal guarantees are, they should not be taken lightly as just another dotted line to sign. The significant risks are very real – but you can claim a certain amount of control over them by negotiating sensible terms beforehand.
Understanding Your Personal Guarantee
Personal guarantees are often required from small business owners seeking property for an LLC or other corporate structure – a common option for small businesses in Arizona. These structures protect their members from personal financial liability if the business fails. This may spell trouble for the landlord, who cannot collect on an unpaid commercial lease and cannot ordinarily hold anyone at the company personally liable to pay the balance. (The same protection doesn’t exist for a sole proprietorship, in which personal and business liability are considered one and the same under the law.) The fact that most commercial leases can extend (and can also be renewed) for a significant period of time, along with the substantial monthly lease obligations, can expose the parties to potential losses in the tens if not hundreds of thousands of dollars. In addition, finding a business to quickly reoccupy a location after a lease has ended is often a long process. Commercial landlords are wary of taking on this substantial financial risk without additional assurances if the business fails.
By requiring a business owner or representative to sign a personal guarantee, the landlord has a potential financial option of collecting on a delinquent or broken lease. Meanwhile, the business owner gets the desired lease without having to show established business financials. It sounds like a win-win scenario, but there is an obvious dark side to the proceedings – the potential consequences for lease holders who can’t meet their obligations.
The Potential Dangers of Personal Guarantees
If you sign a personal guarantee on a commercial lease that the business ultimately cannot pay, then you are liable for the unpaid balance of that lease. In addition, you may also lose access to the property itself. Under Arizona law, the landlord may have the right to evict you, lock you out of the property, and later put the business property sized within the location up for auction as payment of the delinquent lease. If you and your spouse both signed the personal guarantee, then your community property may be exposed in a financial judgement against your business. If only one spouse signed the lease, then the landlord may be limited to collecting from that spouse’s sole and separate property – which is why both spouses are commonly asked to sign.
Smart Strategies for Reducing Your Risk
The prospect of putting your personal finances on the line for a commercial lease may make you understandably uncomfortable. Fortunately, there are some strategies a business can employ that may reduce aspects of personal risk. It is important to understand the actual terms of the commercial lease and, if necessary, modify them to give you a bit more protection. These strategies may include:
- Limiting the guarantee term – Do you have to guarantee the entire term of the lease? You might be able to secure a guarantee term shorter than the term of the lease itself – for example, negotiating a 3-year personal guarantee for a 5-10 year lease.
- Limiting the post-lease financial obligation – You and your landlord might agree to a limited period of personal financial obligation (say, the first 6 months’ rent after default) if you won’t be able to maintain the entire lease.
- Including an “early break” or surrender clause – You might add a clause that allows you to break your lease early at specific, pre-agreed milestones, assuming that the business has consistently paid on time up that point.
- Allowing for lease assignment or sub-letting – Will your landlord let you assign your lease or sub-let the property if you run into financial challenges? It may be worth your while to get this option added to your lease agreement.
While personal guarantees for commercial leases for non-established businesses have become commonplace, it does not stop the negotiation process of the business or its attorney concerning the nature and extent of any personal guarantee.
© 2018 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
