Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.
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Commercial Investment Real Estate L EG AL BRIE F S pagadesign/istock l Landlords want to be assured of the economic strength of their tenants; however, determining what is the right amount of security can be diffi cult. In a perfect world, the landlord takes a full guaranty from a creditworthy person, especially if there is any question as to the tenant's ability to pay the rent and meet its other obligations under the lease. However, the creditworthy principals behind the tenant will likely resist a full guaranty. After all, that is part of the rea- son some company principals choose to organize as corporations and limited liability companies. liability should be related to the value of the lease and the landlord's potential loss. T e larger the risk of loss from a tenant default, the higher the dollar cap should be. Obviously, the perceived credit strength of the tenant is a factor, as well as whether it has been in business for several years or is a new company. Negotiating a maximum dol- lar cap amount for a limited guaranty would allow the lease guarantor to limit its poten- tial liability to an acceptable amount, and it would also allow the landlord to mitigate its risk and reduce potential losses. Formula-Based Guaranty Alternatively, a formula can be used to cre- ate a cap that will cover a landlord's fore- seeable losses. This approach may allow more f exibility than a simple f xed cap. T e following categories are commonly used to create a formula to cover certain out-of- pocket expenses incurred by the landlord at the start of any lease: • the amount of the unamortized tenant improvement allowance and • lease brokerage fees. To the sum of those amounts might be added an allowance for preparing the leased space for a new tenant and an allowance for attorney's fees expended to recover the prem- ises. Some part of the rent, both past due and pending, might also be added. T e following is an example of a formula-based guaranty: Guarantor's maximum liability = delinquent rent + six months' rent + unamortized tenant improvement allowance + any allowances for recovering and preparing the leased space Another variation on this approach is to provide that the number of months of rent that is covered reduces over time. If a ten- ant defaults in year one of a 10-year lease, the guarantor will owe one year's rent plus the other guarantied amounts. If no default occurs until year f ve, then six months of rent might be guaranteed. Of course, a formula-based guaranty will focus on the business considerations of the parties and will dif er from lease to lease. A formula approach can be useful since it is Limited Guaranties For most landlords, some security may be better than none. by Tamarah R. Feigl and Megan Rose Altman In these situations, landlords may still be able to satisfy their need for security with a limited guaranty. T e following three limited guaranties are possible options. T ough not an exhaustive list, they should be a good starting point for negotiations with tenants and any potential guarantors, provid- ing landlords with acceptable security for tenant obliga- tions under the lease. Maximum Dollar Cap T e parties may agree to a maximum dollar cap on guarantor's liability. T e liability can be capped at any amount, and something is better than nothing. T e cap of January | February | 2015 18