Commercial Tenant Guarantors – The Pitfalls

For landlords letting commercial property, a solid guarantee is crucial; however, they can cause problems for the unwary. Julien Pritchard explains.

A solid guarantee is crucial to many commercial letting deals.  Landlords who might be reluctant to let to a little-known retailer or a start-up company into occupation of their property may agree if the tenant offers a guarantee from a stronger company or a director.  It is important that Landlords keep those guarantees in place and ensure nothing is done which may invalidate them.  The law holds traps for the unwary.

Julien Pritchard, commercial property solicitor and Partner at Pinney Talfourd highlights two areas where problems with commercial tenant guarantees can arise and explains how to avoid the pitfalls.

Variations and alterations

If your tenant’s compliance with the terms of a lease is guaranteed by a guarantor, care must be taken not to vary the lease without the guarantor’s agreement.  The 19th-century case of Holme v Brunskill makes it clear that if a lease is varied without the guarantor’s consent, they will be released from liability under the guarantee unless it is evident that the variation proposed will have no adverse effect on their interests.

Where the guarantor is willing to agree to a variation they should be asked to confirm this by formally being a party to any deed of variation. 

Unfortunately, a Landlord can unwitting agree to vary a lease informally which also has the effect of releasing any guarantor.  In the case of Topland v Smiths the landlord granted a licence allowing the tenant to alter and extend the premises it occupied even though the lease prohibited alterations.  The landlord intended this to be a one-off permission, but the tenant’s guarantor argued that the licence had varied the lease in a way that might increase the guarantor’s liability and, as it had not consented to the licence, the guarantor had been released from the guarantee.  The court agreed, leaving the landlord without the safety net of the guarantee to secure the tenant’s performance of its obligations under the lease.

Assignments

If a tenant requests consent to assigning a lease, you must check whether there is anything in the lease which requires them, and their guarantor, to guarantee the new tenants compliance with the lease.  The need to check arises because where you have a lease that was entered on or after 1 January 1996, the law states that if a tenant lawfully assigns the lease to a new tenant, the tenant making the assignment will automatically be released from their obligations under the lease, as will their guarantor.  Nearly all leases will contain such a provision.

This can cause problems where the original tenant is a subsidiary of a parent company which acts as the guarantor, and the parent company wants a provision included in the lease which allows the lease to be assigned to a different subsidiary company if this would better suit the parent company.

Example

Parent company owns subsidiary company A and subsidiary company B.  Parent company is very wealthy, companies A and B are not.  Initially, the Landlord agrees to lease property to company A on condition that the parent company acts as guarantor.  The Parent company agrees but wants to cater for the possibility that it might be more tax efficient for another one of its subsidiaries to be the tenant.  This being the case the Landlord agrees to make provision for this in the lease but only if parent company agrees to act as guarantor for any new tenant.

A term in the lease which purports to make the original tenant’s guarantor (the parent company in the example) responsible for ensuring that the new tenant complies with the terms of the lease will not be enforceable and neither will a voluntary offer by the guarantor to do this, made at the time of the assignment.  It is also not possible for the original tenant’s guarantor to agree to take the assignment themselves so that they become the new tenant.

These restrictions can cause difficulties for tenant companies who need the flexibility to reorganise themselves, often on a regular basis.

It is possible for landlords to get around the restrictions to some extent by including a provision in the lease that requires the original tenant to enter into what is known as an ‘authorised guarantee agreement’ in which they agree to guarantee the new tenant’s compliance with the terms of the lease.  The lease may also provide that if the original tenant enters an authorised guarantee agreement, their guarantor will guarantee compliance with the terms of the authorised guarantee. 

Conclusion

Commercial tenant guarantees are a complicated area and one which is constantly changing as a result of decisions being made by the courts.  It is vital to take legal advice at an early stage if you are considering using one.

If you require advice on commercial tenant guarantees or any other commercial property issue, please contact a member of our commercial property team.

This article was written by Julien Pritchard, Partner and Head of the Commercial Property Department at Pinney Talfourd Solicitors. This article is only intended to provide a general summary and does not constitute legal advice. Specific legal advice should be taken on each individual matter. This article is based on the law as of February 2017.