Question: I am starting a real estate company with two other partners. We are leasing office space. The landlord has requested personal guarantees from each of the three partners. Is there a way for me to guarantee one-third of the obligations under the lease, without being personally liable for the entire obligation?
Response: A softer rental market has given tenants an opportunity to negotiate more favorable lease terms in general. Among other things, this creates an opportunity for tenants to attempt to negotiate limited guarantees, rather than unlimited guarantees, of lease obligations. Limited guarantees can be critically important in both a commercial and residential context. The concepts discussed below are equally useful for an entrepreneur guaranteeing the obligations of his company, or a parent who is asked to guaranty the lease obligations of his child.
Types of Limited Guarantees
Capping the Amount Owed. One of the ways of limiting the guaranty is to cap the amount owed on the guarantee. It is simplest to express the cap as a specific dollar amount. Alternatively, the cap could be set based upon a certain number of months of rent. For example, on the premise that should the tenant breach the lease, the landlord should be able to find a replacement tenant in no more that five months, the lease could set a liability cap of five months of rent (base monthly rent plus common area maintenance).
Avoiding Joint and Several Liability. You may operate your business with two other partners. Your child may share the rented condo with two other co-tenants. You may be willing to be responsible for one-third of the lease, but most boilerplate lease guarantees impose joint and several liability on the tenants and the guarantors. This means that the landlord has the right to collect all of its damages from any one guarantor. Then the guarantor who gets stuck with the bill has the burden of seeking contributions from his fellow guarantors. Independent of whether you are able to cap the gross amount owed on the guarantee (see preceding paragraph), consider the option of limiting your guarantee to only your pro rata percentage of the lease. For example, the guarantors in this paragraph might try to hold out for a guarantee of no more than one-third of the obligations of the lease
The landlord may counter with a compromise making each of the guarantors liable for 150% of such guarantor’s pro rata share. In the example above, this would make each guarantor liable for roughly 48% of the lease obligations (150% X 33%), a substantial reduction from joint and several liability.
Limiting Liability to Rent. Leases create liability for more than rent. For example, leases can create liability for slip-and-fall injury to other tenants or third persons. Leases also create liability for failure to maintain the leased premises and for damage or destruction to the leased premises. The amounts of these liabilities can be extraordinary. Guarantors should strive to limit the guarantee merely to the obligation to pay base monthly rent, and not the other liabilities under the lease. If the landlord has enough clout to hold out for a broader guarantee, the guarantee could be limited to the only the specific liabilities included in the guarantee.
Insurance. Without specific endorsements, it is very unlikely that a guarantor’s insurance will cover the guarantor’s indemnity obligations. Until proven otherwise, guarantor’s should assume that their various liability polices contain exclusions from coverage for liabilities contractually incurred by the insured.
The concept of limited guarantees applies not only in a leasing context, but in all other situations in which B guarantees the debt of A. Most notably, these concepts apply in loan transactions. Any time an individual is asked to give a personal guarantee, that individual should think out the various options for providing limited guarantees.
The above concepts can be mixed and matched with each other. For example, the guarantee might limit each guarantor’s liability to no more than one-third of the rent. Perhaps the lease would make each guarantor jointly and severally liable for all of the rent, but limit each guarantor’s liability to one-third of the other liabilities, and in any event, each guarantor’s liability could be capped at $5,000. The nature of guarantees is only limited by the creativity of the parties seeking to strike a deal.
A version of this article appeared in the Colorado REALTOR® News, the monthly publication of the Colorado Association of REALTORS®.