Please Note: This Article is 6 years old. This increases the likelihood that some or all of it's content is now outdated.

The ideal for any landlord is for the tenant to have a guarantor and provide a rent deposit. But which is better when the landlord has to choose?

The starting point is the status of the tenant. With a tenant that is one person (an individual) the likelihood of that person being of independent financial means would be unusual, even though independent means is a prerequisite because performance of the tenant’s covenants, payment of rent, insurance, service charge, and so on, is due regardless of the profitability of the business for which the tenant uses the premises. That most tenants could only afford to meet obligations out of their business cash-flow means the landlord is continually at risk for the duration of the tenancy.

Insecurity stemming from that situation (payment dependent upon cash-flow) might not be reflected in the price of the investment. Valuation surveyors assume tenant compliance with the terms and conditions of the tenancy regardless. To avoid surveyor-theory and minimise insecurity is one reason why properties let to tenants of undoubted financial standing command higher prices (lower yields); the other reason is that high calibre tenants tend to prefer quality buildings and primary locations. It is also why it is prudent for buyers to be wary of overpaying where a seller has an inflated opinion of the value of the proposition through expecting the yield (selling price) to be on a par with better quality propositions.

Where the tenant is more than one person, the persons concerned would have joint and several responsibility. Each individual is personally liable to the landlord regardless of the tenant’s business partnership. Whether each person would be personally liable within the partnership itself would depend upon the agreement between the persons concerned.

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A tenant that is a partnership (two or more persons) might seem a better proposition, but in practice is not necessarily any better than one person alone. It is not only whether all persons are actively involved in the tenant’s business but also whether all persons are of equal financial standing.

It is prudent to carry out due-diligence before granting a tenancy or consenting to an assignment, but as soon as the person(s) becomes the tenant the landlord”s risk increases. It is generally assumed a tenant is honourable, decent and law-abiding, but intangibles are about trust. The terms and conditions of a business tenancy are thought to be legally-enforceable so the landlord has some comfort there. But outside the scope of the tenancy, whether of equal or unequal financial standing, whether the tenant is one or more persons, whether the tenant is of independent financial means or reliant upon the business cash-flow, arguably the second most important factor for the success of the investment (apart from location) is the one thing over which the landlord has no control and that is how the tenant arranges is own financial affairs.

The two devices commonly used for protecting the landlord’s investment are 1) the guarantor or surety and 2) a rent deposit.

The distinction between guarantor and surety is subtle and does not depend upon what the document calls the entity. It depends upon the exact terms of the agreement. Both entities are similar in that they promise to pay the debt of another, but a surety is primarily and directly liable for the debt, whereas a guarantor becomes liable only after the tenant defaults.

From now on, I shall use the terminology ‘guarantor’ loosely. A guarantor may be another person or persons, or a corporate body. Sometimes, the guarantor’s responsibility is limited by agreement, but often a guarantor’s responsibility for performance of the tenant’s covenants is open-ended, including payment of rent(s) and performance of the other covenants and conditions of the lease.  A tenant with a guarantor might seem more promising for the landlord but the arrangement suffers from the same lack of control over how the guarantor arranges its own financial affairs.

Lack of control is also found with the Authorised Guarantee Agreement, as entered into by the previous tenant on assignment of the tenancy. For the landlord to have someone to call upon in the event of tenant- default rests entirely upon that someone having sufficient liquidity and net worth to fulfil the obligation. Where the tenant is a ‘man of straw’ with not much of a guarantor, the landlord pursuing a person or persons that obviously cannot afford to meet their obligations is pointless. A landlord could issue bankruptcy proceedings but to what end? The cost of pursuing has to be weighed against the likely outcome.

Unlike the guarantor with whom delay may be experienced, the advantage to a landlord of a rent deposit is immediacy: the money is readily available. Even so, the amount of deposit together with the circumstances for withdrawal are only likely to solve the problem of tenant- default when the market is favourable to the landlord. The thinking behind, for example, 3 or 6 months rent deposit is that that period of time would be enough to cover the tenant’s (temporary) difficulties or in the event of termination procure a new tenant. A landlord is under no duty to mitigate his loss when seeking to recover arrears of rent, but likely will want to. Whether a few months is realistic would depend upon the tenant’s co-operation and/or the state of the market at the time. Any worst scenario is not something to which the tenant to whom the rent deposit belongs until default would be willing to contemplate. Hence, there is a limit to how much money a landlord can reasonably expect a tenant to part with for the duration of the deposit. From the tenant’s perspective, a rent deposit is dead money. All the more so when the tenant’s resources are tight and every penny is needed to get the business up and running. The conflict of interest between the tenant’s assumption that rent would be payable by the business and the landlord’s assumption the tenant has the financial wherewithal regardless is only likely to emerge when the tenant is in difficulty. Otherwise, where the tenant gets the money to fulfil its obligations is of no concern to the landlord.

The position is more complicated for a landlord when the tenant is a corporate entity, a company. The company/corporation must be registered in a jurisdiction where a court order would be enforceable for purpose of the tenancy. With small business tenants that are incorporated, it is common for the directors and shareholder of the company to regard the tenant-company as an alter ego. The director(s) and shareholder(s) do not need to be the same person(s) but frequently are. Amongst the advantages of an incorporated business is to avoid personal liability during the course of business activities, but which is not avoided when the landlord requires at least one director to act as guarantor to the tenant.

Where the tenant-company is regarded as an alter ego, it is also common for the director/shareholders when offering themselves as guarantor(s) to perceive the role of guarantor as a mere formality. It is not. It is advisable for a landlord to investigate the guarantor’s assets and the authenticity of the information and facts provided. Anyone can present themselves in a positive light, it is the negatives that one wants to uncover, so as to form a balanced conclusion.  The guarantor might be in hock to a bank. The guarantor’s responsibility is the same whether or not the tenant is incorporated. The guarantor’s net asset value and financial wherewithal needs to be at least as substantial as the lease conveys. The lease may entitle the landlord to refuse consent to the assignment if in the landlord’s reasonable opinion the assignee is not a person who is likely to be able to comply with the tenant covenants of the lease and to continue to be able to comply with them following the assignment; but whether that criterion applies to the proposed guarantor is questionable.  It is advisable therefore for the criteria on assignment to include any guarantors.

The deed of rent deposit needs to be carefully drafted to ensure that in the event the tenant becomes insolvent the administrator or liquidator is not entitled to treat the deposit as an asset of the tenant’s business. Where the deposit would be regarded an asset of the tenant-in-administration, the landlord’s rent ‘cushion’ would be lost.

A well-drafted rent deposit deed will require the amount of deposit to topped up following any increase in rent but in practice often the requirement is overlooked. In any event, the tenant might not have the extra money if the increase is substantial. The duration of the deposit may be for a set time or for the remainder of the term, and be refundable either on termination of the lease or future assignment whichever the sooner. A carefully worded deed would carry the deposit forward on renewal of the lease. Where the deed provides for interest to accrue to the principal,  it is not usually necessary for the landlord to obtain the most competitive rate of interest. The deed could also provide for the tenant to be able to withdraw the interest not more than once a year on written notice to the landlord.  The deposit can be held by the landlord or the landlord’s solicitors and for best practice in a separate account to the landlord’s personal money. Where a deposit has been obtained and the landlord intends to sell the investment, it is advisable for the deposit to be held by the seller’s solicitors to be transferred to the buyer on completion, or for the tenant to inform the new landlord of the existence of the deposit and the need for transfer. Ensuring the matter is dealt with at the time avoids problems in future.

In my experience, it is not unusual for rent deposits to be forgotten about in the mists of time. It is also not unusual for landlord, tenants, and managing agents to mislay the documentation and for disputes to arise when the tenant claims return of the money. In one case I dealt with on behalf of the tenant, the landlord’s interest had changed hands four times during the life of the deposit deed and on each occasion neither seller nor buyer had any record of the deposit’s existence. Fortunately the parties were honourable and it only took a few weeks extra to trace the whereabouts of the money which was then returned in accordance with the deed. Keeping the documentation is important: the tenant’s recollection of how long the deposit should be held could differ from the facts. Where the landlord has discretion as to the timing of the return of the deposit, one point to bear in mind is whether the tenant has confidence in the future for his business. In a matter I’m dealing with at present where I’m acting for the landlord, the tenant says his business is struggling so could he have his deposit back but as I have told him if it’s such a struggle then surely the landlord would be well-advised to hang onto the deposit.

The object of a rent deposit is to give the landlord something monetarily tangible to call upon in the event of tenant-default. Where the tenant is in administration, the landlord is not at liberty to take back the lease unless the lease is disclaimed by the administrator or by order of the court. Since the administrator’s task is to safeguard and dispose of the tenant-company’s assets for the benefit of creditors, the court is unlikely to side with the landlord until the administrator concedes defeat. So, where there is enough money in the kitty for the administrator to pay the rent during the period of the administration, the landlord cannot assume that the lease would be disclaimed.

With larger companies, how the tenant organises its financial affairs is likely to be more sophisticated. Apart from the strong possibility of no guarantors, the landlord cannot assume that the legal tenant would after the lease is completed continue to be the same company that operates the business at the premises. Private investors are notoriously lax in keeping tabs on the activities of corporate tenants and the first time that the landlord discovers that its ‘well-known’ tenant is not  the company the landlord thought he had may not arise until long after the change has occurred. Unless specified in the lease, it is not necessary for a corporate tenant to inform the landlord of a change of ownership of the company: the only notification necessary is a change of name of the company.

Here’s an example, based on a real-life experience, of how a landlord can find himself with a different tenant to whom the landlord thought the property was let. At the grant of the lease, the property is let to ‘X’ Ltd, a well-known retailer trading as X; the landlord is delighted to have secured such a good tenant.  X opens some more branches, the landlord is onto a winner, the investment value is enhanced. After a while, and unbeknown to the landlord, X Ltd is sold to Y Ltd. Y runs X as a separate company. Y wants  X’s trading name but doesn’t want all of X’s existing branches so Y assigns the leases of X’s premises that it wants to keep to Z Ltd, another of Y’s companies. Having stripped out the other assets, Y changes the name of X Ltd to W Ltd and changes Z Ltd’s name to X’s previous name.  Z Ltd trading as X embarks upon an expansion trail and becomes very successful. The upshot of Y’s restructuring is that the landlord’s tenant is now W Ltd, a company of no repute and whose only asset is the lease of the landlord’s property.  To make matters worse, W Ltd is now a dormant company. The landlord’s investment value has plummeted.  W Ltd applies for licence to assign the tenancy to a newly-formed company nothing whatsoever to do with Y or Z for which obtaining the landlord’s consent might be thought an insurmountable hurdle were it not for the criteria in the lease specifying that the proposed assignee must be of at least the same financial standing as the tenant at the date of the application to assign: hence, any company whose status is classified as trading, not dormant, is an acceptable candidate.

Another example of corporate restructuring is the CVA (Company Voluntary Arrangement) where in an attempt to ensure the survival of the business, the tenant instructs an insolvency practitioner either to arrange a pre-pack administration, whereby the profitable parts of the business are immediately sold to a new company often involving the same directors, the unprofitable parts then dumped, or for all landlords to agree to a rent reduction, failing which (so the landlords are told) the company would be put into administration and the likelihood of the landlords getting any rent remote.  Landlords with substantial portfolios can afford to take a hit now and then which is why they tend to go along with the proposals, but for smaller landlords for whom the property is the one investment a hefty reduction in rent can cause problems, particularly if the investment is mortgaged and a revaluation breaches the loan-to-value covenant.

CVA works successfully where the tenant does not have a guarantor. That landlords are willing to be exposed to the risk of corporate failure without take precautions fascinates me. I find it ironic that where the tenant is a small business, landlords invariably want a guarantor and/or a rent deposit, but with large companies where the rent is often considerable landlords are content to rely upon the strength of covenant. The difference in attitude is probably to do with the feeling of being in control: with a local trader, the landlord is likely to have the upper hand, with a large company the landlord’s wishes are undermined by reason of  ‘if you want us as tenant then that’s how we do things’.

A standard clause in leases is for landlord to reasonably require a limited company assignee to provide at least two guarantors who shall be directors of the company. With small companies there is rarely any difficulty to get agreement but try insisting upon personal guarantors when the proposed assignment is to a large company and chances are adamant resistance will be encountered. In 1985, acting for a landlord, I let a shop for 25 years to a quoted plc.  In 1990, I objected to an assignment of the lease between the plc and its subsidiary unless the plc acted as guarantor.  The tenant’s solicitors, threatening to issue proceedings for unreasonable refusal, were emphatic the landlord could rely on privity of contract in the event of default. My client conceded, but I was right to be concerned. In 2013, the lease was renewed and instead of the plc being the long-stop or even the trading company my client now only has the company that takes on the leases.

The ideal arrangement is a guarantor and a rent deposit. Faced with a choice it is probably better to opt for a deposit for a small business.

Please Note: This Article is 6 years old. This increases the likelihood that some or all of it's content is now outdated.
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