Commercial landlords have an inherent fear that tenants will fail to pay their rent. If a tenant does not pay, the landlord knows that the only path to financial recovery or eviction is usually a lengthy court proceeding. That means hiring lawyers and paying legal bills, all while losing potential rental income. To avoid this fate, landlords will sometimes ask for personal guarantees from the owners and/or officers of potential commercial tenants as a condition of giving them a lease.
What are personal guarantees, and should you sign one?
A personal guarantee is a legal document that means exactly what you would expect: an individual promise that, if your business is unable to pay its obligations, you will have ultimate responsibility. For example, imagine that your company’s rent for its commercial office space is $6,500 per month for a one-year lease. If your business cannot afford the last two months of rent for any reason, for example, due to a disappointing sales quarter or higher-than-expected overhead costs, your landlord could sue you personally for $13,000. The judgment would not be entered against the company, but against you, and the debt would be paid from your own bank accounts.
Personal guarantees circumvent the legal rule that, in most business structures, the owners and officers are not personally responsible for the debts of the business. For example, the members of limited liability companies (LLCs) and the directors, and shareholders, of corporations are usually immune from personal liability. The same goes for the executives of companies, who are typically mere employees. The CEO or president might have been the person to agree to a bad lease but is usually not personally on the hook if the company cannot afford to pay it. Similarly, if an LLC is sued, the members’ personal assets are not usually on the line to pay a potential judgment; the LLC itself must pay out of its cash reserves or other assets.
A personal guarantee is a contractual legal device that gets around these rules by having someone promise to cover the debts and obligations of the business. It is ordinarily a separate document from the lease, containing the notarized signature of the guarantor. From the landlord’s perspective, this creates another potential pocket of recovery money. If the business cannot pay the rent owed, the landlord can go after the individual guarantor.
Alternatives to Personal Guarantees
As a commercial tenant, it is likely in your interest to avoid signing personal guarantees on your business’s leases. No matter how confident you are in your business’ prospects, market conditions can be uncertain, or the economy can be unpredictable. Avoid risking your personal assets, such as savings accounts and property, simply to convince a landlord of your company’s solvency. Many commercial landlords require personal guarantees as a matter of course. This is often the case in large urban buildings managed by real estate firms. Smaller property owners might be more willing to negotiate the issue with potential tenants, particularly if the rental market is weak and they would like to fill their space quickly. Even large landlords might be willing to negotiate if tenants are able to allay their fears of default. If your potential landlord wants assurance of your business’s ability to pay, a client may wish to consider other options that are less risky. For example, you could agree to provide financial statements or proof of accounts receivable, to show that your business will be able to cover the rent costs. Another option is to offer to pay the first and last month of rent up front, together with the full security deposit. This would provide the landlord with a good deal of comfort without risking your personal assets.