What is a guarantee and when is it used?
A guarantee is a legal promise made by a third party that the tenant will comply with the obligations in the lease. If the tenant fails to meet their obligations, the guarantor will be liable to fulfil those obligations. For example, the guarantor will be liable to pay the rent if the tenant becomes insolvent.
In commercial leases, where a company will be the tenant of the lease, often a director will be the guarantor for the lease. The director will be putting their personal assets at risk if the company cannot pay the rent, or comply with the other obligations within the lease. This may include the director’s home, for example or any other assets that the director may have. As such, commercial guarantees can be extremely onerous. If a director leaves the company, they will still be personally liable for the leases (unless the landlord agrees to a replacement guarantor in their absolute discretion), without control of the company itself. Therefore, it is usually a condition of the guarantee that a director takes legal advice before signing. If more than one director is acting as a guarantor, they act jointly and severally. This means that if the lease obligations are not met, the landlord may pursue all of the guarantors or just one for full performance of the lease.
It is also common practice for a guarantee to be used when assigning a lease to a third party. The outgoing tenant may be liable if the incoming tenant fails to comply with their obligations in the lease. This is known as an authorised guarantee agreement. This may be required if the lease outlines it is required on assignment. If the outgoing tenant is winding up its business, this may bring up issues as there is a residual liability for the company.
Even when it is a director of a company who is acting as guarantor it will usually be considered a conflict of interest for the same firm of solicitors who are acting for the company to also act in advising the guarantor. Guarantors should always seek their own independent legal advice before proceeding with a guarantee, however this often does not happen as this is likely to be at additional cost to the guarantor.
A rent deposit as an alternative to a guarantee
A rent deposit can sometimes be used as an alternative to a guarantee, although in other circumstances the landlord may require both a rent deposit and a guarantor. The terms surrounding the rent deposit are usually recorded in a Rent Deposit Deed. This is a document outlining the terms of the retention of advanced funds. This means that the landlord may hold the deposit funds from the tenant, as security in the case that the tenant breaches its obligation to pay rent or perform the other requirements under the lease (such as keeping the property in a good state of repair and condition). The level of the rent deposit will be decided by the landlord although can be negotiated by the tenant. The landlord may keep these funds in a separate account, on trust for the tenant, and this will create a fixed equitable interest for the landlord. It may also be held as a charge in favour of the landlord or held by a third party. The landlord may only withdraw these funds in line with the provisions set out in the Rent Deposit Deed. It is therefore important that the deed is drafted carefully.
If the landlord does withdraw funds from the rent deposit account the tenant will usually be under an obligation to ‘top-up’ the deposit so that it remains at a certain level and can continue to be used by the landlord throughout the term of the lease.
The Rent Deposit Deed may be used if the tenant has no trading history as a new company or has minimal UK assets and weak financial status or where a director’s guarantee may be inadequate security for the landlord. If the lease is assigned, the Rent Deposit Deed may be assigned in accordance with the lease or a new Rent Deposit Deed signed by the assignee. If the tenant becomes insolvent, the rent deposit will be treated as protected, so it may be claimed by the landlord if the rent is unpaid, and it cannot be claimed by a liquidator. The landlord must manage these funds in line with trust terms, such as by not mixing these funds with their own. A third party, such as solicitor or managing agent, may hold the funds, however this has become less common in recent years.
Other forms of security may include a bank guarantee, parent company guarantee or a letter of credit from a bank.
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