Mackenzie Elvin

Landlords, Survive the Credit Crunch

One of our clients owns a small commercial building which he had leased to a small business. The tenants vacated the premises before the term expired without paying the required rental and the guarantor was insolvent. Our client wanted to know if there was any way he could recover the rent and better protect himself with future tenants.

Before entering into a lease it is crucial to investigate the tenant’s credit worthiness and if there is a guarantee these type of investigations should extend to the guarantor. This includes credit checks, references where necessary, statements of financial position and an employer verification to ensure the landlord has an accurate picture of the tenants and guarantors ability to meet the obligations under the lease.

The lease should provide that the rent is paid a month in advance and should be followed up as soon as payment is missed so that the tenant is not allowed to get more than a month behind.

There are ways to secure payment ‘up front’ such as rent deposits, bank guarantees and rental bonds. Most tenants will not be willing or able pay a large sum of money, especially where it means tying up comparatively large amounts of capital.

Banks guarantees are sometimes used in commercial leasing arrangements. On default by the tenant the bank will pay the landlord the rental and outgoings to the extent provided for in the lease. Bank guarantees are usually for a limited time and a limited amount. Some tenants may not be able to obtain this type of guarantee from their bank, or it may be too costly for them.

The most common form of security for a landlord where the tenant is not an individual (or is an individual with little business experience or few assets) is to obtain a personal guarantee of the tenant’s obligations. A guarantee creates a liability for the guarantor which enables the landlord to make demand on the guarantor if the tenant breaches the lease. It is important to note that a guarantor will not be bound by an Agreement to Lease in which the guarantor is named but has not signed. It is equally important to note that a guarantee may be invalidated where there is a material change to the terms of the lease without the consent of the guarantor. A guarantor will however be bound by an Assignment of Lease by the tenant even when the guarantor is not notified of the assignment and it is not usual for the guarantor’s liability to extend into the holding over period where the tenant remains in possession on the expiry of the term.

Where there is a breach of the lease such as non payment of rental it may be preferable to keep the lease on foot and only take action to cancel the lease when another tenant can be found. If the lease is cancelled, rights of action for rental to the end of the term can be lost and guarantors released from their obligations.

Landlords have no obligation to mitigate their losses in such circumstances (as opposed to the situation following cancellation) although the situation is generally a practical one not a legal one, as a landlord would most likely want to take a chance on a new tenant and pin their hopes of recovery from a guarantor at some time in the future rather than have an empty building.

A claim can be brought by the landlord in debt for money owed and default interest (if payable) under the lease against the current tenant, the current tenants guarantors and potentially all previous tenants and guarantors. What might happen though is that the landlord might encourage an insolvent tenant to find an assignee or subtenant. The landlord may find a new tenant for the premises and negotiate a settlement agreement with the old tenant where the old tenant agrees to vacate the premises on agreed terms.

There is unfortunately no happy ending for our client. He had entered into an Agreement to Lease with the tenant before seeking our advice or undertaking any checks on the tenant. Although the guarantor had not signed the Agreement to Lease, he did, eventually sign the Deed of Lease but on investigation he had no assets in his own name and the only avenue left open was for our landlord client to bankrupt him. That was small comfort and not something our client wanted to pursue.The building has now been re-let to someone at a lower rental after advice from us and proper checking on the tenant.