Landlords! Check your Tenant’s Creditworthiness

Credit checks are vital.

One of our clients owns a small commercial building which she had leased to a small business. Her tenants vacated the premises before the term expired without paying the rent, and the guarantor was insolvent.

Our client wanted to know if there was any way she could recover the rent and better protect herself with future tenants. Before entering into a lease it is crucial to investigate the tenant’s credit worthiness.

If there is a guarantee these type of investigations should extend to the guarantor and include:

  • credit checks
  • references
  • statements of financial position
  • employer verification

It’s a good idea to require that rent be paid a month in advance, and to follow up as soon as a payment is missed so the tenant doesn’t fall more than a month behind.

There are a few ways to secure payment ‘up front’ such as rent deposits, bank guarantees and rental bonds. Bank guarantees are sometimes used in commercial leasing arrangements. The Bank will pay the landlord if the tenant misses a payment. Bank guarantees are usually for a limited time and amount.

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. This enables the landlord to make demand on the tenant’s guarantor if the lease is breached.

In order for this to be legally binding two things must happen:

  • The guarantor must sign the Agreement to Lease
  • There must not be any material change to the terms of the lease without the guarantor’s consent.

A guarantor will be bound by an Assignment of Lease by the tenant, even when they’re not notified of the assignment. It’s not usual for the guarantor’s liability to extend into the ‘holding over period’ where the tenant remains in possession once the term of the lease has expired.

Where there is a breach of the lease such as non payment of rental it may be preferable to keep the lease on foot, only cancelling 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 circumstances like these though it’s generally for practical reasons, not legal ones. Landlords usually prefer to take a chance on a new tenant than have an empty building.

A claim can be brought by the landlord for money owed and default interest (if payable) against the current tenant, their 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 sub-tenant. The landlord may then find a new tenant for the premises and negotiate a settlement agreement with the old one where they vacate the premises on agreed terms.

There is unfortunately no happy ending for our client. She had entered into an Agreement to Lease with the tenant before seeking our advice or undertaking any checks on them.

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. 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.

Avoid this sort of scenario with expert advice from one of our commercial team.