Landlords of commercial, industrial and retail premises will usually require some form of security from a Tenant, in order to protect themselves where a Tenant defaults under the lease.
Whilst the Landlord may not necessarily contemplate the worth of the Tenant’s security, as the presumption is that the Tenant is entering into the lease with the intention of honouring its commitments, it is important to make sure that the Landlord’s interests are protected.
Below is a summary of the types of security that a Landlord may typically request, and in Part 2, we summarise some common things to look out for when accepting a bank guarantee.
A bank guarantee is a formal assurance by the bank that a sum of money will be paid to the vendor if the tenant (you) do not fulfil the specified obligations under the commercial leasing agreement.
When it comes to commercial leasing guarantees, landlords generally favour a bank guarantee. This is because it is a third party undertaking from an entity of substance, and the bank is required to honour any drawdown request without first checking with the Tenant.
Additionally, bank guarantees survive the Tenant’s insolvency, so there is limited risk to a Landlord that any drawdown of a bank guarantee will be clawed-back as a “preference payment” in an insolvency situation.
The downside to the Tenant is that a bank guarantee generally requires a cash deposit or other minimum-balance facility with the bank, which ties up funds and generally costs the Tenant a premium to maintain. Other forms of third-party security, such as insurance bonds and deposit bonds, are becoming more common these days, but Tenants should first check with their Landlord whether these are acceptable (because the lease document will usually mandate a bank guarantee issued by an Australian trading bank).
Tenants should also check whether their bank guarantee provider has a policy on expiry dates. Many banks these days require the bank guarantee to have an expiry date. Again, this is often resisted by Landlords or prohibited under the lease document.
Landlords of retail premises should note the recent changes to the Retail Leases Act which require them to return a bank guarantee to the Tenant within 2 months of the Tenant completing performance of its obligations under the lease.
A cash deposit is an amount of cash that is held as a deposit in a bank account that is shared between the vendor and the tenant.
Cash deposits are not particularly popular with Landlords.
Aside from the administration required for the Landlord (or managing agent) to open and administer an account, the funds are actually held jointly on behalf of the Landlord and the Tenant. This means that in the event of the Tenant’s insolvency, an Administrator / Receiver / Liquidator may try to claim the funds back, even if the Landlord properly drew on the cash deposit (for lease breaches) prior to the Tenant becoming insolvent. Any pre- or post-insolvency payments out of cash security can be called into question as a preference payment, being a situation where the Landlord’s debt is being satisfied (at least to an extent) in preference to other creditors.
In a retail context, a cash deposit will need to be lodged with the NSW Small Business Commissioner (and note the specific time frame set down in the Retail Leases Act – this must be done within 20 days). In order to make a claim on a cash deposit lodged with the NSW Small Business Commissioner, the Landlord will need to have the Tenant sign the claim form. This may not always be possible if the Tenant is in dispute with the Landlord, or if the Tenant is insolvent.
A personal guarantee is exactly that, a personal guarantee from directors and/or shareholders that stipulates that the obligations of the lease will be fulfilled by the incoming tenant. In the event of default, personal guarantees require the guarantors to pay back the defaulted amount.
Landlords will sometimes require the directors and/or shareholders of a Tenant to personally guarantee the lease obligations of the Tenant. Whilst many Landlords view this as an added assurance of performance of those obligations, because the guarantor is personally committed (and potentially faces bankruptcy if they cannot honour the guarantee), Landlords need to realise that:
In contrast to a personal guarantee, a parent company guarantee may occur where the Tenant entity is a subsidiary of a parent or holding company (or a franchisee of a successful franchise business). Here, a Landlord may feel more comfortable requiring a guarantee from the (higher) entity of substance.
It is possible and, in some cases, this may be preferable to a personal guarantee. However, again, Landlords need to remember:
The overwhelming preference for Landlords is security by way of a bank guarantee. However, Landlords and property managers who accept bank guarantees on behalf of Tenants need to be particularly careful when checking the terms of that document.
The bank guarantee is often handed over as a final step, potentially after a lengthy lease negotiation process. It can often be seen as a formality, but failure to properly check the terms can pose a significant problem.
Here are some helpful tips and some examples of common issues:
Remember, the reason you are holding a bank guarantee is that it is as good as cash, so you should treat it that way. Make sure that it satisfies your requirements and, once you have it, keep it secure.
Never send a bank guarantee by regular untrackable post. If it is lost, the paperwork process (including multiple statutory declarations) to have it cancelled and re-issued is a nightmare. Or even more concerning, if it falls into the wrong hands, a fraudulent claim on the bank guarantee can have significant implications for the Landlord who lost it, and potential ramifications for the banking covenant of the Tenant.
Rob Jarvin is a property expert practising at Kardos Scanlan Corporate Lawyers, acting on acquisitions, disposals and real estate projects in all sectors (including commercial and residential). Rob also has extensive experience with commercial leasing matters, acting for both commercial landlords and tenants. This includes complex development leasing and asset/portfolio leasing for commercial office buildings, industrial development sites and retail shopping centres.