If your tenant defaults on the rent or breaches their commercial lease in some other way, you may be able to call on a former tenant or a guarantor to pay arrears or remedy breaches. This will only be possible if you follow the correct process and act promptly.
The law relating to guarantors and former tenants holds a number of traps for commercial landlords, from situations in which you cannot lawfully ask for a guarantee to the danger of accidentally releasing a guarantor by varying the lease. If there are former tenants or guarantors in the background for your investment property, you must make sure you get your solicitor involved – not just when you are looking to recover arrears, but whenever you enter into any sort of licence or variation with your tenant.
‘Unfortunately for landlords, a guarantor is not the equivalent of a blank cheque,’ warns Ian Cowan, solicitor in the commercial property team with Richard Reed Solicitors. ‘It can come as a shock to realise that you may not be able to ask a guarantor to cover everything the tenant owes or, worse, that what you thought was a watertight guarantee has actually been released.’
Types of lease guarantee
There are two ways in which the performance of the current tenant can be guaranteed:
- Direct guarantees
If you have any doubt about the financial strength of a tenant when a lease is being granted or assigned to a new tenant, it is usual to ask for a guarantor to give a direct guarantee that the tenant will pay all sums due and otherwise comply with the covenants in the lease. The guarantee will allow you to claim arrears and costs from the guarantor and may also give you the right to ask the guarantor to become a tenant by taking a new lease of the premises. The guarantor cannot be required to guarantee performance by anyone other than the current tenant.
- Authorised guarantee agreements
An authorised guarantee agreement (often referred to as an AGA) is a specific type of guarantee given by a former tenant when they assign a lease. This can be valuable for landlords, as long as the outgoing tenant is in a stable financial position. An AGA is limited in time because the former tenant is released the next time the lease is lawfully assigned. An AGA may be given only by an assigning tenant and only if you require it as a condition for giving consent to the assignment. An outgoing tenant cannot be required to guarantee performance by anyone other than the immediate assignee.
The rules on lease guarantees and AGAs are set out in the Landlord and Tenant (Covenants) Act 1995. A central part of the 1995 Act is to ensure that tenants and their guarantors are released from liability when they lawfully assign the lease, except where the tenant gives an AGA. The 1995 Act has a very wide anti-avoidance clause which means that anything in a lease, guarantee, AGA or other contract which would frustrate that release is void. This includes a requirement for a direct guarantor to guarantee performance by a future assignee as well as the current tenant. This has led to some high profile court cases and can cause practical problems. For example, if a commercial property is let to a tenant which is part of a group of companies, they may want the freedom to assign the lease to a different group entity for operational reasons. The obvious commercial deal would be for the parent company to act as guarantor each time – but, even if the guarantor is happy to do this, the courts have ruled that the arrangement would be void under the 1995 Act.
More helpfully, the courts have confirmed that it is lawful for a landlord to require a tenant’s direct guarantor to give a fresh guarantee that the tenant will perform its obligations under an AGA if it assigns. The guarantor will be released at the same time as the former tenant, on the next lawful assignment of the lease.
Claiming from guarantors and former tenants
If your tenant is behind with rent, service charges or other payments, you must act promptly if you want to claim from a guarantor or former tenant. You must serve a formal notice on them within six months of the date when the money fell due. As rent and service charges are usually payable quarterly or monthly, new arrears may arise regularly, so you may need to serve multiple notices. You must get your solicitor involved as early as possible to ensure this is done correctly.
A guarantor or former tenant who pays arrears in response to a notice has the right to request a new lease, which will make them your direct tenant. Whether you want to trigger that right is a tactical decision and your solicitor will be able to advise you.
Guarantors and insolvent tenants
A guarantee is generally enforceable only as long as the obligation being guaranteed is still in force. For example, if a lease ends early (by forfeiture or surrender), the tenant’s obligations will end and so will those of any guarantor.
There is an exception where the lease ends as part of a tenant’s insolvency. Although you can no longer enforce against the tenant, you can still claim against a guarantor or former tenant who has given an AGA.
Beware of variations
One of the biggest traps for landlords is accidentally releasing a guarantor by varying the lease without the guarantor’s consent. Not all variations will release a guarantor but it is difficult to be certain, so you should always get a guarantor to join in any deed of variation or licence which alters the tenant’s rights or obligations. It is difficult to get former tenants who have given AGAs to do this, so you may need to accept some risk that they may be released if you agree to vary the lease.
Even where a guarantor or former tenant is not released by a variation, the 1995 Act says that they cannot be required to pay any amount that is due as a result of a variation which the landlord could have refused. That is best explained by an example. If the lease has a rent review mechanism when the guarantor gives the guarantee and the rent increases in line with that mechanism, the guarantee will cover the increased rent. If the landlord and tenant (or an assignee tenant) agree to vary the lease and replace that mechanism with fixed increases, a guarantor or former tenant will not be liable for anything due as a result of that variation. If the tenant fell into arrears, you would then face expensive legal proceedings to establish what, if anything, the guarantor or former tenant could be forced to pay.
How we can help
The law on lease guarantees is complex and there are risks for unwary landlords. Our expert team will make sure your guarantees are properly drafted and guide you through the process of claiming under them if your tenant falls into arrears.
For further information, please contact our commercial property team on 0191 567 0465 or email: [email protected]