Commercial leases in New Zealand often include a personal guarantee. While these guarantees are very common, many business owners do not fully understand the risks involved when signing one.
So what does a personal guarantee mean for both landlords and tenants, and why it is important to understand your obligations before entering into a lease.
What It Means for Tenants
If you have set up a company to operate your business, the company will usually be the tenant under a commercial lease rather than you personally. Many business owners assume this protects them from personal liability. However, in most cases, landlords in New Zealand will require the directors or majority shareholders of the company to personally guarantee the lease.
This is because some companies, particularly new businesses, may not have significant assets or financial backing. Landlords therefore want additional security to ensure the rent is paid and other lease obligations are complied with in the event the company is unable to meet its obligations.
The most common way landlords protect themselves is by requiring a guarantee.
For business owners, this creates significant personal risk. Even though the lease is in the company’s name, signing a personal guarantee means you may become personally liable if the business fails. In some situations, a landlord could take legal action against you personally. If you are unable to meet the rent payments, this could potentially result in bankruptcy proceedings or the loss of personal assets, including the family home.
The risks can become even greater where the lease term is lengthy or the monthly rental payments are substantial. Before agreeing to act as a guarantor, it is important to carefully consider whether you could realistically manage your own personal debts and living expenses while also potentially covering the lease obligations if the business encounters financial difficulties.
It is also important to understand that guarantors are usually liable on a “joint and several” basis. This means that where there is more than one guarantor, the landlord may choose to pursue only one guarantor for the full amount owed, rather than pursuing each guarantor equally.
Business owners should also be aware that liability under a guarantee may continue even after selling the business and assigning the lease to a new owner. In many cases, the outgoing guarantor remains liable until the commencement of any new lease term or renewal. For example, if there are still five years remaining on the current lease term, you could potentially remain personally liable for that entire period even after selling the business.
What It Means for Landlords
From a landlord’s perspective, personal guarantees are an important way of reducing the financial risk associated with commercial leases. Where the tenant under the lease is a company, the landlord’s rights are generally limited to pursuing the company itself if the tenant defaults.
This can create significant risk for landlords, particularly where the tenant company has limited assets or financial resources. If the company is unable to pay its debts, or is placed into liquidation, the landlord may have little or no ability to recover unpaid rent, outgoings, or other losses suffered under the lease.
For this reason, many landlords require one or more personal guarantors. A guarantor is usually a director or shareholder of the tenant company. Having a guarantor provides the landlord with an additional avenue for recovery, if the tenant company fails to meet its obligations.
A personal guarantee can therefore significantly improve a landlord’s ability to recover losses arising from a tenant default. Without a guarantee, the landlord’s claim may be limited to an insolvent company with little or no assets.
In some circumstances, the outgoing tenant and guarantor may remain liable until the lease is renewed or a new term commences even after the tenant sells the business and assigns the lease to a new owner. This means that if the new tenant later defaults, the landlord may still be able to pursue the previous tenant and their guarantor for payment.
Landlords should undertake appropriate due diligence to ensure the guarantor is financially reliable and capable of meeting the obligations under the guarantee if required. This may involve reviewing the guarantor’s statement of financial position, considering their business experience, and assessing their overall financial standing.
If a guarantor has limited assets or financial capacity, the guarantee itself may not be worth anything. Careful assessment at the beginning of the lease can therefore help landlords avoid issues in the future.
