How To Avoid or Limit Them - Part Two
By Stuart A. Heller
Last month, In Part One on this subject we looked at three ways to avoid or limit personal liability when a landlord asks a tenant for personal guaranties of the tenant’s compliance with a proposed lease. Those approaches involved trying to negotiate provisions that (i) eliminate the personal guaranty requirement based on your company’s financial strength and experience, (ii) limit the period of the guaranty to less than the term of the lease, or (iii) limit the dollar amount of the guaranty to some mutually acceptable amount. Those approaches may fail and you may be forced to sign a personal guaranty if at the time you enter into the lease your company does not have a history of financial strength or foodservice experience satisfactory to the landlord. What can you do then particularly when your company is some form of limited liability business entity such as a corporation or limited liability company? You might try offering to substitute a letter of credit for the guaranty, or if your company does not then satisfy your bank’s criteria for issuing one proposing to include a provision that gives you the right to do so later.
A letter of credit is a document issued by a financial institution, usually your company’s bank, that acts as an irrevocable guaranty of payment up to a preset amount to a beneficiary which in this case would be your landlord, when some preset criteria are satisfied. For example if the criterion is your failure to make a required payment, the letter will provide that your landlord is free to present it to the issuing bank along with a signed statement of how much you owe. The bank is then obligated to immediately pay that amount to the landlord. As far as your landlord is concerned the letter of credit makes your bank the guarantor of your company’s compliance with the lease. This is very attractive to most landlords.
If you have the right to replace your personal guaranty with a letter of credit then you have a mechanism for shifting your personal liability to your company. This will only be possible when your company has achieved sufficient financial strength for your bank to be willing to issue the letter of credit because your bank will want some assurance that if it has to make any payments under the letter of credit your company will be in position to adequately reimburse it. By allowing you to substitute such a letter of credit for your personal guaranty the landlord will not be giving up anything, and in fact will probably have a stronger guarantor than you. The advantage to you is that if your company subsequently builds sufficient financial strength you have a chance to terminate your personal guaranty and no longer have your personal property at risk. An added advantage is that you would no longer have to list the guaranty as a potential liability on your personal financial statement.
Banks usually charge an annual fee for issuing letters of credit and sometimes an application fee as well. However you need not be concerned about these fees until you are ready to consider obtaining the letter of credit. At that time you can decide whether the fee to be paid by your company is worth the relief you will get when you terminate your personal liability.
Coming Next: What is a subordination clause, why is one usually found in a commercial lease, and should it concern you?
With over 35 years experience Stu Heller helps his clients achieve their business objectives, stay out of trouble, and have more time to focus on their strengths. He can be reached at 206-623-0579, fax 206-682-7972, heller@theleasinglawyer.com and hellerlaw@aol.com. His office is at 1325 4th Avenue, Suite 940, Seattle, Washington 98101, and website http://www.theleasinglawyer.com/. Be sure to consult your lawyer before applying any of the above to a particular situation. © 2007 Stuart A. Heller
