Just Where Do Good Guys Finish?
Dan Duray Aug. 12, 2010, 11:38 a.m.
The scene: Broker’s office-midtown Manhattan
The dramatis personae: Landlord, Landlord’s Agent, Prospective Tenant (a start-up hedge fund) and its Broker …
The negotiations to this point: All agreed to except for security and guaranty issues.
(We now listen in on the conversation …)
Landlord: “O.K., let’s wrap this up: three months’ cash or LC and, ah, to close the deal of course we’ll need the ‘standard’ ‘Good Guy’ from Joe.”
So those words verbatim are duly added to the term sheet, and now it’s up to the hapless lawyers to figure out just what the parties had in mind. To get to the point here, we focus in this column on exactly who and what is the “standard” “good guy” and, in fact, pose the not inconsequential question: Is there any such thing as “standard Good Guy Guaranty” language in New York leasing practice?
For many years lease security-especially for start-ups, financial companies and law firms (entities with meager hard assets) had two standard components: cash and a general, unlimited guaranty of payment and performance signed by one or more principals of the tenant company or corporate parent. Sure, there were modifications made, especially in deals where there might be a changing cast of principal characters (law firm partnerships, for example), but not many.
Fast-forward to circa 2000, when it became harder to find anyone to sign an unlimited personal guaranty, yet the concerns above were still very real to Landlord, especially in the retail sector. A dependable cash flow was Landlord’s No. 1 priority, so what was desired was a security device designed to protect him or her or it from a scenario where the tenant stopped paying rent yet remained in the premises; or, having run up many months of arrears, vacated, leaving behind substantial work to restore the premises to re-rentable condition. Beyond that, there was also the cost incurred to remove the tenant (lengthy eviction or bankruptcy proceedings), which quickly burned through the typical cash security.
To fill this void, some sage, in typical New York fashion, said let’s make a deal-come up with a compromise that should satisfy Landlord’s concerns about a tenant milking the space and a guarantor’s natural reticence to put hearth and kin on the line.
The answer was a hybrid: something that had the some basic hallmarks of the unlimited guaranty but also featured a practical legal liability exit strategy, which the guarantor (in his capacity as a principal of the tenant) could deploy if the business was headed south. In the event of tenant default in paying its rent, the guarantor (typically a principal of tenant corporation) will step up to the proverbial plate and be a “good guy”-make sure the landlord is paid up to the date the tenant vacates, with the guaranty obligations terminating at that point.
A personal guarantee with a short fuse. Who could object? In fact, the only one who would not agree to this (very reasonable compromise) would by definition be branded a “bad guy,” and no New Yorker wanted to be stuck with that sobriquet.
Thus, the birth of the good-guy guaranty. In its simplest form: A good-guy guaranty is a limited guaranty whereby the guarantor promises to pay the rent (and, as we shall see, often more) for the period from the tenant’s default until the tenant surrenders possession of the premises.
And now, in the words of the late, great Paul Harvey, the rest of the story:
IN SHORT ORDER, the classic recipe of the good-guy guaranty was expanded (and subsequently super-sized) to encompass many more tenant lease obligations. So we escalated from just payment of the basic fixed-rent arrears to typical additional rent items like taxes and operating expenses; then on to performance: open repair and maintenance obligations, and end-of-term stuff like removing installations made by or on behalf of the tenant during the term; and onward to months of advance notice requirements and payment of unwound rent concessions (per lease provisions that in the event of the tenant’s default, the concession given becomes immediately due and payable as additional rent), reimbursement for tenant-improvement work and even some pro rata share of leasing commissions expended in connection with the tenant’s initial occupancy; and yes, the crescendo, millions of dollars in accelerated rent payments as triggered by the tenant’s default.
SHALL I GO on? I think the evolutionary spiral is apparent. Of course, how the guaranty finally ends up is, as always, a function of market needs, tenant-guarantor clout, and just how savvy counsel is about these matters.
Bottom line: If you look at 10 leases with so-called “standard” good-guy guaranties, you are likely to find an equal number of parameters as to the guarantor’s liability and exactly what it takes (notice, money, performance or-typically-some combination thereof) to end it.
O.K., so the good-guy guarantor has paid, and the space has been vacated, and the keys have been turned over to the landlord. End of the rest of the story, right?
No, sir. There’s still the defaulting tenant and its lease obligations and the landlord’s arsenal of remedies in the event of default. THE GOOD GUY GUARANTY IS NOT A CLAUSE IN THE LEASE, RATHER A SEPARATE AND DISTINCT AGREEMENT, and the defaulting tenant receives no direct benefit. What does this mean in the real world? Well, certainly that the security deposit is gone and also that the tenant (for, literally, what it’s worth) remains liable for all its direct and indirect obligations under the lease: performance and payment. This is often misunderstood by clients (and lawyers, too).
SO WE CAN safely say that the good-guy guaranty has a well-earned niche in the pantheon of practical leasing solutions, but ingenious lawyering (and ever more sophisticated leasing techniques) will continue to expand the net; so when asked to sign the landlord’s “standard” form, potential good guys and their counsel should be vigilant in charting out clearly defined boundaries as to exactly what is being guaranteed.
Jeff Margolis is founding principal of the Margolis Law Firm in New York City, where he specializes in “dirt law”-buying, selling and leasing. He will be writing monthly for The Commercial Observer on real estate law.