Obtaining landlord consent to an assignment or sublease of your lease is a standard requirement for commercial tenancies. While a tenant wishing to exit a lease will generally remain liable for the extent of the term of the lease (even following an assignment), a savvy outgoing tenant will try to improve its position by negotiating a release of its liability in place of new securities from an incoming tenant.
Ben Hickson, Solicitor, Hesketh Henry, examines some of the types of securities which an incoming tenant may offer a landlord to ensure them of its financial stability, potentially giving you as exiting tenant some leverage to reduce or even extinguish your liability altogether.
The ADLS Lease and the requirement not to unreasonably withhold consent
The ADLS Commercial Lease (currently in its Fifth Edition 2008(2) version), is the form predominantly used for commercial leases in New Zealand. Clause 34.1 requires the prior written consent of the landlord to any assignment or sublease, and requires (among other things) the outgoing tenant to prove to the satisfaction of the landlord that the proposed assignee or sublessee is respectable, responsible and has the financial resources to meet the tenant’s commitments under the lease.
While the onus is on the assignor or sublessor entity to prove this to the landlord, the Property Law Act 2007 prohibits the landlord from unreasonably withholding or delaying consent to an assignment or subletting of your lease. Consent is deemed to have been given if it takes too long for the landlord to formally consent.
In the context of an assignment to an unlisted company, clause 34.1(d) allows a landlord to require from the shareholders of the tenant company, a Deed of Guarantee ‘in customary form approved or prepared by the Landlord’. There is therefore some scope for discussion as to the exact form that this guarantee takes. Given the wording of this clause, it is not uncommon for landlords to ‘invite’ an assignee or sublessee to provide a specific type of security when they are conducting their overall assessment of that entity’s financial capabilities.
Types of Securities Commonly Offered by Tenants
The determination of what constitutes an appropriate amount of security is a balancing act often requiring negotiation on both sides. It is subject to trends in the greater property market but also specifics of each case, for example, if an incoming tenant has a proven track record of running a successful business in the particular field for which they seek to use the premises, there will be less security required than a tenant new to the industry. Securities commonly offered are as follows:
1. Personal Guarantees
It is generally expected that those ‘behind’ the corporate tenant (in the company context, usually its directors and/or shareholders) will personally guarantee the contractual obligations of the tenant. This does not necessarily apply to large corporates whose goodwill and size alone may provide the landlord with a sufficient level of comfort to negate any need for personal guarantees. But for small to medium size businesses which make up the majority of the business community, the requirement for personal guarantees is generally not negotiable.
While this undermines a principal benefit of trading under a limited liability company, this is a practical reality and serves to provide the landlord with a level of commitment from the beneficial owners of the tenant. Any assets held in the name of a guarantor will be at risk, should an aggrieved landlord choose to pursue them in the event of default by the tenant. In considering the value of a personal guarantee a landlord may seek information and/or certified accounts on assets and liabilities held in a guarantor’s name, which will substantiate the value of the guarantee.
2. Bank Guarantees
Where personal guarantees cannot be substantiated due to insufficient personal assets, an attractive additional security (or even alternative security, depending on the preference of the landlord) is a bank guarantee. This is a written guarantee from a lessee’s trading bank which honours that tenant’s commitments to a landlord, in the event of the tenant’s default.
Bank Guarantees are less common and are typically fixed to an amount of the annual rental payable. They may not be easy to arrange – a customer will need to have a good history with the trading bank and commonly, significant assets charged with existing securities in favour of the bank – but if obtained they are particularly valuable in the eyes of a landlord who is likely to prefer a bank guarantee limited to an amount of one year’s rent and outgoings over incurring expense in pursuing a director of a tenant company under an unlimited personal guarantee who is facing bankruptcy.
One consideration for tenants when arranging a bank guarantee is that a bank will typically charge between 1% and 2.5% of the likely estimated liability (usually fixed against the annual rent). In these instances it may be worth negotiating with the landlord to reduce the rent accordingly. Another complication is that some bank guarantees are not assignable, meaning that in the event that a landlord sells its commercial premises, they are likely to require a tenant to obtain a replacement bond on the same terms in favour of the new andlord.
3. Security Deposits
Security deposits involve an agreed amount being lodged to a bank account in the name of either the landlord alone, the landlord and tenant jointly or (more commonly) the landlord’s solicitors. The terms of the deposit are agreed between the parties, and is usually on the basis that rent or outgoings may be deducted from the deposited amount agreed between the parties.
From a tenant’s perspective it will be important to ensure that a landlord cannot simply deduct money without issuing prior default notices and allowing the tenant a reasonable amount of time to remedy the default. The deposit should be held in trust in a separate account, and not ‘mingled’ with other funds of the landlord. Any interest earned on deposited money should also be held for the benefit of the tenant and the appropriate withholding tax should be accounted for.
Other Things to Consider – Business Use
When entering into a new lease as tenant it is always preferable to agree on a sufficiently wide business use under the lease so that an application for assignment half way through the term does not also involve an application for a change in the business use. On the other hand a Landlord will generally (especially in a retail context) be trying to limit the scope of a business use, so it will not conflict with the use of other retailers in the complex. These two competing interests will need to be reconciled through negotiation between the parties.
Many outgoing tenants do not expect to remain liable once they have assigned their lease and vacated their commercial premises. Unfortunately this residual liability (at least for the remainder of the term of the lease following assignment) is painfully real for many assignors who discover that their assignee has ended up in financial strife. Whether you are an exiting tenant or an incoming tenant, it is vital that you seek legal advice to negotiate a position with your landlord which will limit (if not absolve) you of potential liability, and ensure that any securities provided by you are fair given the present state of the market.