Personal and corporate guarantees are critical to understand when contemplating investing in commercial real estate. Leases often require guarantees to secure the obligations of the lessee. These guarantees ensure that the lessor (landlord) has a means of financial and legal recourse if the lessee (tenant) fails to fulfill the terms of the lease, such as paying rent or maintaining the property. Two primary types of guarantees used in commercial leases are personal guarantees and corporate guarantees. Each type serves a different purpose and involves different parties, risks, and legal implications.

What is a Personal Guarantee?

A personal guarantee is a legal commitment made by an individual (or group of individuals) to accept responsibility for the financial obligations of a business, particularly if the business fails to meet these obligations itself. This type of guarantee is commonly required by landlords when dealing with small businesses or startups, where the business itself might not have sufficient credit history or assets to stand on its own.

Key Characteristics of Personal Guarantees:

Liability: The guarantor (person providing the guarantee) is personally liable. This means that if the business cannot pay its rent, the guarantor’s personal assets, such as personal bank accounts, real estate, and other investments, can be targeted to satisfy the debt.

Scope: The extent of a personal guarantee can vary. Some are limited to a specific amount or duration, while others could encompass all obligations under the lease.

Risk: High for the guarantor because personal financial risk is involved. There’s also an emotional aspect since personal relationships can be affected, especially if multiple family members are involved as guarantors.

Protection for Debtor: Our legal system has many safeguards in place for personal liability. Assets such as personal residence, auto, retirement accounts and wealth held in trusts are often difficult to access for the person seeking relief. 

What is a Corporate Guarantee?

A corporate guarantee, on the other hand, involves a parent company or another related corporate entity guaranteeing the lease obligations of the tenant. This is more common in situations where the tenant is a subsidiary of a larger corporation or when a financially stronger affiliate wants to back a weaker entity.

Key Characteristics of Corporate Guarantees:

Liability: The corporate entity acts as the guarantor, which means the financial assets of the company are at risk rather than those of any individual.

Scope: Corporate guarantees might also be limited or comprehensive, depending on the lease terms.

Risk: Lower personal risk compared to personal guarantees. However, the guarantor company’s financial health can be adversely impacted if it has to cover failed obligations.

Differences in Application

The application of personal and corporate guarantees in a lease agreement largely depends on the business structure and financial stability of the tenant:

Startups and Small Businesses: More likely to require a personal guarantee because they might not have enough business credit or significant assets to provide security.

Established Businesses and Subsidiaries of Large Corporations: These are more likely to use corporate guarantees, as they can leverage the financial strength and credibility of the parent or affiliated company to satisfy the landlord’s requirements.

Legal Considerations

The enforcement and implications of these guarantees can vary significantly based on jurisdiction and specific legal language in the lease contract. It’s crucial for both guarantors and landlords to understand the terms:

Personal Guarantees: Often scrutinized in personal bankruptcy cases; guarantors should be aware of the “continuing guarantee” clauses that bind them to the lease terms even if the lease is amended or renewed. Landlords should be aware that courts provide a lot of forgiveness in cases of personal bankruptcy.

Corporate Guarantees: These may involve complex corporate law issues, especially if it involves cross-border elements or multiple corporate layers.

Conclusion

Choosing between a personal guarantee and a corporate guarantee involves assessing the financial landscape of the business, the personal risk tolerance of the individuals involved, and the strategic objectives of the corporate group. For landlords, understanding the creditworthiness and the backing behind these guarantees is crucial to manage risk effectively. For tenants, it is about balancing risk and opportunity when negotiating lease terms.

Ultimately, the decision on which type of guarantee to use or accept in a commercial real estate lease involves careful consideration of financial, legal, and relational factors. Both tenants and landlords are advised to consult with legal and financial professionals to ensure that they fully understand and are prepared for the obligations and implications of these guarantees.

At Millcreek Commercial, we have four pillars of success that we look for when providing our clients with real estate opportunities. Single tenant, triple net lease, long-term lease, and corporate guarantee. Corporate guarantees can give investors peace of mind that the lease is backed by a large corporation. To view our portfolio of premium real estate, click here.