Commercial Lease Workouts, Good Guy Guarantees, and COVID-19

For many years, the good guy guarantee (GGG) has played a prominent role in defining relations between commercial landlords and tenants. It is used across all commercial property types, from retail to office to industrial.

The GGG is often viewed as a deterrent against a tenant seeking to exploit the delays inherent in the court system where it can take months for a landlord to evict a defaulting tenant only to find that once the landlord finally obtains a judgment, the tenant will vacate but lacks the available cash to pay the significant arrearage accrued in the interim. The GGG prevents a tenant from remaining in possession of its premises, operating its businesses, and ostensibly turning a profit without the landlord receiving the corresponding benefit it was expecting in the form of the rent payable under the lease.

The GGG provides a powerful incentive for a tenant to act responsibly relative to its landlord. Under the terms of the GGG, the guarantor, typically a substantial principal in the tenant entity, guarantees the rent owed to the landlord. The guarantor will be released from its guarantee once the tenant provides the landlord with advance notice of its intent to surrender and actually surrenders the premises on the designated date. It is also usually a condition to the guarantor’s release that all rent be paid through the date of surrender. This recourse to the guarantor gives the landlord a powerful tool to regain possession of the premises, even if the rent deficiency for the period after the surrender proves uncollectible from the tenant entity.

In the current climate, tenants are still entitled to possession of their leased premises, but if not considered “essential,” they are not in a position to operate. Where the tenant is unable, or is electing, to not meet its rent obligations, it is creating a liability for the guarantor under the GGG. Yet, as the tenant is not operating its business, it is not benefitting from the right to possession and there is a disconnect between the terms of the GGG and the underlying rationale for the parties’ agreement. Accordingly, when discussing rent relief, landlords and tenants should consider whether or not it is their intention that the GGG be enforced with respect to rent arrears accrued during periods occupancy is precluded by COVID-19.

Under the current state of shutdown, tenants who will resume business operations when permitted by governmental authorities, will need to obtain an amicable resolution of any unpaid rent obligations with their landlords. With a dearth of tenants seeking new space to re-open businesses, commercial landlords should be incented to reach an accommodation with existing tenants who want to remain and can demonstrate a need for relief, within limits needed to address the landlord’s own circumstances. On the other hand, tenants who no longer need their premises or cannot resume profitable operations will confront a different dynamic.

Typical commercial lease contracts containing guarantees have historically been enforced by the courts as written. As a result of COVID-19, tenants will look to have future leases more explicitly address conditions that do not necessarily involve physical damage but still prohibit occupancy. A landlord’s willingness to address this concern may be subject to obtaining clarification that rent loss is covered by insurance. Future variables aside, if the parties to an existing lease cannot agree on how to address arrearages accrued during the current pandemic, the courts will have to determine how to enforce these leases and GGGs as written. Historical precedent may or may not provide an accurate guide.

No two situations are ever the same and there is not a “one size fits all” solution. The GGG provisions will require attention and careful consideration by all parties and their advisers, in light of today’s current environment.

For further advice on this topic, and if you have questions regarding your documents and contracts, please let us know.

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