How can Landlords better protect their interests if a tenant defaults on liabilities ?

21st February 2012

Maintaining their investment and subsequent rental income without incurring expense is paramount for Landlords.

Landlords will always strive to let their property to a tenant or tenants who are able to offer a strong covenant. This means finding a tenant or tenants who can provide a consistent and reliable source of income.

However, circumstances, such as the economic climate or the fact that the tenant may be a newly formed company with no trading history, may mean in reality that the landlord has to let premises to a tenant whose covenant strength is not assured.

One way of protecting a landlord’s income stream and investment is to use a guarantor. A guarantor helps ensure performance of the lease covenants and reduces the landlord’s risk of entering into a lease with a tenant, by providing the landlord with an additional source of recourse, i.e., against the guarantor, in the event of a tenant default. 

In addition to providing such security to the landlord, the guarantor may be a source of additional pressures on the tenant to see that the tenant performs the covenants contained in the lease.

Common terms used in a guarantee normally require the guarantor: to pay the rent due under the lease should the tenant fail to do so; indemnify the landlord against any costs or losses resulting from the tenant’s breach; and, should the landlord require, take a new lease of the premises if the tenant’s lease is forfeited.

It should be remembered however that a guarantee is only worth as much as the strength of the guarantor. A natural person is to be preferred to a company due to the company’s limited liability.

A prudent landlord should therefore carry out the same investigations into the guarantor as he would the tenant. If the guarantor cannot be relied upon then the landlord’s position is not protected. The potential financial risk of the weaker-covenant tenant leaves the landlord’s investment exposed.

Reliability of the guarantor is therefore crucial to the landlord’s protection. However there are ways in which the guarantor can be released from its covenants that the landlord should be aware of.

An assignment of certain leases or variation of the terms of the lease by the landlord or tenant will potentially give rise to the unintentional release of the guarantor.

To give certainty and further protection on any assignment the landlord should provide adequate provisions for further guarantees.

 Leases granted after 1st January 1996 are subject to the Landlord and Tenant (Covenants) Act 1995. Liability of the tenant and its guarantor ends on any lawful assignment of the lease. As such the landlord will not have recourse to either in the event the new tenant defaults on its covenants.

To avoid such a risk the landlord may consider the use of rent deposits (which are an option on first granting a lease as well). The tenant deposits a sum of money equal to six months rent for example and should the tenant default, the landlord has recourse to this sum. The security will however usually be limited to the amount of the initial deposit.

Alternatively the landlord may wish to impose an Authorised Guarantee Agreement (AGA) upon an outgoing tenant. Should the new tenant breach its covenants, the AGA provides that the outgoing tenant is still liable to the landlord. Of course, this may prove pointless if it is the outgoing tenant’s guarantor that has the covenant strength.

An additional source of support for the landlord may be to utilise bank guarantees whereby the bank contracts with the landlord to meet the lease liabilities up to a specified threshold and period. The economic climate has however meant that banks are less willing to enter into such guarantees.

For additional information please contact Edward Worthy on 01245 228124 or worthye@gepp.co.uk

The above is not legal advice; it is intended to provide information of general interest about current legal issues.