Good Guy Guaranties and the Designated Hitter
As the father of three active boys, I have spent many hours in the wacky world of youth sports, although some positive gems do stand out.
When one of my sons played at a young little league level, the rules provided that everybody got to bat, but one or two of the team’s 12 players had to sit out each inning instead of fielding. To make sure that the kids on the bench did not feel left out, their endlessly upbeat coach would run up to each of them, arms waving enthusiastically, and exclaim “this inning, you get to be the designated hitter!”
Instead of feeling like a benchwarmer during their turn to sit, each designated hitter sat up proudly beaming a big smile.
Similar euphemisms are used to provide a positive spin (e.g., “correctional facility”) or perhaps mislead altogether (e.g., “enhanced interrogation”).
Commercial real estate leases have their own version with the “good guy guaranty”.
It sounds so pleasant, good guy guaranty. What’s not to like? But unlike with our little league designated hitter, what sounds positive can quickly turn into a big negative.
The idea behind the good guy guaranty is to provide an incentive for a tenant’s good behavior by exerting a financial lever over its principal(s). B.F. Skinner meets real estate with leasing’s version of behavior modification.
A good guy guaranty is a guaranty of certain obligations under a lease provided by a principal of the tenant with decision-making authority, which guaranty stays in effect until the tenant surrenders the premises. The liability is within the guarantor’s control; triggered by the holdover or other default but stopped upon surrender of the premises.
In many jurisdictions it can take months to remove a holdover tenant. Meanwhile, the defaulting tenant often stops paying rent, but the landlord may be required by law to continue to provide services, while incurring large legal and re-marketing costs. And nothing wipes the smile off of the face of a prospective new tenant faster than hearing that there is a holdover tenant.
But over time, and with crafty drafting by landlords, the good guy guaranty has become something of a wild pitch that can impose unexpected increased exposure on the unwary guarantor.
Make sure to address the following six points with any good guy guaranty:
- First, remember that good guy guaranties are not always appropriate. You should only be providing the guaranty if you truly control the tenant (and hence your liability) and can cause it to vacate with a snap of your fingers. If you are an officer of a company, or have a Board of Directors or partners to whom you report and/or owe fiduciary duties, you probably should not provide a good guy guaranty.
- The “surrender” of the premises should be clearly defined. The guaranty must clearly indicate what ends the liability.
Do not let the guaranty require that the tenant vacate the premises “in the condition required under the lease”. The lease may require the removal of alterations at the end of the term; potentially a huge expense. You agreed to cause surrender without strategic delay, not surrender in any particular condition.
- The amount guaranteed should be limited to a quantifiable sum. Your obligations should be specifically limited to the payment of fixed rent (including holdover penalties), specific escalations (e.g., operating expenses, real estate taxes) and electric charges.
You may also need to include reimbursement of the landlord’s legal fees with respect to enforcement of the guaranty (and possibly the lease as well).
- You should not be responsible for all of the tenant’s obligations under the lease, or even for all “additional rent” (since additional rent includes all sums due under the lease).
This broad characterization could include indemnification obligations (such as “slip and fall” lawsuits) or even acceleration of the rent after the tenant’s default, both of which should be specifically excluded. Some guaranties may even try to expand this further to recover a portion of landlord’s TI or brokerage costs.
Landlords will often insist that the liability be extremely high to force the guarantor to cause the tenant to vacate, but in most instances this type of penalty becomes egregious.
- Limit the notice period, particularly after the original expiration date of the lease. Many guaranties allow you the option to cut off liability prior to the expiration of the term by providing notice (often 60 or 90 days) and causing the tenant to surrender (the tenant entity’s liability of course continues). But be careful that the same notice period is not required in a holdover situation after the expiration of the term, which could keep you on the hook as guarantor beyond the surrender by the tenant.
- Provide an exit option in the event you are no longer in a management control position. Over the lease term, you may at some point no longer be able to cause the tenant to vacate (e.g., due to end of employment, retirement or assignment or sublease to a new tenant). In such event, you should be entitled to provide a substitute guarantor reasonably acceptable to the landlord who is now in the position to cause the tenant to vacate (and you should be released from liability). It may be reasonable for you to be released without a substitute guarantor if the tenant ends up as an entity for which a good guy guaranty is not appropriate (see above), perhaps because it goes public or is sold to a public company.
Avoid any requirement that the substitute guarantor have a particular net worth or balance sheet. A good guy guarantor is selected because of his or her ability to make the tenant timely vacate the premises, not based on his or her financial standing.
In the film Bull Durham, Crash Davis, the Kevin Costner character, said “I believe there ought to be a constitutional amendment outlawing Astroturf and the designated hitter.” I understand that he was not a big fan of the good guy guaranty either. But I know a few former little leaguers who might disagree (at least about the designated hitter).