With the prevalence of office leasing by technology and start-up companies and the increase of those same companies running into financial difficulties, landlords have understandably focused on obtaining protection through larger security deposits or guaranties. The marketplace has recently come up with a commercial tenant lease bond to try to address the landlords’ concerns while also providing needed flexibility to tenants.
In today’s newsletter we discuss these lease bonds and provide seven suggestions when acting as sublandlord being asked to accept a lease bond in lieu of a letter of credit or guaranty.
Mintz & Gold LLP
My son Adam’s resume includes under personal interests “movies that are so bad, they are good.”
Adam recently took me to see Hobbs and Shaw, volume 97 of the Fast and Furious series. When I asked if I needed to see the earlier episodes to understand what was going on, he gave me the appropriately disdainful look that only your children can muster.
What is he thinking and I probably get some (full?) blame for that!
Certainly 007 will never be the same since my progeny introduced me to Austin Powers, the international man of mystery character of comedian Mike Myers, which clearly is so bad it is good.
But the overall formula can be, well, formulaic.
And how does Bond always sneak into the villain’s high security evil lair and then single handedly fight off hundreds of evil henchmen?
Austin Powers parodies all of this so wonderfully and there has never been a better villain than Dr. Evil (formerly a Manhattan landlord representative), who even wants his son’s petting zoo to be an “evil petting zoo.”
And they do.
Landlords often require large security deposits and/or guarantees from the many technology and start-up companies in the real estate marketplace. Current problems at companies such as WeWork and Uber will only increase this cautious approach, placing a large financial burden on such tenants.
The surety does its due diligence on the tenant and, in exchange for the payment of an up-front premium, the surety agrees that if the tenant defaults under its lease, the landlord may submit a claim against the lease bond to be paid by the surety (although unlike in a construction scenario the surety usually has only a monetary, not performance, obligation).
The advantages for a tenant are that the premium paid to the surety is often less costly than maintaining a letter of credit and this increases the company’s borrowing capacity and allows the freed-up monies to be invested in the company.
As a tenant, what’s not to like? A lease bond is certainly an avenue to explore for the reasons stated above.
When in the role of a sublandlord, make sure your lease bond is shaken, not stirred, with the following 007 suggestions:
- Resist for LCs. As a sublandlord, you should resist the use of a lease bond in lieu of a security deposit. Cash is a superior security deposit since you hold the funds and can draw down at any time. The primary draw back to holding cash is that in the event of the bankruptcy of your subtenant the bankruptcy trustee may claim that the cash security is part of the bankruptcy estate. A letter of credit is ideal since it will not be deemed part of the bankruptcy estate and can be drawn down relatively easily without challenge, particularly in states in which commercial transactions involving letters of credit are common. With a lease bond, you will have to enforce the bond against the surety which (unlike a bank issuing a letter of credit) might raise defenses that could result in a lengthy litigation.
- What’s a legal newsletter without a few wishy-washy caveats so note that a lease bond that substitutes the credit of the surety for that of your subtenant and covers all of the subtenant’s monetary obligations under the sublease might be beneficial to you by providing, in effect, a guaranty of the sublease by the surety.
- Carefully review and negotiate. If you cannot avoid the use of a lease bond, you should carefully review the lease bond terms and conditions. This is a relatively new animal and there is no standard off-the-shelf model form. Construction industry surety bonds are notorious for their enforcement holes and you want to avoid such problems with your lease bond. The lease bond terms are not set in stone and you can negotiate issues such as notice and cure rights, time periods for payment, assignment rights, payment of legal and other fees of collection etc., so that the lease bond reads more like a letter of credit.
- Require timely payment. The lease bond should require an unconditional payment obligation within a short time period (e.g. three (3) business days).
- The surety should waive defenses. The surety should affirmatively waive all rights and defenses based on suretyship, including any rights or defenses arising through your subtenant.
- Cover costs. All costs of the lease bond (including collection costs) should be the responsibility of your subtenant.
- Do not waive remedies. You should specifically state in your lease that you may pursue all remedies against your subtenant available under your lease and applicable law. As with any other security deposit, payment of sums under the lease bond must not be your only remedy.
- 007. I am out of bullet point issues, but needed this one so I could say that we had 007 suggestions. Hey, this is an “evil newsletter” so we take evil poetic license!