Congratulations. You have joined a startup and have shown both initiative and courage. Your new company has finally arrived at the point where you need more bodies and a place to put them. It’s time to move out of WeWork, Regus, or one of the other temporary set ups and get office space of your own, and the boss has put you in charge of that task.
You should find a real estate broker specializing in office space that will explain the market to you and show you prospective spaces. It’s a complicated process and a good broker and real estate lawyer are essential. The lease is going to be for a term of a few years and the landlord will be concerned with security for your performance – money that is held by the landlord in case the business defaults on its leasehold obligations. In New York City the landlord may also request a so-called “good guy” guaranty. This note is concerned with that aspect of security in a New York City deal.
Your broker will tell you that a good guy guaranty is a “standard” request in New York. That is accurate. Nonetheless, before you agree to have someone in your company sign one you should say, “Slow down a second.”
The good guy guaranty is a limited form of personal guaranty.
First, let’s do a little basic background. Let's say the lawyers set up a company for the startup called “SU NewCo., LLC” (which we are just going to call “NewCo” from now on). NewCo signs all your contracts and employs all your staff. NewCo takes all the liabilities and, if things go sideways, its members may lose their investment, but other assets will be safe from creditors (like the prospective landlord). A guaranty of any kind eliminates that protection. Whoever signs it puts his or her personal assets on the line for the guaranteed liabilities, in this case the rent for the lease term. Obviously, this is to be avoided if possible. Now remember, NewCo is 100% liable. The guaranty is in addition to NewCo’s liability.
The good guy guaranty is a limited form of personal guaranty. In its purest form, the guarantor only guaranties the obligations for so long as the space is occupied by NewCo. Once the space is returned to the landlord, the guarantor no longer accrues liability. The guarantor continues to be responsible for all the obligations that arose before the surrender of the space, but none afterwards. I have indicated that this is the “pure” form of the good guy guaranty, because many landlords will try to extend the liability as much as they can get away with, to cause it to more closely resemble a full, if limited, guaranty. While beyond the scope of this note, it is something that your real estate lawyer should be aware of and should protect you against.
If a tenant defaults and the landlord has to evict them in court, it takes months to get the space back...
While this sort of protection for the landlord might seem odd, there is a perfectly good reason for it. If a tenant defaults and the landlord has to evict them in court, it takes months to get the space back, sometimes many months.
In order to protect themselves from many months of litigation landlords crafted this guaranty. At its heart, it isn’t a guaranty of money, it is a guaranty of behavior. “If you (NewCo) are going to default on the lease, at least be a good guy and surrender the space to me. Don’t make me have to endure a whole eviction proceeding to get you out.” The existence of the guaranty is supposed to encourage this good behavior. (I want to re-emphasize that NewCo continues to be liable. This is not an arrangement for NewCo to walk from the lease obligation without penalty.)
Sounds reasonable enough, but here’s a wrinkle. In order for the scheme to work, the guarantor has to be able to control the behavior of NewCo. If he or she cannot, the good behavior can’t be imposed. Additionally, the guarantor cannot be subject to termination by NewCo for any reason at all. There are entities that cannot offer a good guy guaranty no matter how much the landlord insists. General Motors couldn’t, for example. There is no one person who both controls the behavior of GM and can’t be fired.
...there could be a well-meaning manager who signs the good guy guaranty to secure the space for his bosses only to get fired the following week.
For a guarantor to execute the guaranty and accept the liabilities that it entails without these conditions being satisfied is beyond reckless. If he or she was to do so, and NewCo defaults on the lease without physically vacating, the guarantor could complain without any effect on the move-out. Furthermore (and this has happened), there could be a well-meaning manager who signs the good guy guaranty to secure the space for his bosses only to get fired the following week. He is now guarantying his ex-bosses’ leasehold obligations. Total disaster.
So that’s the bottom line. If you are contemplating agreeing to execute a good guy guaranty, you must both be in control and be totally immune from being fired. Otherwise you have to tell your broker in the lease negotiations that, reasonable or not, a good guy guaranty is not happening.
[A partner at New York-based law firm Ingram, Shane O'Neill focuses a substantial portion of his time on commercial leasing matters on behalf of both landlords and tenants throughout the United States.]