The recent COVID-19 outbreak and lockdown has had a significant impact on commercial leases in Rotorua. The effect of these events will likely reverberate for some time (particularly for businesses which cater to overseas tourists).
With businesses shutting down or being put on hiatus, we may see an increase in vacant commercial premises and increased competition for good tenants. While it is important for landlords to have properties tenanted, it will also be increasingly important for landlords to check that prospective tenants are suitable and that both tenant and guarantors have sufficient resources to ensure compliance with lease obligations.
The unpleasantness of tenant default
As many commercial landlords will be aware, tenant default can result in potentially lengthy, stressful and expensive processes. In worst-case scenarios, the process of terminating a lease can be even more disappointing once it is uncovered (usually once the rent is in significant arrears and outgoings have not been paid for some time) that not only is the tenant insolvent, but the guarantees given by guarantors are not backed by assets. Such situations can leave landlords thousands of dollars out of pocket, as not only have they lost income, but they also have to foot the bills for chasing the tenant, outgoings and the costs of re-letting the property.
Looking before you leap
Although it may be tempting to “just get a tenant in” to fill a vacancy, landlords should (wherever possible) carry out thorough checks into prospective tenants and guarantors. This could include credit checks and investigations into prior business experience and accounts. Such checks often give indications to the landlord as to whether the prospective tenant is likely to be a good fit and keep up with its obligations.
Knowledge of what assets the tenant owns (and whether the assets are subject to any security interests), will also give landlords an indication of whether or not the landlord stands a realistic prospect of recovering outstanding amounts from the tenant in the event of default.
Who – or what is backing the tenant?
Personal guarantees are common forms of security where tenants are small businesses. In practical terms, however, guarantees do not always provide the protection intended, as guarantors can (and do) take measures to put their personal assets out of reach of creditors. It is therefore important for landlords to investigate what assets are owned by the guarantors (and whether any form of asset protection is involved).
By way of example, if a personal guarantee is given, but the guarantor’s assets are in fact owned by a trust, it could be extremely difficult and expensive (if not impossible) for the landlord to access those assets. When looking to recover monies owed, knowledge of guarantor assets and ownership arrangements is critical in assessing whether it will be possible or cost-effective to do so.
To lease or not to lease
Once investigations are complete, the landlord could find that the tenant is completely unsuitable and refuse to enter lease arrangements. However, if the tenant is suitable and the landlord does decide to enter into leasing arrangements, the next step is ensuring that suitable security is provided for the lease. Often, this will be a personal guarantee. However, if there are little or no assets owned by potential guarantors, the landlord could instead request a bond or a bank guarantee as an alternative to. Facilities like these are useful if there are few or no significant guarantor assets.
In the event of tenant default, bonds or bank guarantees may go at least part of the way to limiting the impact of default on the landlord. In fact, a bond or bank guarantee may in some circumstances be better than a personal guarantee, as personal guarantees must be enforced (and the landlord is likely to rank behind secured creditors), whereas a bank guarantee or bond may be simpler for the landlord to access.
Nothing is certain but death and taxes
Life happens. Regardless of the care taken in ensuring that landlord and tenant are a good fit, unforeseen events can rapidly destroy otherwise profitable businesses and what should have been a long and happy landlord/tenant relationship. Investigations into prospective tenants are therefore not substitutes for consistent monitoring of your lease.
Any unremedied default by tenants should be dealt with as quickly and effectively as possible. Swift action often minimises the possibility of long, drawn-out tenant exits and allows for losses to be minimised. However, if the worst comes to the worst and the lease needs to be terminated, knowledge of tenant’s and guarantor’s situations can often put a landlord in a far better position than they would otherwise be.
For more information
If you would like to learn more about the changes to commercial leasing and how to conduct thorough due diligence, please feel free to contact Helen Nathan on 07 349 7486 or email firstname.lastname@example.org.