Reasons the NYC Covid-19 Anti-Personal Guaranty Law Is Just Not That Great For Commercial Tenants
I. Stuff You Should Know Before We Get Started
Here is some stuff you should be aware of before we get into the substance:
- This article, as with all my publications and presentations, is intended to equally educate commercial landlords and commercial tenants.
- I do not mean to pick on the City Council. This is not an easy time to be legislating. It is my job, however, to analyze and anticipate.
- This article assumes that the reader understands what a Good Guy Guaranty is, and several other commercial real estate terms-of-art. But just in case, I am going to put a Glossary at the end of the article.
- For another perspective, read Joshua Stein’s article on the New Law. As you likely know, Josh is a transactional lawyer. He is the guy who puts these deals together piece by piece and understands them like nobody else in the City or State. His perspective is always worth considering.
II. Problem 1: The New Law does nothing for commercial tenants who signed their leases in their own names – they are still personally liable! How fair is that?
What do all these commercial tenants have in common?
- Jane, a psychotherapist, who rented a suite of three offices, with her colleagues.
- Mohammed, who rented a small retail store.
- Cho, who rented a small restaurant.
- Annie, who rented a small art gallery in Brooklyn.
What they have in common is this – they all took a commercial lease in their own names, as opposed to in the name of a company! Therefore, they are all personally liable under their commercial leases, even for the Covid Period. The New Law does nothing to protect them. The New Law specifically protects “natural persons who are not the tenant…”
If Cho had formed a corporation, Cho’s Biscuits, Inc., a company he is the sole shareholder of, made the company the tenant under the commercial lease, and guaranteed the lease in his personal capacity, then under the New Law, Cho would not be personally liable. But what’s the practical difference between Cho signing in his personal capacity or Cho signing in the name of his company? Arguably, the person who is not sophisticated enough to know that one should never sign a commercial lease in their own name (for about a million reasons) is the person who could really use the help of the government in a pandemic. Yet this law does not protect people who signed their commercial leases personally. This seems bizarre to me.
I’m just saying!(fn1)
III. Problem 2: For some crazy reason, the New Law does not actually protect…wait for it…guarantors!
For some crazy reason, the New Law does not actually protect…wait for it…guarantors! Let’s look at the text of 1932-A:
A provision in a commercial lease or other rental agreement involving real property located within the city that provides for one or more natural persons who are not the tenant under such agreement to become, upon the occurrence of a default or other event, wholly or partially personally liable for payment of rent, utility expenses or taxes owed by the tenant under such agreement, or fees and charges relating to routine building maintenance owed by the tenant under such agreement, shall not be enforceable against such natural persons…
[if the business was closed due to the pandemic and]
…The default or other event causing such natural persons to become wholly or partially personally liable for such obligation occurred between March 7, 2020 and September 30, 2020, inclusive.
This is even more bizarre to me. The vast majority of personal guaranty provisions are NOT, “in a commercial lease or other rental agreement.” Guaranty provisions appear in wholly separate documents from leases and rental agreements, called “guaranties”. Many leases never even mention that there will be a separate guaranty. The lease is silent about the guaranty. Yet the guaranty exists, apart from the lease.
A guaranty is not a “rental agreement.” You might think this sounds like semantics, and it is possible that courts will interpret “rental agreements” to mean any agreement at all, related to or entered into in connection with a lease. That, however, is going to require a judicial stretch, because a guaranty’s existence as a contract completely separate from a lease is significant here.
A lease is between a landlord company and a tenant company. But the guaranty is between the landlord company (usually, it could be a subsidiary of the landlord company or an investor in the landlord company) and an individual (usually who has a strong relationship to the tenant).
Let’s look at a quick example of why the New Law, as written, will be problematic to enforce. Landlord LLC and Tenant Inc. enter into a lease on May 1, 2019. Landlord LLC’s principal investor is Mr. Big LLC, Tenant Inc.’s principal is Bob, and Bob’s mother-in-law is Ayelet. On May 15, 2019 Mr. Big LLC and Ayelet enter into a separate contract, a guaranty of Tenant, Inc.’s obligations under the May 1 lease. Let’s go back to the New Law, which invalidates any personal guaranty provision “in a commercial lease or other rental agreement.” Well, there is a guaranty provision – but it is NOT “in” the lease or a rental agreement. The provision is in a separate contract, entered into on a different date, by parties who are different than the landlord or tenant. Thus, it would, indeed, be a judicial stretch to say that such guaranty provisions are “in” the lease. They simply are not.
Having said this, some leases do contain guaranty provisions (see Real Estate Board Standard Form of Store Lease 2004) and, in that case, the guaranty provisions could possibly be argued to be in the lease. Perhaps the City Council was only concerned with these types of guaranties. The problem then is this – almost no one uses the guaranty provisions in the form leases.
If the City Council had meant to protect good guy guarantors, the New Law should have simply said that guaranties of the subject leases are not enforceable during the Covid Period.
IV. Problem 3: The New Law may be useless in any of these common scenarios…and this is just what I can think of off the top of my head…!
A. Hello?! What if the Good Guy Guaranty requires the guarantor to be current on the rent before being off the hook?
Many good guy guaranties require the tenant to do all of three things for the guarantor to be off the hook personally:
(2) Give notice of anywhere from 30 to 180 days; and
(3) Be 100% current on the rent at the time of surrender.
So, let’s say it’s April 2020 and you are a commercial tenant, running a business as an entity and you have personally guaranteed the lease and you want to go out of business. Let’s say the lease has another five years left on it. In order to get out of the guaranty, and protect yourself from being on the hook personally for the better part of the next five years, you need to give 90 days’ notice before you surrender and be current at the time of surrender. So…you are telling me that you are NOT going to pay May, June, and July rent, because the New Law exculpates you from personal liability for those three months? Great. But now you have not satisfied the dictates of the good guy guaranty, and you are not off the hook for the rent personally from October 2020 through the end of the lease. What tenant is going to make that choice? Probably none. For this guarantor, the New Law is ice in the wintertime.
B. What if the landlord draws down on the security deposit for the arrears during the Covid Period and then seeks replenishment after the Covid Period?
So, let’s say the commercial tenant owes rent from April through August 2020 (5 months). The commercial landlord is holding six month’s rent as security. The landlord draws down on the security deposit and cures the tenant’s default of the five months of rent. Now it is October 2020 and landlord demands, as per any standard commercial lease, that tenant replenish the security deposit.
Landlord will argue two things when asserting that the guarantors remain personally liable for replenishing the security. First, the demand to replenish came after the Covid Period. Will this argument work when the default giving rise to the draw down happened during the Covid Period. I don’t know, my crystal ball is broken.
Landlord will also argue that the guarantor was absolved of three items of liability by the New Law (see text above):
- utility expenses or taxes
- fees and charges relating to routine building maintenance
Landlord will argue that the lease’s requirement that tenant replenish security was not one of the forgiven items. Will this work? Crystal ball…broken.
C. What if the landlord waits for the expiration of the Covid Period and then claws back many months of free rent that tenant received at the beginning of a lease?
So, let’s say the commercial tenant owes rent from April through August 2020 (5 months). The lease began in January 2018, and at that time, the commercial landlord gave the tenant three months of free rent at the beginning of the lease, “provided Tenant does not Default in performing any of its obligations under this lease…”. Well a default is occurring, so the landlord claws back the free rent that covered January –March 2018. The tenant does not pay any of it. Under the New Law, the guarantor might not be liable for the five months during the Covid Period, but is guarantor liable for the clawed back free rent?
The tenant will argue that the free rent came due during the Covid Period. The landlord will argue that the free rent was due at the beginning of 2018, the concession merely evaporated because of the rent default during the Covid Period. Who is correct? Crystal ball = broken.
I can think of ten more problems with this New Law. But Microsoft says I am already at 2,032 words.
Whoever drafted the New Law did not fully appreciate how complex the average commercial lease is and how all the remedies available to a commercial landlord to be wielded against a commercial tenant can be employed. And no two commercial leases are the same.
I have a new legal product I call CLaRA! “Commercial Landlord Remedies Analysis” (“CLaRA”), and it provides clarity to commercial landlords (or commercial tenants) by analyzing all the remedies available to a landlord during a commercial tenant default, by an in-depth written review of the full lease chain (all riders and amendments) and the guaranties and other relevant documents.
This New Law will inspire a lot of litigation. But there will be a lot of litigation anyway. And there will probably be more new laws and cases interpreting all these new laws. We all must roll with the punches. These are difficult times for everyone.
Good Guy Guaranty: A type of limited guaranty that typically cuts off the guarantor’s liability upon the tenant’s surrender of the premises (i.e. vacatur and turning in the keys), and, as has increasingly become standard practice, upon the tenant’s satisfaction of additional conditions, such as notice and being current on all rent.
Security Deposit Draw Down: Landlords should make sure that they give the proper notices, if required under the lease, before drawing down the security.
Security Deposit Replenishment: Most commercial leases require a commercial tenant to, upon notice from the commercial landlord, to replenish the security if the landlord draws down on it, so that the security deposit is always the amount tenant was originally required to deposit.
Free Rent: Many leases allow tenant to have a period of free rent at the beginning of a lease. Landlords do this to entice tenants to choose their buildings over other options and to soften the difficulty of a tenant having to finance a buildout at the beginning of the lease, during which the business will not have any income. Landlords rationalize the initial loss by calculating the benefit of having the full lease term.
Claw Back of Free Rent: If the tenant is in default, there is an argument that the landlord is entitled to be paid the free rent. Increasingly, commercial leases have provisions requiring tenants to pay back the free rent in proportionate amounts, depending on how far into the lease term they are.
fn1. Not to mention the fact that, as of the time of this writing, there is virtually no rent relief for the average NYC residential tenant, who remains personally liable.