Understand Your Lease

Understanding your commercial lease and it’s terms and conditions is crucial for business owners. A lease will likely be one of the largest business expenses you will have.

Commercial landlords regularly ask corporate shareholders to guaranty their corporate employer’s lease obligations in the business lease contract. This is especially true with leases involving start-up companies with little or no business track record. From the landlord’s standpoint, a guaranty gives some security that the lease will be performed in the event the corporate tenant goes belly-up. By having access to a second source of funds (the corporate shareholder’s), the landlord is more likely to sign a lease with a business tenant who lacks a credit history and trade references.

From the individual corporate officer’s perspective, signing a lease guaranty is a risky proposition. If the corporate tenant is unable to pay rent, the landlord can go after the corporate officer’s (who guaranteed the corporate lease duties) personal assets after it gets a money judgment. The assets a judgment creditor typically focuses on include a judgment debtor’s

  • bank accounts,
  • wages (creditor can garnish up to 15% of gross wages),
  • and real estate (a creditor can place a lien or “hold” on real estate held by a judgment debtor and cloud the realty’s title).

Illinois law strives to strike a balance between holding parties to their contractual agreements on one hand, and on the other, still protect an individual lease guarantor from agreeing to take on more financial risk than he intended.

 

An Illinois Case Note

Stonegate Properties, Inc. v. Piccolo, 2016 IL App (1st) 150182 presents a recent Illinois case example of the nature and limits of a lease guarantor’s obligation to make good on a defaulting corporate tenant’s lease duties. There, the plaintiff office landlord sued to hold a corporate tenant’s CEO and lease guarantor liable for rental damages after the corporate tenant defaulted and declared bankruptcy.

The guarantor defendant successfully moved to dismiss. She argued that she was released from the guaranty by the lease parties making material changes to the lease and by doing so, increasing the guarantor’s risk with no additional consideration to the guarantor.

Siding with the lease guarantor, The Court cited and applied these operative contract law principles in siding for the guarantor:

  • A lease is a contract between a landlord and tenant, and the general rules of contract construction apply to the construction of leases;
  • A guaranty is a promise by one or more parties to answer for the debts of another. A clearly-worded guaranty should be given effect as written;
  • A guaranty is considered a separate, independent obligation from the underlying contract. Where a guaranty is undated, a court will still consider it as drafted contemporaneously with the underlying lease if the guaranty refers to that lease;
  • In the context of commercial lease guaranties, a guaranty’s term is only extended if the underlying lease term is also extended in accordance with the lease terms;
  • Common guaranty defenses involve changes to the underlying contract that materially increase the guarantor’s financial risk;
  • Where the risk originally assumed by a guarantor is augmented by acts of the principal (the person whose debts are being guaranteed), the guarantor is released from his contractual obligations;
  • Where a corporate principal signs a lease in her corporate capacity, she is not personally responsible for her corporate employer’s lease obligations. This is because a corporation is a separate legal entity from its component shareholders.

(¶¶ 40-45, 46-55, 60-62, 65-66)

Finding for the guarantor, the court found that the landlord and corporate tenant materially increased the guarantor’s risk and because of that the guarantor’s consent to the lease changes was required in order to bind the guarantor.

Since the guarantor never gave her express consent to the lease changes (broadening the leased premises from two office suites to 5; tripling the monthly rent), she was immunized from further guaranty obligations once the corporate tenant and office landlord signed the lease addendum.

The Court also rejected the office lessor’s attempt to fasten liability to the guarantor under a piercing the corporate veil/alter-ego theory. Since the plaintiff didn’t sue to pierce the corporate veil (such as under an alter-ego theory), the Court found that the guarantor’s execution of the lease addendum as an agent of the corporate tenant didn’t bind the defendant personally to the corporation’s lease obligations. (¶¶ 72-77).

 

Afterwords

Stonegate provides a thorough analysis of the contours of a commercial lease guarantor’s liability. While a guaranty is construed as written under basic contract law principles, if a commercial landlord and corporate tenant change the underlying lease obligations and in the process increase the guarantor’s risk, the lease changes won’t bind the guarantor even where the corporate agent who agreed to the changed terms and the lease guarantor are the same person.

 

Paul B. Porvaznik is a commercial litigation attorney with Davis McGrath, LLC in Chicago. He has nearly two decades’ experience in handling cases (from suit filing through trial or settlement) in the areas of general business disputes, collections, mechanics lien foreclosures to landlord-tenant and commercial lease disputes. He also writes his own blog.