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aaron hall: i'm aaron hall, business attorneyin minneapolis. steve freeman: i'm sitting with steve katkovof thompson hall. when it comes to, let's say, the small business owner they're lookingfor 1200 square feet. let's say that their rent is going to be $2000 per month. whatwould be an average amount that they would expect to give to the landlord to hold, andhow long will they hold it? until the end of the term? or is there a time period thatthat security deposit could be applied towards rent?steve katkov: the landlord would turn that question to you and say, "what—". beforei answer that, what is the tenant's leasing experience? has this tenant been a successful[leases] in previous businesses or in previous
locations? so let's assume, hypothetically,that this is a new business. this is a true start-up with no leasing experience. the landlord'sanswer to that question is going to be very different than if it was a major corporationwho's operating 80 or a hundred locations under leases. in our scenario, it is mostlikely that the landlord is going to ask for a security deposit equal to the first andthe last month's rent. and if it's a term of a year, chances are the landlord's goingto bargain to keep the security deposit until the lease is either renewed or terminatedat the end of the term. it's a guarantee of performance. so another way to eliminate it—becausesteve, for some small businesses, first and last month's rent, especially if you're ina start-up, that's a big nut to crack right
off the bat where cash is king. i want tohold it and use it in business operations to acquire inventory, for instance, or hirean employee, and be able to cash flow my payroll. it is a significant issue for small businesses.one alternative to what might be considered a large security deposit, or difficult securitydeposit terms, is to offer a personal guarantee from the owner of the business. now if ourtenant is organized as a corporation or a limited liability company, then the obligationsunder the lease fall to that entity. the tenant could say, in response to a request for eithera large security deposit or one that the landlord wants to hold for the term of the lease, isto say, "what if i gave you a security deposit equal to one month's rent? you hold that untilthe end of the term guaranteeing my performance
not only of base rent but that additionalrent. common area maintenance charges are a great example. but instead, i'll also giveyou a personal guarantee of the obligations of my company." and often, landlords willaccept that assuming the guarantee has some substance.steve freeman: so that brings up an important point. if the small business owner is an llcas an example, which is probably the cheapest way for them to go and maybe in their situation,a smart way to go. and they go and lease a property but they give a personal guarantee.fast forward 18 months, they're not doing so well. they realized that they need to getout of the space at the very least, or they need to file bankruptcy. now if the companyfiles bankruptcy but they've signed a personal
guarantee, what happens to them at that pointbetween them and the landlord? steve katkov: a guarantee in broad terms,whether it's in a landlord-tenant context or a lending context, where the llc borrowsmoney from a large banking institution with that one's a personal guarantee, is reallya contract of indemnity. in other words, the guarantor is promising to indemnify or makewhole the landlord from defaults of the underlying obligor, the party that's really contractedfor performance. so if an entity were to file bankruptcy, the entity's obligations underthe lease agreement would be terminated by the bankruptcy action, but not so with theguarantee. guarantee's are generally better thought of as continuing promises of performance.and sometimes—and you'll see documents that
instead of saying "guarantee" at the top,they'll actually say "continuing guarantee". the point trying to drive home to the guarantoris that your obligation continues regardless of what fate befalls the party who's actuallyobligated on the primary obligation. tenant would be the primary obligation of the company.steve freeman: okay. so to put it in layman's terms, what that means is—going back toour small business person. they lease the property for 5 years, as an example, i seta 5-year lease. 18 months into it they realized, "this isn't going to work. i'm going to haveto file bankruptcy and i have too many creditors after me." and they informed the landlordof that. and the landlord can then say to them, "i feel really bad for you but you oweme 3 and a half years of rent, regardless
of what happens with the corporation."steve katkov: right. so the only recourse for the guarantor, our tenant, our client,is to also seek the protection of the bankruptcy court by filing either chapter 13 which isan individual plan of reorganization, or a chapter 7 which is the liquidation. or lastly,negotiate a buy-out if you will of the guarantee. but the—here's the key point. that tenant,guarantor, our client, must get a written release of the guarantee.steve freeman: but if we're representing the tenant in this scenario, we would try to getthem to not sign a personal guarantee if there was any way around it. would that be a goodassumption? steve katkov: it is. it's always our firststep forward in negotiating on behalf of tenants
with the landlord, is to let the landlordknow that our initial offer and terms will not include a personal guarantee. it's onething if the business goes belly up, and the owner's done everything they can to make ita success. it's another thing if the owner does everything they can in good faith tomake the business a go, and has to file personal bankruptcy. but you will find, and our tenants,and our clients will find that the idea of a personal guarantee will always be floatedby commercial landlords, particularly with tenants who have little or no leasing experience.steve freeman: so here's an idea. if you were going to go into commercial space, again smallowner, could you go in with the understanding between you and the owner that the first 24months, there would be a personal guarantee
and a renewal of the lease? and then afterthose 24 months, go in and renew the lease, not have a personal guarantee but have itagainst the corporation instead? steve katkov: our response would be to negotiatefrom the outset that what we would consider a success factor. in other words, if our tenantis successful, then we expect the tenant to benefit by the release of the security depositand/or release of the guarantee. now that's the best way to make this happen. and at thompsonhall, we think this way. we think, what if in two years the tenant's super successfuland maybe not only needs to renew the lease, but god forbid, expand? so that should bepart of the discussion, too, rather than only look at risk management as preventing negativeconsequences for the owner. we first look
and assume success. and if the landlord wantsa security deposit and a guarantee to assure performance, then the discussion should bearound the timing at which point the landlord can assume that our client is a good bet.steve freeman: so steve, let's say that the tenant in your scenario, they've done reallywell. they need to expand and there's not space where they are currently. but they'reonly halfway through their lease. what obligations do they have? and what can they do? what aretheir options at that point to find new space and get out of their current lease?steve katkov: and this we spoke earlier, steve, cash flow for small business is always critical,and particularly for start-ups. so imagine a scenario where the tenant didn't plan forsuccess and has outgrown its space. could
it possibly cash flow two leases? the existinglease—because again, it is an enforceable agreement against the tenant, and the tenantmay have signed a personal guarantee. so the stakes are high—as well as go find a largerspace maybe next door or across the street. most small businesses can't afford to cashflow two locations, or two don't make sense. so one vehicle, is to get the landlord's agreementto sublease the property. in this context, the tenant then becomes almost like a landlord.and that's why we call it a sublease. it's secondary to the lease agreement between landlordand tenant. again, an important drafting point going into the relationship, rather than lookingat it as i'm going to fail and might have to leave and close shop, and subleasing, orto make good on my promise under the lease
agreement. let's think about it in terms of,i'm going to have success, and i need to expand, and i can't. an important negotiating pointis to get the landlord's agreement on subleasing. generally, a tenant has no right at commonlaw to sublease. states vary on that issue. and it smacks against our old world propertyconcept that the tenant has a really established significant real property interest, even thoughit's just a lease hold interest, just the tenant. but it's this contract law that'scoming in and saying, "well that's not a benefit of the bargain." it might have been in olddays, but this is modern world. and unless the document allows for subleasing, the tenantshould presume he can't do it. so negotiate for it upfront. and then the discussion willbe around whether the landlord can be unreasonable
in who you present as the new tenant.steve freeman: so in that scenario, the landlord would have the right to approve or disapproveanyone who might do the sublease, if he even allows it.steve katkov: correct. and we would always argue that tenants obtain the right to sublease,and to limit the landlord's acceptance or rejection of a potential [sublease] to whatis reasonable. steve freeman: let's say that the tenant isable to find a subtenant. they sublease. the owner approves it. now they're released ofliability, and they don't have to worry about that lease anymore. is that correct?steve katkov: not necessarily. the primary obligation still resides with the first relationship:landlord-tenant. the tenant, unless they get
specific release from the landlord, also remainsliable for the performance under the lease whether his tenant performs or not. ultimately,we would encourage tenants in that scenario, if they anticipate issues with their landlord,to obtain release from the lease particularly when our tenant has worked to present a veryqualified replacement tenant. landlords, on the other hand, like subleasing because nowthey have two actors to go after in the event of non-performance: the tenant, and the subtenant.steve freeman: really, we're talking about the shifting of risk. so if the tenant, thefirst tenant, the original tenant, is able to get out of and be released from the obligationsof that lease, that's great for them. not so good for the current landlord. but in thescenario would be better if they did it that
way.steve katkov: it would be better for our tenant, less complicated for all the parties nonetheless.and in a small leasing scenario of a thousand, 1200 square feet, the issue of landlord makingtenant improvements, which he intends to recapture from the lease payments, is less intense thanif it was a 70000 square foot lease in which the landlord invested 50, 70, or even a hundredthousand dollars to improve on behalf of the tenant. and that's where we really see issueswith subleasing come into play. because part of the landlord's out of pocket expenses couldbe significant tenant improvements. generally, that won't be a large number in a 1200 squarefoot. and landlord's are much more amenable to not only a full lease—a release of thetenant's obligations under the lease. but
they certainly are amenable to subleasing.steve freeman: let's say that rather than move, the tenant has done so well that nowthey found a buyer. a buyer's come out of the woodwork and offered them a sum that theyjust can't believe someone would buy this building for, not building but the business.what would take place? what needs to take place? now i understand that there shouldbe some kind of an assignment. and how does that impact the relationship between the currenttenant and owner of the business, and the landlord?steve katkov: in rough terms, we like to think of subleasing as not relieving the obligationsof the primary tenant from performance under the lease. whereas with assignment, we arepresuming and hoping that it includes a release
of those obligations. so if the question is,does the landlord, by law, have to allow assignment? the answer is no. that is a matter of contractlaw. so it's a matter of what your lease states. so in addition to the other protections thatwe bring for our tenants and thinking about success, is we also have to think about whetheror not this lease should be assignable. and we would argue that it should always be assignable.landlords generally don't want that. and again, different issue if it's 70000 square feetand the landlord has put significant tenant improvements in place. because they've hadto do a credit analysis, if you think about it, it's almost an under riding process thata lender might go through in managing risk. what's my outlay? when am i going to get mymoney back? when i get it back, how much have
i made of money? and last but not the least,what is the risk that i'm not going to get it back? so assignment in a small lease contextpresents less of a challenge to a landlord than in a large leasing context. we wouldargue that it should be in the lease, for the occasion that the client receives a non-solicitedoffer that's just too good to be true. and part of selling the business and moving on,is not only acquiring the value from the buyer, but also a release of existing or currentobligations. you want to leave that behind, too. and an assignment provision in the leaseis necessary for the tenant who sells the business, to get rid of the lease obligations.now typically, landlords will say, "okay. i'll agree to assignment, but i get to reviewthe quality of the new tenant or the buyer
of your business."steve freeman: so are you saying, in this scenario, that the landlord could actuallykeep the sale from taking place? steve katkov: it depends whether or not thelease is an asset of the business. it is in the strictest terms. but is it a valuableasset? and in some business contexts, a long term lease, while it might be a burden insome situations, can be an advantage in a business sale. because going back to our previousdiscussion about location location location, a buyer of the business, once the businessin that location, if that location is available only on a short term basis, then the leaseis not as great an asset as it can be. and that's where the rubber meets the road, becausetenants, particularly in start-ups, are nervous
about long term commitments. and the otherhand, if they think about success rather than failure, and location is critical to theirbusiness and its growth, you would argue for a long term lease. so in the sale of a business,which is something we do for clients as well, we have a schedule of assets. and a leaseis not seen as an asset. it's usually on the schedule with liabilities because it requiresthe buyer or the current tenant to pay money. so it ends up on a schedule of liability.but i will tell you as a practical matter, businesses that are flourishing in a particularlocation have, as an arrow in their quiver, a long term lease in place.steve freeman: and the drawback for potential new buyer of that—just so that people understandthe importance of the location, the current
location—if that buyer looks at that shortterm lease and thinks to themselves, "i'm going to have to move this business if i can'trenew the lease, and that could cost me thousands of dollars. and i may not be able to copythe location that i've got nor the traffic that's currently coming in to this particularbusiness." so it is a big deal. steve katkov: it is. and also—not to lookat the dark side of business in america, but let's be frank. a business owner with a verysuccessful tenant who learns of a sale, and the tenant has only a matter of months lefton a lease, you might suspect that the landlord would be highly motivated. that when negotiatingwith the buyer of the business, the lease terms are much more [owneresque], that baserents' going to go up, and common area maintenance
provisions are going to be expanded. theymay still be pro-rata, but maybe he'll try to negotiate to include some items that thecurrent tenant and seller of the business wouldn't allow.steve freeman: so in this scenario, someone approaches you to buy the business, you don'tgo running to the landlord. you run to the attorney first.steve katkov: you run to steve. yes. and again, to make the—we agree, and it's self servingand i understand that, but i really believe that sitting down with knowledgeable businesslawyers, and i tie those two together, require lawyers that have done something other thanpractice law. and thompson hall, we have a lot of those.steve freeman: and this scenario, if you've
had a good attorney that did your divorce,they may not be the best person to do your lease.steve katkov: yes. or your cpa.
