Landlords need to do due diligence on commercial tenants
Attempting to recover money owed under a commercial lease can be time consuming, stressful and expensive for a landlord. In worst case scenarios, the process of recovering funds owed can be disappointing, when it is discovered that not only has the tenant no way of repaying the amounts owed, but the guarantees given by guarantors are not backed by assets. Such a situation can leave landlords out of pocket by thousands of dollars. Conducting thorough investigations into potential tenants and guarantors before entering into lease arrangements can provide landlords with a better chance of recovering monies owed. While no amount of due diligence into potential tenants can completely protect landlords from circumstances where tenants default, landlords can take steps at the commencement of leases to protect their position.
Landlords should check a prospective tenant’s history (including credit checks) and make inquiries as to the tenant’s prior business experience. It may also be useful to request business plans and accounts (if the prospective tenant is an existing business). These investigations may give the landlord an indication of whether the tenant is likely to be able to keep up to date with payments of rent and outgoings. 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 in the event of default.
Where guarantors are involved, landlords should investigate what assets are owned by the guarantors and what the ownership arrangements of those assets are. When looking to recover monies owed, knowledge of who owns what assets, and what the ownership arrangements are in place is critical in assessing whether or not it is worth the cost of enforcing the guarantee. By way of example, if a guarantor owns land, but the guarantor owns the land as a trustee of a trust, the landlord would have no recourse against the land held in trust by the guarantor.
Upon completion of the landlord’s due diligence, the landlord may refuse to enter into leasing arrangements with the prospective tenant if the tenant is unsuitable. If the landlord does decide to enter into leasing arrangements, the landlord may choose to request a bond or a bank guarantee from the tenant. 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. If guarantees are being given in relation to the lease, the landlord should ensure that such guarantees are backed by assets, so that if the tenant defaults in relation to the rent, the landlord stands a reasonable chance of success in recovering outstanding amounts from the guarantors.
While landlord due diligence is not a substitute for monitoring the lease and ensuring that any defaults are dealt with as quickly as possible, ensuring sufficient investigation into the tenant and guarantor will often put a landlord in a far better position in the event of tenant default than would otherwise be the case.
If you are a landlord considering entering into a new lease, please feel free to contact Franklin Law to discuss. For information on issues raised in this article, contact the author Evan Whetton.