You Sold the Business, But Did You Sell the Liability? Personal Guarantees in Retail Leases

Crownmark Lawyers | Commercial & Property

The sale of a small business tends to end the same way. Stock is counted, staff are transferred, the incoming operator signs the assignment of lease, the landlord consents, and the keys change hands. Everyone shakes hands and the file is closed.

Two years later a letter arrives from the landlord's solicitor about rent arrears at premises the seller has not set foot in since. The business that owes the money is not theirs and has not been for a long time. The letter is addressed to them personally, and it is not a mistake.

The reason is usually a personal guarantee, and it is one of the more common problems we see in small business sales.

A guarantee is not part of the lease

When a company takes a commercial lease, the landlord will almost always ask the directors to guarantee it. That guarantee is a separate promise, given in an individual's own name, to answer for the company's obligations if the company does not meet them.

This matters when the business is sold, because what usually transfers is the lease. The guarantee sits alongside it. Assigning a lease moves the tenant's rights and obligations to the incoming tenant, but it does not automatically discharge the promise the outgoing director made personally, and a guarantee often continues to operate not only for the balance of the current term but for renewals and extensions as well.

The result is that a person who genuinely believes they exited the business years ago can remain exposed to the performance of a tenant they have never met.

Victorian law does provide a release, on conditions

The position is not hopeless, and in Victoria it is often better than business owners assume.

Where the premises are retail premises under the Retail Leases Act 2003 (Vic), the Act provides for the release of an assignor and its guarantors when a lease is assigned in connection with the sale of the business. The intention of the provision is exactly what a seller would expect: that a person selling their business should be able to leave the lease behind them.

The release, however, is conditional. It depends on a disclosure process being carried out properly at the time of the assignment, including the provision of an updated disclosure statement to the incoming tenant and the various confirmations that go with it. Where those steps are followed, the release operates. Where they are not, it does not, and the guarantee simply continues.

This is the part that is most often missed, and the reason is practical rather than legal. The assignment is dealt with in the same short window as the sale of the business itself, usually under time pressure, alongside a settlement date that will not move. The disclosure requirement looks like administration. It is treated as administration. Nobody discovers otherwise until the new operator stops paying, which is frequently long after the sale proceeds have been spent.

Not every commercial tenancy is a retail lease

The statutory release only reaches leases that qualify as retail premises leases under the Act. Whether a particular tenancy qualifies depends on the nature of the premises and the use to which they are put, and the answer is not always obvious. A number of warehouses, offices and other commercial premises fall outside the Act entirely.

Where the Act does not apply, there is no statutory release to rely on. Whether the outgoing tenant and its guarantors walk away depends entirely on what the deed of assignment and the landlord's consent actually say. A landlord has no particular reason to offer a release, and in practice will not be asked for one unless someone acting for the seller thinks to ask.

What is worth checking

For anyone who has sold a business, or is preparing to, three questions are worth putting to whoever holds the file.

The first is whether the guarantee has any end date at all, or whether it is drafted to continue for the life of the lease and each renewal of it.

The second is whether the disclosure steps were completed at the time of the assignment, and whether the documents evidencing that were retained. A release that was available but never properly claimed is of no use later.

The third is whether the deed of consent released the outgoing tenant and the guarantors by name, or whether it merely permitted the assignment and said nothing else. Those are very different documents, and they are easy to confuse when read quickly.

Getting it right costs very little at the time

Dealt with during the sale, this is a small piece of work. The disclosure obligations are known, the release is available where the Act applies, and where it does not apply a release can usually be negotiated as part of the consent, particularly while the landlord still wants the assignment to proceed.

Dealt with after a demand has arrived, it is a different matter entirely, and the negotiating position is considerably weaker.

If you are selling a business, it is worth having the lease documents reviewed alongside the sale contract rather than after it. If you sold some years ago and have never checked what happened to your guarantee, an hour spent on the file will tell you whether you remain exposed. Either way, it is better to know.

If you would like us to look at a lease, an assignment, or a guarantee you are unsure about, we are happy to help.

 Harjit Mahindroo

 Managing Partner

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