Are you sure about your surety? Bank guarantees in leasing transactions
With no standardised form of bank guarantee in New Zealand there are many things landlords, tenants and banks need to think about and seek advice on to ensure that the guarantee they are using achieves each party’s expectations.
Becoming the norm rather than the exception
New Zealand landlords and tenants are increasingly turning to bank guarantees as security for performance of the tenant’s lease obligations, and it’s no wonder why: the tenant’s shareholders and directors can avoid giving a personal guarantee, and the landlord can avoid the trust accounting implications of holding a rental bond.
A promise by a bank (for a fee) to pay a landlord
A bank guarantee (also known as “bank bond”, “letter of credit”, “demand guarantee”) is a written promise by an institutional bank (or sometimes an insurance company) to pay a specified sum to the landlord when the tenant is in arrears or otherwise in default under the lease. A bank guarantee is similar to a personal guarantee, but with the superior credit support of a bank.
Most bank guarantees will be “on demand”, meaning that the landlord can call on the bank guarantee by simply giving notice to the bank that the tenant is in default, and without having to give proof of the default or even having to advise the tenant that it intends to call on the guarantee.
In approaching a bank to provide a guarantee, tenants should expect that the bank will require some security in exchange for giving the guarantee: usually a mortgage over a property, a general security agreement or a cash deposit. If the landlord calls on the bank guarantee, the bank will take steps to enforce its security against the tenant. Banks will also charge a fee and/or margin for providing a bank guarantee too.
Terms are not standardised, so get advice on them
There is no standard form of bank guarantee in New Zealand, nor any governing legislation as to what a bank guarantee must include. It is therefore important for parties to obtain advice on the terms. Most banks will have their own template form of guarantee (a simple document, usually only 1 – 2 pages), which usually contain terms addressing the following:
- Purpose: A statement to the effect that the guarantee is given as security for the tenant’s performance of its obligations under the lease.
- Parties: The parties’ names, matching the lease documents.
- Premises: A description of the premises, matching the lease documents.
- Amount: The guaranteed amount. This will usually be a number of months’ worth of rent and outgoings (priced at the commencement date) plus an amount to cover the GST payable on those.
- Expiry: A recorded expiry date or trigger event. Most banks will look to tie expiry of their bank guarantee to expiry of the initial lease term. Landlords should consider including a buffer period beyond the lease expiry to deal with any tenant default that only becomes apparent at that time (for example, tenant reinstatement default).
- Requirements for demand: The information that any landlord demand notice must contain in order to be accepted as valid by the bank. Banks will need to ensure the guarantee clearly stipulates all information the bank will require in order to make payment, and that it is only obliged to accept demand notices that strictly comply with those requirements (because, otherwise, the bank’s ability to call on the tenant’s security could be prejudiced). Similarly, landlords will need to carefully consider whether they will have all such information available when it comes to calling on the guarantee. Often the guarantee will include a prescribed form of demand notice.
No governing legislation – so add terms to the lease
There is no legislation governing the use of bank guarantees in the context of leases, so landlords and tenants should agree what is to happen to the bank guarantee when certain events occur under the lease. These terms should be agreed as part of the initial lease negotiation and documented in the terms of the deed of lease. Examples of relevant events include:
- Rent reviews: Because the bank guarantee will be for a sum specified at the commencement date, if the rent goes up at review the original guarantee amount will not cover as long a period of arrears as it once did. Landlords may want a replacement or additional bank guarantee.
- On renewal or extension of the term: Landlords may want the bank guarantee to cover any renewal term but tenants may be seeking a release or partial release of a bank guarantee if they have punctually paid the rent and complied with the terms of lease up to that date.
- On assignment of the lease: Tenants wishing to assign a lease do not usually want continuing contingent risk under a bank guarantee on premises they no longer occupy.
- On sale of the property: Landlords usually want to be able to sell the property (and lease) with the benefit of the occupying tenant’s bank guarantee.
Don’t put it in place and forget about it
Generally, bank guarantees are of high commercial importance before lease commencement. Tenants should make sure the correctly executed original bank guarantee is delivered to the landlord at the time stipulated by the lease documentation, as it will often be a pre-requisite for handover of the premises. Once received, landlords should ensure the original guarantee is stored in a secure location, as the bank will often require the original to be returned with any demand notice.
Our Real Estate team is happy to discuss any questions you may have on bank guarantees in lease transactions.