BiggerPockets

When Tenants Go Bad...

In a struggling economy, tenants often leave before the end of their tenancy, leaving months of unpaid rent and damage to the property. In such situations, landlords are also often stuck with thousands of dollars spent on tenant improvement work, brokerage, and costs of re-letting the premises. A landlord's claims for unpaid rent, lost rent, brokerage commissions, property damage, and costs related to re-letting the premises can be substantial. However, in bad times, defaulting commercial tenants usually do not have any money and defaulting corporate tenants can easily dissolve themselves. Therefore it is very difficult to recoup these losses.

Here are some ways that a landlord can protect itself:

(1) Personal Guaranty. A landlord should always try to get a personal guaranty from the company's owners, officers or board of directors (especially if the tenant is a new company with little credit history). It is not uncommon for a landlord to require guaranties from the principals or parent corporations of higher risk tenants. While a small company may not have any assets, the owners often own homes or other property on which a judgment can be levied. If there is a risk of losing the potential tenant over this issue, a landlord can negotiate the terms of the guaranty. Depending on the tenant's financial condition, market conditions and a landlord's exposure, the landlord may want to consider a limited personal guaranty, e.g., a cap on the amount or a gradually decreasing amount.

(2) Letter of Credit. Demand a letter of credit from the tenant's bank for a specified amount to secure the tenant's obligations under the lease. If the tenant defaults under the lease, then the landlord can draw on the letter of credit. A letter of credit is an independent obligation of the issuing bank. Therefore, the issuing bank must honor the draw on the letter of credit even if the tenant is insolvent and even if the parties are litigating over issues of default or the amount of damages. This is a huge advantage. From a tenant's perspective, a letter of credit may be preferable to a large security deposit because it does not tie up large amounts of tenant's cash.

(3) Attorneys' Fees Provision in the Lease. This provision allows the prevailing party to recoup its attorneys' fees in litigation. This makes it worthwhile to pursue a defaulting tenant because the landlord can recoup its legal expenses.

(4) Higher Security Deposit. It is not uncommon to demand up to six months worth of rent as security deposit in commercial leases.

(5) Bank Records and Identification. Have the tenant fill out a new tenant questionnaire that asks for personal information such as home address, drivers' license number, and social security number. This information will come in handy when you need to serve a tenant or its guarantors with a lawsuit or need to chase down his or her assets. Also keep a copy of a rent check from the tenant in your file so that you have the tenant's bank name, branch and account number for collection purposes.

(6) Photographs of Damage. Soon after a tenant vacates or abandons the premises, take pictures of the premises and damage, if any. A picture is worth a thousand words.

With some or all of these protections in place, it may make sense to pursue a tenant that has gone out of business. For example, while the company may be insolvent, the guarantors often have homes or other properties which the landlord can pursue or lien after judgment. With an attorneys' fees provision, the landlord can add any legal fees to the amount owing. Lastly, where a party is guaranteeing the company's performance, you may have a much better chance of settling up front to get the debt paid. If not, a lawsuit to collect the amount owing is often simple, cost efficient and straightforward.

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