indemnity-expert

What is an Indemnity Agreement?

Indemnity Agreement (or Guarantee) = Third party (guarantor) becomes liable for tenant's obligations under lease.

Parties:

• Landlord: Creditor seeking additional security
• Tenant: Primary obligor under lease (usually corporation with limited assets)
• Guarantor: Third party providing guarantee (typically tenant's principals, parent company, or affiliates)

Purpose: Provide landlord with additional creditworthy party to pursue if tenant defaults.

Indemnity vs Guarantee

Guarantee (common law):

• Secondary obligation: Guarantor liable only if tenant defaults first
• Dependent on tenant's liability: If tenant's obligation void/unenforceable, guarantee fails
• Guarantor has defenses: Can raise tenant's defenses (lease invalid, landlord breached, etc.)

Indemnity (stronger):

• Primary obligation: Guarantor liable directly, without landlord first pursuing tenant
• Independent of tenant's liability: Even if tenant's obligation void/unenforceable, indemnity survives
• Guarantor has fewer defenses: Cannot raise most tenant defenses

Modern practice: Most commercial lease "guarantees" are actually indemnities (structured as primary obligations with waiver of defenses).

Language creating indemnity: "Guarantor is primarily liable and Landlord may proceed directly against Guarantor without first pursuing Tenant."

When Landlord Requires Guarantee

Weak tenant credit:

• Startup with no operating history
• Thin capitalization (minimal assets)
• Poor credit rating or history of defaults
• Professional corporation (assets tied up in accounts receivable)

Tenant is special purpose entity:

• Numbered company created solely to hold lease
• Subsidiary with no independent assets
• Single-purpose corporation

High-risk business:

• Restaurant (high failure rate)
• Retail (market volatility)
• Business with short operating history

Standard practice: Personal guarantees common for leases where tenant is closely-held corporation and principals have substantial personal net worth.

Key Indemnity Provisions

Guarantor's Covenants (Core Obligations)

"Absolute and unconditional" language: "Guarantor unconditionally and irrevocably guarantees full and prompt payment and performance of all Tenant's obligations under Lease, without demand, presentment, protest, or notice."

Effect: Guarantor liable for:

• All base rent and additional rent
• Operating expenses
• Tenant's repair and maintenance obligations
• Indemnification obligations
• Damages for breach
• Costs of enforcement (legal fees, court costs)

Joint and several: If multiple guarantors, each is fully liable (landlord can pursue any or all).

"Absolute and Unconditional" Provisions

Standard clause: "This Indemnity is absolute and unconditional and shall not be discharged, impaired, or affected by: (a) Any extension of time, indulgence, or modification of Lease granted to Tenant; (b) Any assignment, subletting, or transfer of Lease; (c) Tenant's bankruptcy, insolvency, or dissolution; (d) Any failure or delay by Landlord in enforcing Lease against Tenant; (e) Any defect in Landlord's title or right to lease; (f) Any change in Tenant's corporate structure or ownership; (g) Any defense, setoff, or counterclaim available to Tenant."

Effect: Guarantor cannot escape liability based on changes to lease, tenant's financial condition, or landlord's actions.

Waiver of Defenses

Guarantor waives:

• Statute of Frauds: Can't argue indemnity should be in writing (it is)
• Bankruptcy discharge: If tenant goes bankrupt, guarantor still liable (bankruptcy discharges tenant but not guarantor)
• Modifications: Landlord can modify lease with tenant without guarantor consent; guarantor still liable
• Release of tenant: If landlord releases tenant, guarantor remains liable (unusual - typically guarantor released if tenant released)
• Notice and demand: Guarantor liable without landlord first demanding payment from tenant

Most important: Guarantor waives right to assert tenant's defenses (e.g., landlord breached lease, lease is invalid, rent is excessive).

Continuing Guarantee

"Continuing guarantee" language: "This Indemnity is a continuing guarantee covering all of Tenant's obligations under Lease as originally executed and as amended, extended, or renewed."

Effect: Guarantor liable for:

• Original lease term AND all renewals/extensions (even if term extends 10-20 years beyond original expiry)
• All amendments (rent increases, expanded premises, additional obligations)
• Holdover rent (if tenant remains after lease expiry)

Guarantor's concern: Liability extends indefinitely unless indemnity contains sunset provision or release mechanism.

Survival After Lease Termination

Standard clause: "Guarantor's liability survives termination of Lease and continues until all of Tenant's obligations are fully satisfied, including damages, arrears, and costs of enforcement."

Effect: If lease terminates due to tenant default, guarantor liable for:

• Rent arrears up to termination
• Accelerated rent for remaining term (if lease permits)
• Landlord's damages (re-letting costs, tenant improvement costs for new tenant, rent shortfall)
• Legal fees and costs of enforcement

Guarantor's liability can exceed total rent: If landlord re-lets at lower rent, guarantor pays difference for remaining term.

Guarantor's Negotiation Points

Limited vs Unlimited Guarantee

Unlimited guarantee (landlord prefers): "Guarantor's liability is unlimited in amount and duration."

Limited guarantee (guarantor negotiation):

• Dollar cap: "Guarantor's maximum liability is $[X]" (e.g., 12-24 months' rent)
• Time limit: "Guarantor's liability terminates [2 years] after Lease commencement if Tenant not in default"
• Both: "Guarantor's liability capped at $[X] and terminates after [2 years] good performance"

When landlord accepts limited guarantee: Strong tenant credit improving over time, guarantor has limited net worth, competitive leasing market.

Release Provisions (Burn-Off)

Automatic release after good performance: "If Tenant performs all obligations for [24] consecutive months without default, Guarantor is automatically released."

Conditional release: "Guarantor released if Tenant maintains minimum net worth of $[X] and is not in default."

Landlord's resistance: Rarely grants automatic release. If release granted, typically requires 2-3 years good performance + financial covenant.

Guarantor's Right to Cure

Standard clause (guarantor-favorable): "Landlord shall provide Guarantor with copies of all default notices sent to Tenant. Guarantor has right to cure defaults within same time periods as Tenant."

Effect: Gives guarantor opportunity to cure before landlord terminates lease. Protects guarantor's interest (lease termination = accelerated liability).

Landlord's version: Landlord not required to give guarantor notice; can proceed directly against guarantor.

No Amendments Without Guarantor Consent

Guarantor protection: "Landlord and Tenant shall not amend Lease to materially increase Tenant's (and thereby Guarantor's) obligations without Guarantor's consent."

What triggers consent requirement:

• Rent increase >10%
• Term extension beyond current expiry
• Expansion of premises (increases rent)
• Addition of material new obligations

Landlord's pushback: Refuses limitation on amendments. Compromise: Guarantor consent required for material changes only.

Landlord's Enforcement Strategy

1. Immediate recourse: Landlord can pursue guarantor immediately upon tenant default (doesn't need to sue tenant first, exhaust tenant's assets, or obtain judgment against tenant).

2. Joint and several liability: If multiple guarantors, landlord can pursue any one for full amount (guarantors have right of contribution among themselves).

3. Enforcement costs: Guarantor pays landlord's legal fees and costs of enforcement (typically in addition to liability cap if any cap exists).

4. Interest: Guarantor liable for interest on unpaid amounts (at rate specified in lease, often 18-24%/year).

5. Set-off: Landlord can set off any amounts owing by landlord to guarantor against guarantor's liability (if guarantor also a tenant in building, landlord can set off guarantor's security deposit).

Bankruptcy-Proof Provisions

Standard indemnity is bankruptcy-proof:

• If tenant goes bankrupt, tenant's lease obligations may be discharged or disclaimed, BUT guarantor remains liable
• Guarantor cannot use tenant's bankruptcy as defense
• Landlord can pursue guarantor for full lease term obligations even if tenant disclaims lease in bankruptcy

Key bankruptcy-proof language: "Guarantor's liability is not discharged or affected by Tenant's bankruptcy, insolvency, receivership, proposal, or any other insolvency proceeding."

Why this works: Guarantee is separate contract between landlord and guarantor. Tenant's bankruptcy doesn't affect guarantor's contract.

Guarantor's exposure in tenant bankruptcy: If tenant disclaims lease, guarantor liable for greater of:

• Rent for notice period required under bankruptcy legislation (typically 3-6 months), OR
• Landlord's damages (accelerated rent for remaining term, re-letting costs, rent differential)

Guarantor Due Diligence

Before signing indemnity, guarantor should:

1. Review entire lease: Guarantor liable for ALL tenant obligations (not just rent). Review:

• Operating expense escalations (can increase significantly)
• Repair and maintenance obligations
• Insurance requirements
• Environmental indemnification
• Default remedies and damages

2. Assess tenant's financial strength: Is tenant likely to perform? If weak, guarantor will be called on.

3. Negotiate limitations:

• Dollar cap (12-24 months' rent)
• Time limit (burn-off after 2 years)
• Material amendment consent
• Notice and cure rights

4. Confirm indemnity is required: Can tenant provide alternative security (larger security deposit, LC)?

5. Understand exposure: Maximum liability can be 5-10x annual rent (if tenant defaults early in 10-year lease and landlord can't re-let at same rate).

Common Issues

Issue 1: Tenant modifies lease, increases rent Guarantor's position: Not liable for increased rent because didn't consent to amendment. Landlord's position: Indemnity covers all amendments; guarantor's consent not required. Result: Depends on indemnity language. If indemnity says "absolute and unconditional," guarantor liable. If indemnity requires consent for material amendments, guarantor not liable for increase.

Issue 2: Landlord delays enforcing against tenant, damages increase Guarantor's position: Landlord should have mitigated damages by terminating lease sooner. Landlord's position: Indemnity says landlord has no duty to mitigate or enforce promptly. Result: Generally landlord wins - indemnity allows landlord to delay enforcement without releasing guarantor.

Issue 3: Tenant assigns lease to stronger credit, guarantor wants release Guarantor's position: New tenant is stronger credit; guarantor should be released. Landlord's position: Indemnity is continuing guarantee covering all assignees; no release. Result: Guarantor remains liable unless indemnity contains release provision for assignments to creditworthy assignees.

Issue 4: Guarantor dies, estate claims indemnity terminates Guarantor's estate position: Personal guarantee terminates on guarantor's death. Landlord's position: Indemnity survives guarantor's death; estate remains liable. Result: Indemnity survives death (it's a contract binding on estate). Guarantor's estate liable.

Best Practices

For Landlords:

• Require indemnity from tenant's principals if tenant is thin capitalization or startup
• Use "indemnity" language (primary obligation) not "guarantee" (secondary obligation)
• Include "absolute and unconditional" provisions
• Continuing guarantee covering all amendments, renewals, assignments
• Survival after lease termination
• No release provisions (or release only after 3+ years good performance)
• Joint and several if multiple guarantors
• Require personal financial statements from guarantors before accepting

For Guarantors:

• Negotiate limited guarantee (dollar cap + time limit)
• Burn-off after 2-3 years good performance
• Guarantor consent for material lease amendments
• Notice and cure rights
• Release if tenant assigns to creditworthy assignee
• Alternative security (larger deposit, LC) instead of personal guarantee
• Consider whether guarantee is appropriate for risk (don't guarantee if tenant likely to fail)

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