Don't Rely on Guarantor's Personal Liability as Extra Assurance
If you’re unsure that a prospective tenant will be able to pay its rent, getting a guaranty can assuage your fears and protect you from not being able to collect what the tenant owes. While a tenant might be able to produce a third party who’s willing to act as a guarantor on the tenant’s promise to pay—that is, the guarantor will step in and perform the lease obligations of the tenant if the tenant fails to do so—that strategy works only if you can actually hold the guarantor to its promise. Some owners try to go one step further, by holding the guarantor personally liable for breaches. But in some situations, a technicality can work in the guarantor’s favor, letting it off the hook personally if the tenant’s company wasn’t incorporated during the lease. Recently, a New York office building owner learned the hard way that a tenant’s incorporation status can relieve it of personal liability—and that part of due diligence before signing a lease should include determining that status.
Case on Point
A company that specialized in disc jockey (DJ) services used a guarantor to secure its lease with the owner of the space. The tenant had been incorporated in Delaware in the past, doing business as a limited liability company (LLC). The corporation had dissolved by the time the owner and tenant signed the lease, but the owner wasn’t aware of that.
The tenant vacated the space before the end of the lease, still owing unpaid rent. The owner sued the tenant and sought to hold the guarantor personally liable in addition to being liable under the guaranty.
The owner argued that a person who signs a contract on behalf of a dissolved corporate entity is personally liable under the contract unless the contract was necessary to wind up the company’s affairs. And, as a result, the guarantor was responsible for the breach.
The company annulled its dissolution after it vacated its space. The trial court pointed out that as a general rule, when a dissolution is annulled, the entity’s corporate status is reinstated and contracts entered into during the period of dissolution (here, the lease) are “retroactively validated.” A guarantor won’t be held personally liable for the obligations undertaken by the entity while it was dissolved if a reinstatement of the corporation resulted in the lease being valid after all.
While it was true that officers or directors of corporations could be held liable if there was a showing of fraud or misrepresentation, here, the guarantor (who was an officer of the tenant’s company) hadn’t failed to disclose the dissolution of the tenant’s company to the owner for the purpose of fraudulently inducing it to enter into the lease with a defunct company. Importantly, the trial court pointed out that information as to corporate status is easily available and the owner could have verified that at any time prior to signing the lease.
Door Swings Both Ways After Revival
The trial court stressed that after a limited liability company’s revival, “it shall be as exclusively liable for all contracts, acts, matters, and things made, done, or performed in its name and on its behalf by its members, managers, employees, and agents prior to its revival as if its certificate of formation had at all times remained in full force and effect,” the trial court emphasized. So the guarantor still was liable under the terms of the guaranty. For that reason, the court refused to dismiss some other claims by the owner, including a claim for back rent and a claim that the tenant had damaged the space prior to moving out.
It’s a good idea before signing a lease with a tenant, to include as part of your due diligence confirming that the tenant’s company is currently incorporated. And if it’s not, but you’re still willing to sign the lease as long as there is a guarantor, understand that you can’t rely on the guarantor being personally liable later for a breach. The guarantor can let itself off the hook for personal liability if the company annuls its dissolution [115 W. 27th St. Assoc. LLC v. Perez, August 2016].