Picture this. Your name is Shelly Smith. A few years after graduating dental school, you purchase a dental practice from a retiring practitioner at the edge of town. As part of the transaction, you enter into a lease assignment for the space – you list yourself, Shelly Smith, D.D.S., as tenant to the lease. From this point forward, you run your practice from a fairly deserted plaza at the edge of your beloved city. Months pass, traffic to your clinic isn’t the best and, after a year or two in business, you begrudgingly conclude that business isn’t doing as well as you hoped. Cash flow is tight, and, ultimately, you reach the point where you miss more than a few rent payments. You default on your lease. Your landlord comes to collect and, lo and behold, the realities of a tenancy held personally show its true colors. Your personal liability is at the forefront and, unfortunately, your landlord reaches out to you (and to your personal assets) to collect on what’s owed.
A circumstance where your personal assets are at risk are, obviously, not ideal. This article will explore the differences between corporate and personal tenancies, how personal tenancies differ from personal guaranties, and general step-downs when negotiating personal liability with your landlord.
Considering Your Vehicle: Personal Tenancies vs. Corporate Tenancies. Understandably, a very common choice vehicle for your tenancy is often your name and yourself personally – why not? It seems like the obvious choice. But, it’s important to understand that the vehicle within which you carry your lease can vary – other options are available beyond holding a tenancy under your own name and designation. Specifically, you can, should your landlord agree, enter into a lease as a corporation to limit the personal consequences described above. The corporate vehicle provides you with greater privacy, permits you to separate your personal assets from business assets and, more importantly, from your obligations under your lease agreement. Ultimately, holding your tenancy within a corporation insulates you and your personal net worth, should the business fail and an event of default becomes inevitable.
Personal Guaranties vs. Personal Tenancies. Often, the terms “personal tenancy” and “personal guaranty” are used interchangeably. However, consider the following examples:
Example: A lease held personally: Shelly Smith, D.D.S.
Example: A lease held within a corporation: Shelly Smith Dental Clinic Inc.
Example: A personal guarantee: Shelly Smith Dental Clinic Inc., with a personal guarantee provided by Shelly Smith
It’s important to understand that these concepts may be considered differently – a personal tenancy can be considered a lease vehicle while a personal guarantee can be considered lease insurance for the benefit of the landlord.
Corporate Tenancies and Personal Guaranties:
Ensuring that a tenant pays rent on time is obviously a matter a landlord takes seriously – but it’s an obligation that is, very often, unsecured. Therefore, while there are indeed options to how your tenancy can be held, a corporate vehicle isn’t a right nor are you automatically entitled to it – tenancies held under a corporation very often accompany some sort of personal guarantee.
Consider Shelly’s case – Shelly is a brand-new graduate, fresh out of dental school, taking over a practice location where she’s virtually unknown to the landlord, without an established reputation in her profession (yet), and who hasn’t built up a reputation of reliability with her landlord. Commercial landlords ultimately strive to protect their own interests. Meaning, should Shelly request to hold her tenancy under Shelly Smith Dental Clinic Inc., it would be entirely unsurprising for her landlord to consider and request some sort of security, in the event that Shelly the New Grad defaults on her lease – such as the personal guarantee. When requiring the personal guarantee from Shelly, the landlord therefore has some semblance of insurance and further recourse against Shelly personally, should her business not proceed according to plan – Shelly would therefore still be personally responsible for defaults in rent despite the corporate vehicle she wishes to hold her tenancy in.
On the other hand, consider Greg the Veteran – he has occupied his space for over 20 years, with a lease held under Greg Johnson, D.D.S. He has always paid his rent on time, and is, by all accounts, a very reliable tenant with steady flow of business. His lease comes up for renewal this year, and he puts forward a request to transfer his lease to a corporate vehicle, Johnson Family Dental Clinic, Inc., for both tax and liability reasons. From a commercial landlord’s perspective, when considering reliability, financial consistency, and trustworthiness – Greg the Veteran seems like a safer bet in comparison to Shelly the New Grad, when it comes to ensuring that the risk of default is minimal. In Greg the reliable Veteran’s case, there is certainly likelihood that the request to strike personal liability may be accepted because Greg the Veteran has proven himself to be a party the landlord can rely on.
Landlord Negotiations and Your Protections
Personal guarantees are not an insignificant matter. By signing one, you put your own personal net worth at risk. A saving grace for Shelly the New Grad (or, newer dentists or tenants in general) is that leases are certainly negotiable. While it’s common for landlords to request a personal guaranty, there are still several avenues of protection which could, certainly, lead to the ideal circumstance: a lease held within a corporation, with a personal guaranty that isn’t required or entirely struck.
There are several step-downs that can be offered during your lease negotiation. For example, setting a time limit to your guarantee may be offered (Example: Shelly Smith Dental Clinic Inc., with a personal guarantee provided by Shelly Smith for the first two years of the lease term only). Negotiations may also include setting a limit to your guarantee amount (Example: Shelly Smith Dental Clinic Inc., with a personal guarantee provided by Shelly Smith for an amount up to, and not exceeding, $80,000).
The Right to Distrain
Keep in mind, however, that a corporate vehicle doesn’t protect you from blatant acts of wrongdoing nor does it protect you for default. No, it isn’t a free for all.
In specific states and provinces across North America, the right to distrain in favor of landlords does indeed exist (and, unfortunately, reinforces the requirement of personal guarantees). Consider the case where Greg the Veteran, with a lease under Johnson Family Dental Clinic, Inc. and without a personal guarantee, unfortunately and surprisingly defaults on his lease. Depending on the laws in your state or province, landlords do indeed have the ability to collect on their rent by pursuing the assets and goods of the tenant – and, should Greg the Veteran, in a panic, clear out his assets from the premises without his landlord’s knowledge, some states or provinces provide the landlord with the right to pursue damages from the tenant, for even up to double the value of the goods and assets removed from the premises by Greg.
It’s therefore important to understand that shell corporations do not necessarily make you invincible and untouchable. Greg the Veteran, as tenant and business owner, still has the obligation to fulfill the obligations his business agreed to in a binding contract.
There are various vehicles in which personal obligations may arise in a commercial leasing context. Overall, be aware of your options, its consequences on your business and taxable liability, limits you can negotiate to your personal liability, and the protections you have available, should you demonstrate yourself to be a viable candidate for a lease held within a corporate vehicle.
Cirrus Consulting Group has had many years of experience negotiating with landlords on a variety of issues. Consider hiring professional negotiators to create a properly structured lease agreement for you, discuss your options with respect to your lease vehicle and personal liability, and help ensure the success of your property and your dental practice.
About the Author
Barbara de Dios, B.A. LL.B | Legal Counsel, Canadian Dental Services
Barbara de Dios is Corporate Counsel at Canadian Dental Services Corporation. Prior to joining CDS, she worked as Associate Lawyer at Cirrus Consulting Group, working on behalf of clients across North America in connection to the review, drafting, and negotiation of commercial lease agreements in various states and provinces. She has also worked as associate counsel for a capital markets and investment company based in downtown Toronto, specializing in corporate governance and general corporate/commercial law, where she also previously completed her articles. Barbara graduated from the University of Toronto and earned her legal degree from the University of Birmingham. She was called to the Ontario bar in September 2016.