When the lease outlives the business
After a business falters, its legal obligations live on – but your personal assets can be protected.
Dianne Fernanadez, Keva Juice, Vacaville, Calif.
My son and I opened a small smoothie business two years ago. We did great until the economy fell. We opened it under an LLC, and he has since bought me out. Now, he has to take money out of his personal account to support it every month. He just got a rent reduction of $600 a month, but that won’t be enough. He has it for sale and has a possible offer coming through. If that falls through he is planning to close the doors. He is afraid the landlord will go after his house. I have lost my home and have nothing left, so I’m not too worried about losing my property.
What is the best way to go about getting out of this? What kind of repercussions are we facing, as we still have three years on the lease? We spent $107,000 on the build-out (new tile floors, bathrooms, etc.) as it was a brand-new complex. The landlord inherits this – does this help? The business has no loans against it as we refinanced our homes and/or paid everything in cash. Please help!
By Shara Rutberg, CNNMoney.com contributing writer
Your son’s assets should be protected by his use of an LLC unless he gave a personal guarantee to the landlord or the court “pierces the company veil” that protects against personal liability, says David Sokolow, a professor at the University of Texas Law School. Courts rarely do that – it’s a move typically made against sham companies.
“It’s unlikely that the court would pierce the veil if your son didn’t siphon funds from the firm or use it to perpetrate a fraud on the landlord,” Sokolow says.
The LLC, however, is liable for the remaining three years on the lease. This means the landlord can sue for damages, which would be reduced by any rent he or she gets from a replacement tenant during that time. Additionally, a court may subtract out whatever benefit the landlord receives from the improvements made to the space, though it probably wouldn’t deduct the full $107,000.
There’s no real way to get out of a lease unless the landlord’s willing to renegotiate. However, “as long as the lease was signed only by the LLC and not by you or your son individually, your personal assets should be shielded from the landlord’s claims,” Sokolow says.
Hiring an attorney is expensive, but the experts highly recommend it in your case. Unwinding obligations when a business fails is complicated, and having a professional on your side with expertise in the legal details pays off in the long run.
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DiggI have to disagree with the following.
“A guaranty is virtually impossible to enforce”
I hear you on the premise of being in the business for 50 years. However if the lease is written correctly saying a guaranty is not enforceable is like saying co-signing on a car note is not either.
Now a few of the following exceptions could occur:
1) Termination right is in the lease
2) Economic termination is possibly included
3) Buyout is in the lease
4) Possibly sublease the space (right probably exists)
However one way to likely get out of a guaranty is likely bankruptcy on the personal side.
As far as retail lessor working with the tenant I totally agree, the last thing they want to do is bring lawyers into the game, incur additional expenses, etc…….Thus they were probably more likely to let you out of a lease especially if they could find another tenant…..however the events of the past year plus almost certainly change everything.
A guaranty is virtually impossible to enforce because of numerous legal requirements which can be found in yourlaw library or a commercial attorney. By all means talk to your lessor who knows you and he made a dumb deal and lay your cards on the table but avoid taking an attorney who will only inflame the relationship with the lessor. I know from 50 years experience as a lessor.
In my experience; (if the business fails and there is a personal guarantee) the landlord will market the property once you leave it. If and when he locates a new tenant, he now has a damages amount that was personally guaranteed. If this amount cannot be negotiated then he is entitled to all legal remedies…like a judgement against you personally.
When a tenant jumps his lease in Canada the landlord receives two months rent and nothing more. Do you have anything like this in the States?
Paul Tomas says no commercial landlord gives a one year lease and it would be suicide for the landlord…well,,,they do and can if they want to…and in a bad market rent for a year is better than no rent at all as long as the landlord does not sink finish out money in it…and a landlord WILL do a one year lease or what they say as keeping tenants on short fuses,,,if they have other ideas for the property or that space in 2 or 3 years so they can avoid the hassle and expense of buying out the lease to do what they want to do….so yes,,,,there are cases where a one year lease is done,,and its not super rare these days.
Actually, last year I negotiated a 1-year commercial lease, with a 6-month default clause. And if they had to put a lot into build outs, they should have negotiated more breathing room into the lease. Everything on a commercial lease is negotiable, and should be negotiated. But the time to do that is before the company fails! But, really, many landlords will let you out of a space if you can find a tenant to take over your lease. They don’t want a court fight, either. Especially a publized one.
Chances are a guarantee was signed. LLC’s are probably the least respected of corporate strcutures (partly because they are so simple and inexpensive to form, and thus easier to walk away from) and thus landlords, finance, and mortgage companies generally want more to go after then some LLC (likely no liquid assets) you formed for the sole purpose of running a particular business.
No commercial landlord gives 1 year leases to small spaces like a yogurt shop. Maybe a 3 year deal if you are lucky, most likely 5 years. In all my years in commercial real estate, I have never seen a 1 year commercial lease. That would be suicide for a commercial landlord.
Some lessons learned:
1) Don’t sign a long (5 yr) lease on a brand new, untried business. You can usually get a 1 year with up to 4 option years.
2) The most expensive space is in a new developement because the first tenant has to “build out” the interior, which as you found is a really expensive, delays your opening, and probably not recoverable at the end of the lease.
Obviously the LLC has no assets for the landlord to go after. Any decent attorney can easily help them declare the LLC bankrupt. If the business has failed, move on. Do not keep throwing good money after bad. The landlord will not bother chasing them as they have few assets and the court will not pierce the veil without massive evidence of fraud. The $107,000 in improvements are a loss. Maybe the landlord get get some value but chances are the next tenant will need their own build out anyway.
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I`m only 16,but I`ve looked my father how is he fighting to repay his motgage in any of possible ways he can.So,I wanna tell you that you should sacrifice yourself as long as you can,but if you cannot,I suggest you to sell all your property,then buy yourself a new low priced house,repay all credits or mortgages you may have and open a new small-size business when from you are going to earn and segregate some money for crisis like this.