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Monday, 30 April 2012

Record Insolvencies, Pressure on Lenders & Lease Guarantees

The outlook for the remainder of 2012 is grim as insolvencies rocket to levels not seen since the 1990s, according to a spring report by the Ernst & Young Item Club.

The report also comments that commercial real estate (CRE) portfolios represent a continuing drag on bank profitability.

The sharp drop in property values and downward pressure on rental income have seen many lenders giving “forebearance” to customers by waiving loan-to-value and debt-service covenants, offering payment holidays and extending debt maturities.

Lenders are trying to sit it out in the hope that loan recovery rates will be higher when property prices and incomes eventually recover.

They are also wary of offloading large volumes of distressed sales on to the market, as prices would be hit even further, creating a spiral.

Not surprisingly, the report concludes, banks also remain cautious about extending additional credit to the CRE sector.

The Bank of England recently reported that the amount of bank credit made available in the CRE sector had seen a further decline in the first quarter of 2012, and was expected to fall “significantly” during the second quarter.

All this is happening of course against the backdrop of a double-dip recession.

In this climate, anyone in the business of granting new leases needs to take whatever additional security they can get.

That might mean insisting on a guarantee from a parent or group company.

With smaller companies, often the only available guarantee will be a personal one from a director of the company.

Take great care when accepting personal guarantees.

They may be unenforceable if the guarantor can show he didn’t know what he was signing, or that he was put under pressure to sign a guarantee unwillingly (see my post What Can You Do if Your Tenant Stops Paying or Goes Bust? for more details of a recent case).

At the very least, you need to get written confirmation from the guarantor that he is aware of the risks and was given an opportunity to take legal and financial advice.

You also need to know if the guarantor is financially sound, otherwise the guarantee won’t be worth the paper it’s written on.

You can do an online insolvency search for free. Also, carry out a credit check and get a reference from a bank or accountant.

What are the most common alternatives to a director’s guarantee?

·         Corporate guarantee from another company (not necessarily related). You would still need to carry out financial checks, but they might be easier to do and the guarantee would be less vulnerable to challenge.

·         Instead of getting a guarantee from a director, make him a joint tenant instead, with “joint and several” liability, so he steps into the company’s shoes if the company stops paying. You still need to check his financial soundness though.

·         Rent deposit. If documented in the right way, these give you a fixed (albeit limited) pot of money on which you can draw in the event of a default.

·         Bank guarantee. Arguably the best of the lot, but given the banks’ reluctance to take on more exposure, how willing will they be to give one?

Of course, a guarantor might look a good bet when the guarantee is given, but by the time of the default he might be worthless too, especially if his fortunes have gone down with the company he’s guaranteeing – which is quite likely.

Sometimes, there's simply no protection against failure and that’s the dilemma banks and many investors find themselves in today.

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