When negotiating a guaranty, a tenant’s guarantor may seek an arrangement limiting its liability to set a “dollar cap” amount that subsequently decreases—or “burns off”—over the term of the lease. While accepting a decreasing dollar cap can help you close the deal, it can also come back to burn you if you’re not careful. 

One big risk is ending up with a dollar cap that’s low or that burns off too fast, leaving you without adequate protection when and if the tenant goes belly up. The good news is that you can protect yourself by including the right safeguards in your guaranty agreement. Here’s a look at the five protections attorneys say you need, as well as a Model Guaranty Clause you can adapt for use in your own decreasing dollar cap guaranty agreements. 

Phase 1. Negotiate the Decreasing Dollar Cap Guaranty Business Points

There are many ways to structure a decreasing dollar cap in a guaranty. Example: Where a tenant signs a 15-year lease, you may agree on a burn-off period to occur over the first 10 years of the lease term, with the dollar cap decreasing by 10 multiplied by the original dollar cap amount each year. 

Alternatively, you might provide for the dollar cap to decrease only twice during the 10-year burn-off period, e.g., by one-half in the fifth year of the lease term with the remaining one-half being eliminated in year 10.

To make any kind of deal, the landlord, tenant, and guarantor will have to negotiate and reach agreement on four crucial business points:

• The initial dollar cap amount;
• The length and timing of the burn-off period;
• The date(s) each decrease in the dollar cap amount will take place, which is typically the anniversary of the lease commencement or other key date in the lease; and
• The amount of each dollar cap decrease.

In addition to bargaining leverage, the outcome of negotiations on these points will depend on factors such as the tenant’s net worth, type of business, track record, future prospects, and the size of the security deposit. 

Phase 2. Put 5 Legal Safeguards in the Guaranty Agreement

Once you reach agreement on the business points, you face the challenge of drafting a decreasing dollar cap guaranty agreement that will afford you maximum legal protection. According to attorneys, there are five basic things a landlord must do: 

1. Ensure initial dollar cap is high enough to cover up-front lease costs. The starting dollar cap amount listed in the guaranty agreement should be high enough to cover at least your out-of-pocket lease costs should the tenant default early in the lease term. Such costs may include broker’s commissions, buildout expenses, improvement allowances, rent concessions, and buyout payments made to a previous tenant to make the space available to the current tenant. An initial dollar cap amount representing only a fraction of the total rent the tenant owes may be adequate, as long as it covers these up-front costs, attorneys suggest [Clause, par. a].  

2. Exempt certain expenses from dollar cap. There are certain costs that you should specifically say are not subject to the dollar cap. Key expenses to carve out include:

• Collection costs and attorney’s fees—otherwise, enforcing the guaranty could cost you a lot of money;
• Environmental liabilities you incur as a result of the tenant’s use of the space—which can run into millions of dollars; and 
• Losses and liabilities resulting from the tenant’s negligent or willful misconduct [Clause, par. a].

3. Avoid cap ties to rent payments. Be careful about the wording you use to describe the initial dollar cap once you agree on the amount. Attorneys caution that sneaky guarantors might try to initially cap their obligations by saying they guarantee only the “payment of [X amount, e.g., $100,000] of rent” under the lease. Such language enables the guarantor to claim that the guaranty terminates once the tenant pays that X amount. And that means you won’t be able to go after the guarantor if the tenant subsequently stops paying rent. To avoid this outcome, the guaranty should say that the guarantor’s liability won’t exceed a specific dollar amount, excluding certain costs. This way, the guarantor is responsible for payments up to that amount, and the tenant’s previous rent payments won’t be applied to the cap [Clause, par. a].

4. Set three conditions for dollar cap decreases. Ensure that decreases in the dollar cap are conditional rather than automatic. List three conditions that must be met each time a dollar cap reduction scheduled in the guaranty can take effect: 

Condition 1. Guarantor must provide notice: Condition each dollar cap decrease on the guarantor’s providing you written notice demanding the decrease. Say that notice must be provided within a specific and limited time period, e.g., no later than three months and no earlier than six months, before the decrease is scheduled to take effect [Clause, par. b(i), c(i)].

Condition 2. Guarantor must not be in default: Bar the dollar cap decrease from taking effect if the guarantor is currently or has previously been in default of its obligations under the guaranty [Clause, par. b(ii), c(ii)].

Condition 3. Tenant must not be in default: The no-current-or-previous-default condition for the dollar cap to decrease should also apply to the tenant in terms of its obligations under the lease. Decreasing the dollar cap in these circumstances will only serve to limit the liability of the guarantor that you might have to sue to carry out the defaulting tenant’s lease obligations [Clause, par. b(iii), c(iii)].

Strategic Pointer: Don’t be surprised if the guarantor or tenant pushes back on the second and third conditions by insisting that they be limited to “material” defaults. This is a reasonable demand, attorneys suggest, although you might want to counter by limiting the number of times a tenant or guarantor default—whether material, not material, or cured—can occur in a year (or other specific period) before it does become a bar to the dollar cap decrease.

5. Keep guarantor and tenant on the hook for unpaid obligations. Include language in the guaranty agreement clarifying the impact of dollar cap decreases on the tenant and guarantor’s liabilities. Specifically, say that such decreases won’t release the tenant and guarantor from: 

• Any debts, such as base rent or additional rent, still owing as of the date that the dollar cap is eliminated even if those debts haven’t yet been billed [Clause, par. d(i)]; or
• Guarantor’s obligation to pay all of the expenses the guaranty excludes from the dollar cap in accordance with Section b of the clause discussed above, to wit, the landlord’s recovery costs, attorney’s fees, and costs and losses incurred as a result of the tenant’s environmental liabilities, negligence, or willful misconduct [Clause, par. d(ii)]. 

MODEL GUARANTY CLAUSE

Put Legal Safeguards in Guaranty Clause

Here’s template language to add to a guaranty agreement to protect your legal interests in the event that you must accept a guarantor’s demand to limit the guaranty by establishing a set dollar cap that decreases over the term of the lease. Talk to your attorney about adapting the Model Clause to your particular business arrangement and situation..    

DECREASING DOLLAR CAP

a.         Dollar Cap. Guarantor’s total monetary liability under this Guaranty shall not exceed $_____ (“Dollar Cap”) exclusive of Landlord’s costs of collection and attorney’s fees, and all of Landlord’s costs, liabilities, fines, damages, penalties, judgments, and losses arising from: 

(i)         Tenant’s default under Clause [insert # of clause that addresses tenant’s environmental duties and liabilities] of this Lease; or

(ii)        Tenant’s negligent or willful misconduct.

b.         Decreases in Dollar Cap. If all of the following conditions are met, then Guarantor may decrease the Dollar Cap to [insert amount that is equal to one-half of the initial dollar cap] as of the [insert date, e.g., the first anniversary] of the Commencement Date (as defined in the Lease): 

(i)         Landlord receives from Guarantor a written notice at least [insert time period, e.g., three (3) months but not more than six (6) months] prior to the [insert date, e.g., the first anniversary] of the Commencement Date demanding that the Dollar Cap be reduced to [insert amount]; 

(ii)        Guarantor has not defaulted under any term of this Guaranty on or prior to [insert date, e.g., the first anniversary] of the Commencement Date; and

(iii)       Tenant has not defaulted under any of the terms of the Lease or prior to [insert date, e.g., the first anniversary] of the Commencement Date.

c.         Elimination of Dollar Cap. If all of the following conditions are met, then Guarantor may decrease the Dollar Cap to zero as of the [insert date, e.g., the fifth anniversary] of the Commencement Date (as defined in the Lease)]: 

(i)         Landlord receives from Guarantor a written notice at least [insert time period, e.g., three (3) months but not more than six (6) months] prior to the [insert date, e.g., the fifth anniversary] of the Commencement Date demanding that the Dollar Cap be eliminated; 

(ii)        Guarantor has not defaulted under any term of this Guaranty on or prior to [insert date, e.g., the fifth anniversary] of the Commencement Date; and

(iii)       Tenant has not defaulted under any of the terms of the Lease or prior to [insert date, e.g., the fifth anniversary] of the Commencement Date.

d.         No Release. Neither the decrease in the Dollar Cap in accordance with Paragraph b hereof nor the elimination of the Dollar Cap in accordance with Paragraph c hereof shall constitute a release or discharge of Tenant or Guarantor with respect to: 

(i)         Any obligation or liability that is outstanding or unsatisfied as of the date of the decrease in the Dollar Cap in accordance with Paragraph b hereof or as of the date of the elimination of the Dollar Cap in accordance with Paragraph c hereof, whether such obligation or liability is unbilled or calculated, accrued, or incurred under the Guaranty or the Lease, including, but not limited to, the payment as and when due of Base Rent and Additional Rent (as such terms are defined in the Lease) and any other charges and damages payable by Tenant under the Lease; or

(ii)        Guarantor’s obligation to pay any and all expenses and fees excluded from the Dollar Cap, as required to be paid by Guarantor under Paragraph a hereof.