While pro forma in most New York City leases, outside the city, “good guy” clauses have to be requested by the tenant and carefully negotiated. A “good guy” clause is mistakenly thought of as a get-out-of-jail free card, where only the tenant benefits, but the clause is more complex, more nuanced.
In a nutshell, a “good guy” clause enables the tenant to change the terms of the lease mid-stream, impact the landlord’s security, and potentially walk away from a leased property before the term-end, provided all the conditions of the clause are met.
Looking from each side, landlord and tenant, the clause can actually be a benefit to both parties in different ways.
For the tenant, and depending on how it is negotiated, it can be used to: (1) release a guarantor from ongoing personal responsibility for the lease before the lease term expires; (2) early-term a lease; or (3) convert a fixed term lease to a month-to-month tenancy.
For many landlords, particularly those that lease to small businesses or start-ups, a personal guaranty is a prerequisite. That guaranty can adversely impact a tenant for the life of the lease, generally five years, or more. One way to minimize the exposure (and the guarantor’s ability to borrow elsewhere) is to use the “good guy” clause to release the guarantor after a fixed period of time (perhaps half the lease term) if all of the rent is current, the premises well kept, and all of the other lease terms honored. There may also be times when the landlord has invested in tenant improvements, and those unamortized improvements may also have to be paid back in exchange for the release. Same with unamortized lease commissions.
Another tenant use of the “good guy” clause is to “early term” a lease. Let’s say business has been disappointing, or adjacent spaces have been vacant too long, or the foot traffic promised doesn’t materialize, or adjacent retail is notably down-market or doesn’t align with a tenant’s offerings: the “good guy” can be used to terminate a lease before its natural expiration, again if all of the conditions of the clause are met.
Another option, and this one may work for both the landlord and the tenant, is to exercise the “good guy” in a manner that converts a term lease to a month-to-month lease before the natural lease term expires. This works for the tenant, as it enables the tenant to continue operating without the long-term commitment. It could also work for the landlord, as the landlord can terminate the lease (generally with one to two months’ notice) for a better credit-rated tenant paying a higher rent for a term longer than what remains on the underlying lease, especially in a climate or rising rents or inflation.
The drawback for the landlord with a “good guy” is of course the lack of certainty for the long-term income stream. It also can make financing or selling the property harder, as the income stream becomes hypothetical or illusory. A landlord may have to bargain with the tenant to waive its “good guy” rights should the landlord need to refinance or sell. Lenders and buyers will generally devalue a lease containing an unexercised but viable “good guy” clause.
To exercise a “good guy” clause, the tenant generally must make the landlord whole, reimbursing it for unamortized tenant improvements and commissions. The landlord can also charge an administrative fee, sometimes a month or two of extra rent, as a condition of releasing a guarantor or a tenant.
The clause can also provide a release of the guarantor at the exercise of an option period, provided that all obligations under the underlying lease were met – the “good guy” can be exercised along with the option, effectively releasing the guarantor’s obligations under an option or lease renewal period, leaving only the corporate entity or LLC liable on the lease obligations.
The tenant usually gets only one bite at the “good guy” apple and must decide if it wants to act in advance of the exercise date. Of course, there can be more than one exercise date, such as at half-term, or at the end of an annual occupancy date, but most common is a single do-or-die date for exercising the clause.
In sum, “good guy” clauses should be carefully negotiated to accomplish specific ends. They can be landlord or tenant friendly. They need to be understood as a tool to manage an investment in the landlord-tenant relationship, and not simply viewed as a tenant wanting a way out of a lease before it even has the keys to the front door.