You’ve probably heard the phrase “bank guarantee”, or “BG” for short, thrown around in conversation with offices leases.. But what does this somewhat elusive phrase mean, exactly? How is it significant to you? Simply put, bank guarantees underpin the financial performance of the lease or are in default of their lease, the bank guarantee can be drawn upon by the property owner.
What is A Bank Guarantee?
A bank guarantee provides a security bond over a property or asset to make sure your financial position is protected. Bank guarantees can be granted for commercial leases, meaning the financial institution will cover the tenant’s lease obligations if they default on their rental agreement.
The financial contract, made between a lessor, lessee and the bank, must set out the purpose and terms, a description of the property, the amount of the guarantee and the timeline. The Australian Banking Association sets out a range of requirements for a bank guarantee, advising independent legal and financial advice.
The benefit of a bank guarantee is that it provides certainty for both parties that their liabilities will be covered. There is certain financial terminology around bank guarantee agreements, for example, the financial instrument of the bank guarantee being a banker’s acceptance. This simply means that the bank is responsible for the potential liability, and not an individual.
How long it takes to process a bank guarantee depends on your financial institution. The Commonwealth Bank of Australia notes organisations are more likely to be approved for a bank guarantee if their accounts have not been overdrawn or in arrears in three months, if they have not been declared bankrupt, and have cash reserves.
How Do Bank Guarantees Work?
Bank guarantees in commercial property work to protect the Owner from the tenant failing to pay their rent. So, how do bank guarantees work?
The three-way agreement is secured by an asset, cash or other asset, and the financial institution agrees to pay a set amount in the event of rental default. Bank guarantees generally attract fees and charges. The agreement should be assessed by a lawyer to determine its terms and conditions, and the expiry date of the bank guarantee.
In some cases, the prospective landlord may ask the lessor to provide security or assurance that the lease will be paid. This protection can be achieved by either a bank guarantee or a security deposit, which is a deposit similar to a bond that the owners can use if the rent is not paid.
Owners can access their bank guarantee by contacting their financial institution. The recovery of funds is not always assured, however. In 2014, a court determined the property owner could only access the funds once it was proven in court that the tenant had breached.
What are the Different Types of Bank Guarantees?
There are different ways to structure a bank guarantee, depending on the form of security held by the financial institution and the entity establishing the contract.
One way to set up a bank guarantee is to establish a term deposit as the security. Another way is to utilise the value of real estate as the security asset. It is worth noting that property-secured guarantees do not accrue interest, however funds in a term deposit will earn interest.
Another form of security over an asset, however, is an insurance bond. While not used as much as bank guarantees, it provides a similar promise of payment if the lease is breached. However, it does not require tangible collateral to secure the guarantee and it is not an Owners preferred means of security.
Some people opt to provide personal guarantees over their lease, agreeing that directors an individuals or shareholders take on the obligation of the lease agreement.
How Do You Negotiate A Bank Guarantee?
Banks recommend you seek legal and financial advice before entering into a bank guarantee with your lessor or lessee. It is a legal contract and companies and individuals have ended up in lengthy court proceedings. There are ways to negotiate with the Owner, to demonstrate your financial capacity, if you do not wish to, or cannot, obtain a bank guarantee. This could include funding the fit-out of the premises, providing a personal guarantee or negotiating an incentive structure. There is also a relationship between the incentive amount, structure (being rental abatement or upfront cash for a fit out) and security. The less incentive required as "cash" gives tenants leverage to negotiate a lower bank guarantee.