Use Indemnity Agreement to Ensure Tenant's Viability

Performing due diligence on a prospective tenant is one way to try to determine whether the tenant is financially viable. But what if you end up leasing to a tenant that proves to be a risk, no matter how careful you thought you were when researching it? One example of a risky tenant is one that’s merely a “shell” company—that is, a company that serves as a vehicle for business transactions without itself having any significant assets or operations. The bad news about renting space to a shell company is that you have a tenant that’s a variable on your hands, because if it later defaults under the lease it’ll be harder for you to go after it. The good news is that there’s something you can do before signing a lease with a tenant that will protect you in a shell company scenario: Attach an indemnity agreement to the lease. Here’s how you can make a standard element in many leases fit a specific situation so you’re not left on the hook for a troublesome tenant.

Perform Due Diligence Before Leasing

If you suspect that your prospective tenant may be a shell company, or simply a company that has few or no assets, you should conduct a financial search and credit search, which will uncover the assets of the particular company. You can also ascertain the tenant’s financial strength by asking it for three years of financial statements.

If you’re still not totally comfortable, ask for the tenant to provide an indemnitor who will be primarily liable for the lease obligations—including paying rent—if the tenant defaults. An indemnitor is different from a guarantor, which would be secondarily liable if the tenant defaults.

The problem with a guarantor is that you first have to pursue your options against the tenant to recover what you’re owed, before you go after the guarantor, which can be lengthy and costly. When you use an indemnitor, you can skip that process and go right to the indemnitor for relief.

Using Attachment Saves Time and Money

Ask your attorney about including in your lease an indemnity agreement like our Model Agreement: Protect Against Risks of ‘Shell’ Company. You would include the agreement as an exhibit in an attachment to the lease. Be prepared, however, for the tenant to try to negotiate to use an indemnitor for only the first few years of the lease term. Try to require the indemnitor and indemnity agreement to last throughout the full term.

Additionally, it’s important for you to do a financial background check on the indemnitor, to make sure that you’re actually protected by the indemnity agreement. It’s useful only if the indemnitor really has assets that you can go after in case of default. Remember that, as always, as the owner, you have the final say in what you require from the tenant.