Lease Bonds are a type of surety bond often needed to secure the use of property. These bonds guarantee that the Lessee, or person using the property will honor the terms of the lease. These bonds are often used to guarantee payment, but can also guarantee other conditions and performance of lease obligations. Lease bonds usually also guarantee that the property will be returned in good condition, proper insurance will be maintained and sometimes that taxes will be paid.
The party that is leasing the property (the lessee) is called the principal on the bond. The principal pays money to a third-party financial guarantor called the surety or surety bond company. The principal also provides the surety with indemnity and agrees to reimburse the surety for any losses. In return, the surety provides a lease bond to the party providing the use of the property (the lessor). The lessor is referred to as the obligee on the bond. The bond guarantees that if the principal does not fulfill the lease terms, the obligee can make a claim against the bond to the surety. If the claim is valid, the surety will have to pay the obligee. The surety may then seek reimbursement from the principal.
Lease Bonds are a valuable tool to protect lessors. The surety bond company may be easier and faster to collect from than trying to go after the lessee if a default occurs. The surety bond company must also be financially strong and liquid to be licensed by the state.
There are many types of lease bonds but usually they fall into one of two categories. These include private lease bonds and public lease bonds.
Lease Bonds are very common in private leases. Residential and commercial real estate leases often require lessees to post protection to guarantee that payments will be made and terms will be honored. Sometimes these bonds are called “rent bonds” for this reason. While lease bonds are frequently used for commercial property leases, they are also becoming more common for residential leases. Lease bonds can also help lessees obtain better terms in many cases by ensuring that the property owner or developer will be paid.
Lease bonds may also be required when either the property owner or lessee wants to make significant improvements to a property. In order to make this kind of investment, the property owner or developer will usually want to guarantee that the lessee will enter into a long term lease and be able to fulfill the agreement. It may also be required by the property owner’s lender as a condition of lending the property owner money for the project. For example, suppose a grocery store is interested in a retail strip center. They approach the owner about entering into a 15 year lease at the location in exchange for the owner renovating the property to their specifications. This would be a significant investment for most owners and developers. In addition, the location will likely not be suitable for anything other than a grocery store if the tenant defaults. Therefore, the property owner may want a lease bond to guarantee a long-term lease with the grocery store before investing in such improvements.
Those that wish to use public land and property must often sign a lease with the state, municipality or federal government. Public lease bonds are usually a requirement for these leases. Common examples of public leases are airports, government buildings and land usage. Normally, airports are owned by a municipality. Each airline signs a lease to use the airport for business. Lease bonds are a common way to secure these leases. Another example is public land. A utility company may wish to use public land to build solar panels, power plants or other purposes. They may lease land from the entity and use a lease bond to guarantee the terms.
Lease bonds can be considered high risk. They are a type of financial guarantee. Should the lessee not fulfill the lease, the surety could be stuck paying the entire bond penalty. Surety bond companies will look heavily into the financial strength of the lessee, especially on commercial leases.
The term of the lease is an important underwriting factor. The longer the lease, the more risk to the surety. A lot can change with time. Even the best run organizations can suffer financial setbacks. Therefore, when a bond company is guaranteeing a long term lease, they will want to make sure the company has the adequate net worth and liquidity to weather economic downturns.
Whether a lease bond can or cannot be canceled significantly changes the risk. Some lease bonds let the surety cancel by giving notice. These bonds are much less risky. Other lease bonds are non-cancelable. These bonds can present significant risk to the surety bond company. Even if the lessee’s financial position deteriorates, the surety cannot get out of the lease obligation.
The two most common alternatives to lease bonds are letters of credit or cash. Lessors may prefer these two alternatives because they give the lessor more control. Cash and letters of credit can usually be taken with little or no warning or defense to the lessee. The lessee must then bring litigation to get them back. Alternatively, lease bonds require the surety to investigate the claim and make sure it is valid before paying out on the bond in most cases. For this reason alone, lessees often prefer lease bonds while lessors often prefer an alternative.
An advantage for lease bonds is that they do not tie up a lessee’s resources or borrowing ability like cash or letters of credit. The lessee can then use cash or borrowing to meet other obligations, grow or expand while still meeting lease obligations.
Lease bonds are good for lessors as well. Because potential tenants do not have cash or borrowings tied up, they might be more willing to lease property or sign a longer-term lease. Additionally, having more cash and borrowing may allow them to keep meeting their lease obligations.
Another additional benefit for property owners and landlords is bankruptcy protection. Most jurisdictions will include any cash that the lessor is holding as part of the bankruptcy proceeding if the tenant files for bankruptcy protection. That can leave the lessor in a difficult spot. However, most jurisdictions will leave the lease bond in place during the proceedings which gives the lessor protection.
Read more about the differences between surety bonds and cash or letters of credit below.
There are several important bond form considerations for lessors, lessees and surety when using lease bonds. Many of these are negotiable depending on the relationship and the surety’s willingness to negotiate.
Most surety bonds require that the surety investigate and pay the obligee in a timely manner. However, “timely” can vary in opinion. Often, these payment terms can be negotiated to a fair middle ground such as 15 - 30 days from the notice of claim. Usually there is also a cure period that gives the lessee and surety time to rectify a problem.
Who pays for collection costs, legal fees, rent during investigation, ect.? These are all items that can be important and negotiated in advance for all parties on the bond.
For commercial leases, it is typical to require three years of financial statements from the company, a copy of the lease and bank information for the applicant. The proposed lease agreement and terms are vital as the bond is guaranteeing the agreement.
For residential lease bonds such as those needing deposit bonds for apartments, condos and homes, the process is usually simple. A copy of the lease agreement is still needed. In many cases, an application and credit check is all that is needed. Some bond companies will require the applicant to submit personal financial statements as well.
Lease bonds are a great way to protect property owners and developers while allowing tenants to hold onto their cash and borrowing ability. Axcess Surety has experts in surety bonds for both lessors and lessees. Contact us today to see how we can help you with your lease obligations.
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