For an investor considering the purchase of a commercial
property, the covenant strength of the tenant(s) and any
guarantor(s) is of central importance. Investment properties are
purchased for the benefit of an income stream and an investor will
wish to be as certain as possible that that stream will continue to
flow. Likewise, a financial institution considering lending to the
owner of an investment property will wish to have comfort that the
rental income will continue to be paid so as to service the
Historically in Jersey, with a more domestically oriented
property market, it was not common for purchasers or funders to
seek to obtain up-to-date financial information in relation to
existing tenants or guarantors. If a building was let to, say, a
local law firm with personal guarantees from the partners,
purchasers and funders could generally satisfy themselves based on
their own knowledge of the local business community.
The commercial property market has, of course, evolved
significantly and continues to do so. Whilst there remains a body
of local investors, many investment properties are acquired by
institutions or funds with no day-to-day involvement in Jersey
business. Furthermore, the profile of tenants and their guarantors
is increasingly corporate. If a guarantee is provided, it will
generally be provided by another corporate entity in the
tenant's group rather than by individuals.
For these reasons, up-to-date financial information in respect
of corporate tenants and guarantors is of increasing importance for
investors and funders. A certain amount of information can be
obtained from public sources but much cannot. Crucially, Jersey
companies (with the exception of public companies and their
subsidiaries) are not required to file accounts. In the
circumstances, it has become common for landlords to require the
inclusion in new commercial leases of express covenants requiring
the provision of financial information.
Such covenants will typically require the landlord to be
provided with annual accounts of the tenant and any guarantor, if
the relevant company does not publish its accounts, within a
defined period after the accounts are prepared. In addition, the
landlord will be permitted to disclose such accounts to financial
institutions proposing to lend money to the landlord and to
potential purchasers of the property, on condition that any such
recipient enters into a confidentiality agreement (non-disclosure
agreement) with the tenant/guarantor. In order to minimise the
scope for argument as to the form of the confidentiality agreement,
an agreed form can be scheduled to the lease.
There are a number of possible refinements of these clauses. For
example, where a tenant is concerned at the prospect of its full
accounts being made available to a competitor, an alternative can
be provided for, such as a certificate from its auditors confirming
certain key financial indicators.
In the absence of any contractual obligation such as this, a
tenant or guarantor cannot be compelled by the landlord to disclose
its accounts, and the landlord may have to offer something in
return if it wishes to have accounts supplied. It is understandable
therefore that landlords are anxious to include such obligations
when negotiating new leases and indeed when an existing lease
requires to be varied for any reason.
Sight of a company's latest accounts are valuable when it
comes to assessing covenant strength but at the same time their
limits should be acknowledged. A company's accounts provide a
snapshot of its financial position at a defined point each year.
Material changes could have occurred in the period between the
year-end date and the date upon which a purchaser or funder
receives a copy of the accounts. Trading performance could have
improved or deteriorated to a material degree or the ownership
structure could have changed. Nevertheless, they are an important
element in the due diligence carried out by prospective purchasers
and funders and it is clear therefore that tenants and their
guarantors must expect to have to assume disclosure obligations
when entering into commercial leases.
Article first published in CONNECT in November 2016
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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