Are you a landlord of a commercial or retail lease premises? If so, you’d be familiar with the importance of obtaining some form of security over the lease that will ensure the rental obligations and other obligations are upheld, and that the lessee performs all duties under the lease. Although most landlords will demand a bank guarantee from their tenants, the reasons for this preference are not well understood.
This article will be broken into 2 parts. Part 1 will explain why a bank guarantee, as a form of security over a commercial lease, is more effective than a cash bond (also known as a security deposit). Part 2 will look more closely at some of the procedures that should be followed when accepting a bank guarantee as security.
What makes a bank guarantee a better option?
In the last decade, the emerging preference of landlords of commercial and retail leases has been to ask their tenants to provide them with a bank guarantee instead of a cash bond. But what is a bank guarantee, and what makes it a better option? A bank guarantee is a commitment from a bank to meet your financial obligations under the lease should you be unable to meet these obligations yourself. The bank will only usually guarantee you for the amount specified in the lease.
A bank guarantee is a good option for a landlord, as it gives them security from a third party, which gives them confidence that even if the tenant cannot pay, the bank will be able to. If the tenant is no longer able to meet its debt (and becomes insolvent), a bank guarantee will become operational. A cash bond operates differently, and would typically be considered trust money held for the benefit of the tenant. If the tenant were to become insolvent because it has entered administration/liquidation, then the appointed party (liquidator, for example) in charge of managing the tenant’s financial obligations may recover the cash bond from the lessor. This is known as a ‘preference payment’. During this process, the appointed party may also seek to recover whatever part of the bond that may have been released to the lessor right before the tenant became insolvent.
In contrast, the landlord can use a bank guarantee before the tenant becomes insolvent, and will not have to worry about the possibility that these funds will be recovered as a preference payment.
Disadvantages of cash bonds
Apart from the risk that cash bonds will be recovered as preference payments, there are also some added administrative steps that may make bank guarantee a more appealing option to landlords.
Cash Bonds under Retail Lease Legislation
The relevant retail leasing legislation in New South Wales is the Retail Leases Act 1994. Under this Act, landlords must lodge cash bonds at the NSW Fair Trading in less than 20 days after it is received, or from the commencement date of the lease, whichever occurs at a later date. Fines will apply for non-compliance with this procedural step.
If, at the end of the term, or upon the tenant defaulting, you, as the landlord, wish to call on the bond, you will need to lodge a specific form with the NSW Fair Trading. Both parties – landlord and tenant – will need to sign this form in order to have the bond released to the landlord without any significant delay. The landlord may lodge the form regardless of whether the tenant is supportive of the claim, but the NSW Fair Trading will give the tenant a period of 14 days to either allow for the release of the bond or to challenge the claim.
Under Queensland’s retail leasing legislation, solicitors and real estate agents are permitted to keep cash bonds in their office trust accounts. These funds will be held and released in accordance with the terms and conditions of the lease. Another option is for the cash bond to be kept in another bank account for the parties to the lease. Both landlord and tenant would need to give their respective authorisation for the funds to be withdrawn at any stage.
Under the ACT version of the Act, known as the Leases (Commercial and Retail) Act 2001, the landlord is required to hold the security deposit in trust where it will attract interest. This interest earned must be accounted by the landlord to the tenant. Under the Act, specifically section 43, the only deductions that the landlord can make from the bond are those which recover any monies that the tenant owes under the lease, provided this deduction is lawful under the Act.
If you need assistance with your commercial lease, whether in drafting, negotiating, or resolving a dispute, LegalVision has a team of highly skilled leasing lawyers who have assisted both landlords and tenants faced with legal difficulties. Stay tuned for Part 2, which will discuss some of the procedural requirement of bank guarantees.
For a fixed-fee quote and legal advice, call LegalVision on 1300 544 755.