As a tenant, entering into a commercial (or retail) lease is a big decision and requires substantial commitment, especially financially.
On top of rent and outgoings (which sometimes also include a promotion levy) which you must pay during your term, there are other types of security and payments that you may need to provide to the landlord before your lease commences.
We look at the different types of payments and securities which your landlord may ask you to provide on signing a lease, along with the associated risks.
Bank Guarantee/Security Deposit
All commercial leases will usually require either a bank guarantee or a security deposit (usually a cash bond), which is a sum of money the tenant provides before the commencement of the lease.
A landlord will generally lodge a security deposit with the government department responsible for administering retail leases. For commercial leasing, there is no requirement to lodge a security deposit. As such, a landlord can hold on to this money during the term.
A bank guarantee can take up to 28 days for a bank to process from the tenant’s first application. It’s then crucial for tenants to plan ahead if they intend to obtain the type of security.
Why Does the Landlord Require Security?
This security is the landlord’s protection in case a tenant breaches the lease or does not pay rent when it is owing.
The lease will usually set out the following:
- the conditions under which the landlord can apply the bank guarantee or security deposit, and
- an obligation on the tenant to ‘top up’ any amount the landlord has used.
This guarantee or deposit will also usually increase in proportion to any increase in rent. For example, it may need to be topped up with each rent increase annually during the 5-year lease.
The landlord will return the guarantee or deposit to the tenant at the end of the lease, less any outstanding amount owing. For example, if the tenant does not make good the property, the landlord may draw on the security and return the balance.
If a tenant enters into the lease as a limited liability (Pty Ltd) company, a landlord will commonly request a personal guarantee from all the directors. A tenant will often require the tenant to provide the personal guarantee in addition to a bank guarantee or security deposit.
While the bank guarantee (or security deposit) is security for the lease, the personal guarantee is the landlord’s security for the tenant’s company.
A personal guarantee does not require the tenant (or the company directors) to provide any money up front. If the tenant never breaches the lease and pays rent on time, the landlord may never draw on the guarantee. Personal guarantees can, however, place the personal assets of the guarantors at risk (e.g. home or motor vehicle).
Tenants may consider alternatives to a personal guarantee, such as:
- offering to increase the security deposit or bank guarantee instead of providing a personal guarantee; or
- requesting a cap on the personal guarantee (e.g. a limit of $20,000).
Although it’s sensible to avoid offering up a personal guarantee, the commercial reality is that a landlord may insist upon it. If this is the case, the tenant should seek financial advice to understand how, if called upon, providing a personal guarantee will impact their assets.
Commercial (or retail) leases often require different types of security, including a bank guarantee or security deposit or a personal guarantee. A security deposit (or bank guarantee) and personal guarantee have different purposes and it is not uncommon for a landlord to require the tenant provide both. Where possible, tenants should avoid personal guarantees and if they are unavoidable, seek financial advice.
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