Pursuant to most leases the tenant pays rent one (1) month in advance and therefore as a landlord you get some comfort (security) from that arrangement. However, if the tenant fails to pay a month’s rent on time, generally you are precluded from evicting the tenant until you have advise the tenant of the failure and give the tenant a reasonable time (usually fourteen  days) to make good the arrears. If the tenant doesn’t make good, then you inevitably have costs associated with evicting the tenant, chasing the outstanding rent and the cost of finding a new tenant. All of which will likely far and away exceed the one (1) month’s rent paid in advance which you hold this is why you should consider requiring your tenant to provide some form of additional security.
This begs the question: what is a reasonable security?
The Amount of Security
As far as the amount goes I take the view that a prudent landlord will address any defaults by the tenant quickly such that the security can be as little as the equivalent of two (2) or three (3) month’s rent plus outgoings.
As far as the form goes, typically for small and medium business tenants, it is provided by way of either:
- a security deposit; or
- a bank guarantee.
A security deposit, is also known as a cash bond, and essentially is the same as a bond which would be given under a residential lease… it is an amount of money equivalent to a certain amount of rent (i.e. three months’ rent) which is paid to the landlord, or the landlord’s agent, at the commencement of the lease. In the case of a commercial lease, the landlord is entitled to deduct from this deposit any monies due but unpaid by the tenant under the lease.
A bank guarantee, is a written undertaking from a bank (or sometimes another financial institution like a credit union) in favour of the landlord and to the effect that the bank will pay the amount of the guarantee to the landlord if required. The landlord is entitled to claim under the guarantee an amount equal to any monies due but unpaid by the tenant under the lease. Bank Guarantees also are usually equivalent to a certain amount of rent, typically three months).
What are the main practical differences between a security deposit and a bank guarantee?
From a landlord’s perspective holding a security deposit gives you more control and immediacy over the actions you may take to recover monies owed by the tenant. You hold the money and you don’t need to satisfy a third party (i.e. a bank) that you have an entitlement to the money.
The reverse applies from a tenant’s perspective. With a bank guarantee the tenant knows that the bank, acting prudently, is likely to make some enquiry as to the landlord’s right to access the funds secured by the bank guarantee.
Obtaining a bank guarantee generally will cost more than providing a security deposit, however, the funds used to secure a bank guarantee can sometimes attract interest for the tenant. If a security deposit is paid by the tenant to the landlord, then the landlord gets the benefit of the interest on the security deposit.
If the commercial premises you are leasing out are “retail premises” and subject to a retail lease, any security deposit must be lodged with New South Wales’ Department of Fair Trading. Further, when it comes to a landlord calling upon a cash deposit held by NSW Fair Trading, the landlord must lodge a form signed by both the landlord and tenant, or if the tenant does not sign it then NSW Fair Trading will still give the tenant the opportunity to contest the claim to the bond.
However, the risk that you need to be aware of is that usually a security deposit/cash bond is considered to be held on trust by the landlord for the tenant. The risk that this poses for you as the landlord is that if the tenant becomes insolvent, the liquidator may be able to reclaim the security deposit from you and use to it to pay out the tenants creditors in order of priority. Depending on where you sit in the order of priorities, you could miss out.
If your tenant becomes insolvent then it may be best if you have the benefit of a bank guarantee… otherwise, I’d prefer have the cash.
In addition to the points considered above, from a business perspective, it may not be best for you to impose a bank guarantee as a condition in your commercial or retail lease.
For example, if the tenant under your lease has been your tenant for a long period of time and has already paid of security deposit, they may feel that is unfair for you to impose a new burden on them.
However, this is a matter for you consider by weighing up the practical and commercial implications that may flow from having a security deposit versus a bank guarantee.
How can we help?
In any event, you should obtain legal advice if you are going to be leasing commercial or retail premises so that you are aware of what you rights and obligations are and also to ensure that the lease and associated documents are correctly prepared and enforceable.
We are able to assist you and provide advice in relation to all aspects of commercial and retail leases, including which type of security you should require from the tenant.
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