It is always prudent for a landlord to request the tenant pays a security deposit in some form at the commencement of a lease. This provides the landlord with some level of recourse against the tenant in the event of a default. This may include for the non-payment of rent or damage that is caused to the premises by the tenant.
Under most commercial lease agreements, the landlord will have the option to request the security deposit be paid by way of either a bank guarantee or a cash bond.
A bank guarantee is an undertaking made by a bank on behalf of the tenant as security in favour of the landlord to protect it against potential loss or damage under the lease. Essentially, this is a promise from the bank that, in the event the tenant breaches the lease, the bank will pay the landlord up to a specified amount of the bank guarantee to remedy the default. There is generally no requirement for the tenant to agree to the bank making payment to the landlord (i.e. the landlord making a request will be sufficient for the funds to be released to the landlord).
A cash security deposit is a lump sum of money paid by the tenant to the landlord at the commencement of a lease that acts as security to cover any potential damages, unpaid rent or other breaches of the lease. The landlord will then have access to the cash bond and may draw on this amount during the term of the lease to rectify any default by the tenant. Provided the tenant does not default on any of its obligations under the lease, the cash bond is typically refunded to the tenant at the conclusion of the lease.
Although it may be surprising, from a landlord’s perspective, it is preferable for a security deposit under a lease to be provided by way of a bank guarantee rather than a cash bond.
Unlike a cash bond, a bank guarantee is a form of credit where the bank assumes the responsibility to pay the landlord if the tenant fails to meet their contractual obligations. Importantly, as a bank guarantee is a separate promise made by the bank to the landlord, it will not be affected by any liquidity issues or insolvency faced by the tenant.
In the event the landlord accepts a cash bond as security, which may be appropriate where the security payable is a nominal amount and it is impractical to obtain a bank guarantee, a landlord can help to further protect itself by registering a security interest against the cash bond on the Personal Properties Securities Register (PPSR).
Importantly, the registration of a security interest on the PPSR provides additional protection for landlords in the event of a tenant insolvency. Where a tenant becomes insolvent, a landlord who has registered their security interest on the PPSR will generally take priority over unsecured creditors, meaning the landlord’s claim to the cash bond will be satisfied before the claims of other unsecured creditors.
Where the landlord fails to register its interest and the tenant becomes insolvent, the cash bond is likely to vest in the tenant. The landlord will then become an unsecured creditor and will likely lose the benefit of a portion of the security deposit. It is for this reason, that it is preferrable that a bank guarantee be provided as this will not be impacted by the insolvency of the tenant and will not be subject to competing claims by other creditors.
For more information, please contact our Corporate & Commercial team on 03 5273 5271 or email info@coulterlegal.com.au.