Are you a commercial landlord in the process of letting your property? Are you concerned that your prospective tenant is not financially credible? Do you want to increase your protection against a potential defaulting tenant?
In this article we will discuss ways to increase your security as a landlord by incorporating protective measures into a leasehold agreement. The focus of this article is as follows:
1. What is a Rent Deposit? How/ why they are used.
2. The advantages and disadvantages of a Rent Deposit.
3. What is an Authorised Guarantee Agreement? How/ why they are used.
4. The advantages and disadvantages of an Authorised Guarantee Agreement.
As a landlord you want to ensure that you are protected as much as possible against potential rent arrears or other financial losses due to a tenant defaulting on the terms of the lease. Therefore, it is imperative that landlords consider implementing protective measures to ensure that any rent arrears or other monetary defaults can be recovered without the need for a lengthy legal process to recover monies.
What is a Rent Deposit?
A rent deposit is a sum of monies deposited by the tenant to the landlord as security against non-payment of rent and/or financial consequences to the landlord of some other breach of the lease (including the costs of enforcement).
Therefore, the term ‘rent deposit’ can be misleading because the rent deposit is not just available to cover rent arrears, but other financial losses incurred as a result of the tenant’s default.
A rent deposit is usually taken when a lease is either granted or assigned to a tenant whom the landlord considers to be a ‘weak tenant’, i.e., a tenant who has been unable to provide the landlord with sufficient evidence of his/her financial standing before becoming the tenant.
Where a rent deposit is paid it is usual for the terms under which it is paid and held to be set out separately from the lease in a Rent deposit deed, which defines the rights and obligations of the parties.
Main types of Rent deposits?
In theory at least, there are several different ways of structuring a rent deposit: However, the three listed below are commonly used.
Deposit held in the name of the tenant and charged to the landlord
Deposit held by the landlord in trust for the tenant.
Deposit held by a third-party stakeholder for the tenant but charged to the landlord
Deposit held by the landlord on trust for the tenant:
When a deposit is held by the landlord on trust for the tenant the rent deposit deed is drafted to allow the landlord to access the deposit in case of default by the tenant, with the tenant only being entitled to repayment of the deposit at the end of the tenancy or in other defined circumstances.
Deposit held in the name of the tenant and charged to the landlord:
When a deposit is held in the name of the tenant but charged to the landlord, the landlord is considered a secure creditor for the purposes of the deposit. A rent deposit deed can be adapted where the rent deposit belongs to the tenant but is charged to the landlord
Deposit held by a third-party stakeholder for the tenant but charged to the landlord:
When a deposit is held by a third-party stakeholder for the tenant but charged to the landlord, the landlord is once again a secure creditor for the purposes of the deposit. The third party in such cases is usually the landlord’s solicitor.
Benefits of a Rent deposit deed
There are many benefits obtaining a rent deposit from a tenant. The most obvious being the ability for the landlord to access the funds for the purposes of offsetting any outstanding rent or other financial losses incurred due to the tenant defaulting on the terms of the agreement.
Obtaining a rent deposit means you can physically hold the monies which is far preferable as opposed to having to take legal action against a tenant or guarantor for breaching the terms of the lease agreement.
Disadvantages of a Rent deposit deed
As a landlord if you are planning on asking for a rent deposit, be cautious as this can deter potential tenants. This can become problematic for a landlord if they are requiring a tenant to occupy the premises as soon as possible. Many tenants may not be open to the idea of having to pay a lump sum deposit to take on a lease.
If monies are held in an account for which the landlord is responsible, you still have a fiduciary duty to ensure any monies used from the rent deposit are strictly for rent default or other financial losses directly incurred due to the tenant defaulting on the terms of the lease agreement. Therefore, there is additional pressure on the landlord to ensure that he/she is complying with their fiduciary duties.
Rent deposit deeds are often drafted and used in addition to the leasehold agreement; therefore, a landlord would have to factor in additional costs such as legal fees if these provisions are not incorporated.
An authorised guarantee agreement is an agreement which places an obligation on a departing tenant or a third- party to guarantee the performance by the new tenant or assignee of the tenant covenants contained in the lease agreement.
It provides a guarantee to the landlord to compensate them for any financial losses they incur if the incoming tenant defaults on the terms of the leasehold. It was introduced by section 16 of the Landlord and Tenant (Covenants) Act 1995 (LT(C)A 1995).
Benefits of an Authorised Guarantee Agreement
Landlords frequently seek a covenant from the guarantor to become the principal debtor. This means that they would have joint liability with the tenant for any breaches of the lease agreement. The value of this guarantee to a Landlord is that the guarantor may remain liable even if they cannot enforce a claim against the tenant. However, the guarantor’s liability can never exceed the tenant’s liability.
If a lease continues beyond the contractual term, the guarantor can still be held liable even though the term has ended. This is known as “holding over”. They would continue to be liable until either of the parties serves notice to end the agreement or enter into a new agreement.
Disadvantages of an Authorised Guarantee Agreement
It is important to carry out due diligence not only on any prospective tenant but also the guarantor.
In Harvey v Dunbar Assets plc, a bank guarantee purported to impose joint and several liability on four individuals (together defined as ‘the Guarantor’) under a single composite document. It was envisaged that all four individuals would execute the guarantee, but in fact the signature of one of them was forged. When an action was brought under the guarantee against one of the other signatories, the Court of Appeal held that his signature of the guarantee was subject to a condition that it would be duly signed by all the other intended guarantors named in it; given that this had not happened, there was no liability under the guarantee.
A guarantee can become void if changes are made to the underlying leasehold agreement. Therefore, landlords should ensure there is protective wording in place to avoid releasing a guarantor of their obligations.
If a leasehold agreement is varied between a landlord and tenant, this would release the guarantor unless the guarantor consents to these changes. Therefore, it can become problematic if the guarantor refuses to consent to any variations the landlord and tenant wish to make.
The Code for Leasing Business Premises in England and Wales 2007 provides that an AGA should only be required by the landlord if the Assignee is of lower financial standing than the outgoing tenant or if the Assignee is registered or resident overseas.
In smaller transactions it is more appropriate to use a rent deposit than a guarantor.
How can Pure Business Law help?
Pure Business Law are specialist conveyancing Solicitors based in Bedford and London and operating nationally. We draft leasehold and other property agreements and tailor them to your exact requirements. We can also advise in and draft Authorised Guarantee Agreements and Rent deposit deeds. We can advise you on the most suitable one for you.
If you would like to discuss the preparation of a Rent deposit deed or Authorise Guarantee Agreement for your business or anything raised in this article, please contact us and speak with one of our solicitors.
Pure Business Law is regulated by the Solicitors Regulation Authority and is a licensed member of the Law Society of England & Wales.