16/06/2006 - Rent Deposit Commercial Property
Rent Deposit Commercial Property

"If ever I marry a wife
I'll marry a landlord's daughter.
For then I may sit in the bar
And drink cold brandy and water"
Charles Lamb 1775-1834

Given that the landlords daughter is probably not an option, most tenants starting out or starting up are obliged to put down a rent deposit before they are allowed to rent commercial property.

It is now relatively unusual for leases of commercial property to be secured by personal guarantees, although it still happens and parent company guarantees are common for securing lease obligations of subsidiaries.

Rent deposits are cash. Money supplied by a Tenant which the Tenant cannot use for a long time. Money which the Landlord can take in the event of tenant default. Good for a landlord, but a poor use of capital in the eyes of a tenant-just at the time it is most needed.

The rent deposit arrangement is a transaction linked to a commercial lease, which often engenders more questions per page than the lease to which it is tied. This post is an endeavour to recite and answer some frequently asked questions  (in no particular order). The first section deals with a tenants angle. Landlords should refer to the final section.

The Tenants perspective

I am to be a tenant and have agreed to put down a 6 month rent deposit  that means half of the annual starting rent, right?

Possibly but it is more likely, in the case of rent which is subject to VAT, that it will be the figure you have in mind multiplied by 117.5%.

OK but I want my landlord to give me an invoice  I assume this will not be a problem?

Unfortunately you will not get an invoice. The existence of VAT just means that the amount of the rent deposit is increased. There is no vatable supply in putting down a cash deposit and you will not be able to claim any part of it as a VAT input.

If I put down a 6 month rent deposit does this mean I am paying my first 6 months rent way in advance?

No it is not an on account payment. The rent deposit is ignored when judging whether a tenant has kept up with its rent payment under the Lease. For example if there is no rent free period and the first three months rent is payable on completion of the Lease (and a six month rent deposit is payable) the Tenant will have to allow for payments totalling 9 months rent on completion and the next payment of rent will be due 3 months later.

I accept that as a start up operation, it is necessary for me to put down a rent deposit, but it represents much needed cash. Can I get the landlord to pay it back when I have got a good track record of payment?

The payback mechanism is entirely negotiable and therefore depends on bargaining position. In the case of a property which has a substantial rental value a tenant is unlikely to see the return of his cash deposit for a long time  it is almost like key money

What can be negotiated?.

Well there is a standard test in the property industry for judging a tenants credit worthiness. It is achieving in each of 3 consecutive years, profits in excess of 3 times the annual rent (this is a general yardstick and some landlords apply a higher multiple and some impose an additional assets test). You may be able to negotiate the return of the deposit if you pass such a test, but the reality may be that if you are empire building in a start up business the prospect of accumulating profits during the first five years is unrealistic. (Expansion eats into profits) There is a likelihood that this mechanism may not trigger the return of the money in the foreseeable future. Take care to ensure the document refers to pre-tax profits and not post tax profits.

OK but it is my money. I get it back some time?

Yes it is usual for the rent deposit deed to include as a trigger mechanism  for return of the money, the transfer (assignment) of the Lease and the expiry of the Lease (with the Tenant having vacated). In the meantime it should be shown in the as a positive item in the tenants balance sheet.

So in such a case if I assign I can get my money back?

Yes if there is no default and all conditions recited in the document are fulfilled. Do be aware of one trap which is that some landlords try to keep the deposit for as long as a departing tenant has liability under an authorised guarantee agreement (this means that the deposit stays with the landlord until the next owner of the lease further transfers it or the lease expires).

What about the interest?

It is normal for the interest to be credited to the tenant. Most landlords try to get the Tenant to agree that interest is rolled up with capital and amalgamated with the cash on deposit, so that it is only paid when the original deposit is repaid. Some will accept that interest should be paid to the tenant as it accrues.

Will I have to pay any further money in respect of the rent deposit?

If the tenant defaults the landlord has power to withdraw funds from the deposit to cover the default. In such a case the tenant is obliged to pay the sum taken by the Landlord so that the deposit is returned to the amount it would have been had there been no default.


Is the amount of the deposit affected by a rent review?

Possibly  many landlords include a provision that where there is an increase in rent on review there is a corresponding increase in the amount of the rent deposit, but frequently they accept the deletion of this.

What about alternatives? A bank guarantee for example

Most landlords view bank guarantees as second best to a cash deposit, but will usually accept them for the same sum. In practice bank guarantees do not save on liquid cash resources as the relevant bank will want a back to back security, which often involves putting the cash sum down. They are often appropriate when the tenant is a UK start up of an established overseas business. But beware of the handling charges/arrangement fees and even more importantly the extra delays caused by trying to get the landlords solicitor and the banks solicitor to agree the document.

Points for a Landlord

Which is better for me a rent deposit or a bank guarantee?

Each case turns on its own but in general a cash deposit is better than a bank guarantee. It should be easier to negotiate and significantly once a bank has discharged its liability to pay the full guaranteed amount it has no further liability. Contrast this with the position of the tenant under a rent deposit deed where it is obliged to restore the deposit to the original amount. Of course this may not be an advantage in if one takes the view that the most likely reason for having recourse is insolvency of the Tenant.

Can I take the money from the cash deposit that I hold separately if the tenant goes into administration?.

In a situation where the money stands charged as a security you may not be able to without the consent of the Court or the Administrator. This is because most rent deposit deeds create a charge over a security (the cash deposit) and the law requires the charge holder (i.e. the landlord) to obtain the consent of the Court or of the administrator before executing against the security. These are the type of rent deposits that are usually registered at Companies House as a charge created by the tenant.

This is bad news. Can I structure the security differently

Yes. Avoid rent deposit deeds that create charges over the cash deposit. It is better to word the instrument so that it is a collateral security falling within the Financial Collateral Regulations 2003. An alternative to this is to copy some institutional landlords who call the rent deposit a loan or a debt. The document then recites when the debt is to be repaid (often in the same circumstances that a normal rent deposit would be repayable). The landlord usually agrees to pay interest on the indebtedness.

The differences may be cosmetic in substance but may be significant if the tenant goes into administration. Note that if the Landlord has a bank guarantee in lieu of a rent deposit the administration of the Tenant is unlikely to be an issue. A demand is made on the bank and provided the demand falls within the time and quantum limitations the bank should pay without examining the underlying circumstances.

What about the amount of the rent deposit or the bank guarantee?

The big situation is where the tenant goes bust. What sum of money would provide reasonable compensation if this happened? This is a commercial judgement. The landlord is likely to be out of at least one quarters rent. He has letting and marketing costs, restoring the property to a state which makes it lettable and the void represented by the marketing period and the likely rent free period. Some landlords may take the view that cover for 6 months is inadequate. Each transaction turns on its own and market practice.

John Gillette (DDI 020 7299 6929)
Barker Gillette LLP, 11-12 Wigmore Place, London W1U 2LU
www.barkergillette.com

For more information contact John Gillette on 0207 299 6929
email: john@barkergillette.com