This guide is not legal advice. You should get independent legal advice to deal with your situation.
In Part 1 of this guide, we discuss what the security deposit and bank guarantee (together, the security) are. We also discuss some practical problems you as the landlord may face. And we share how you may overcome those problems. In this Part 2, we discuss some of our secrets to drafting the security clause. This will allow you to compare and confirm that you have maximum protection in your lease. We will refer to the bank guarantee as the ‘guarantee’ and the security deposit as the ‘deposit’.
When must the tenant provide the bank guarantee or security deposit?
The first thing to include in a security clause is a duty to give the security. This may seem obvious, but when does the tenant need to do this by? As with all contracts, the timing is as important as the duty itself. In most cases, an ‘offer to lease’ will precede the lease. This is a precursor document to a lease much like a terms sheet, a heads of agreement or a MOU. One purpose of the offer to lease is to have the tenant give the security in advance. This then ties in with the lease. The lease would say the tenant must give the security “on or before the date the tenant signs this lease”. This is instead of “on or before commencement of the lease”.
Obtaining the security before the tenant signs the lease has some benefits. It demonstrates that the tenant can afford to proceed and is keen to proceed. It may avoid you incurring legal costs in preparing the lease if the tenant then tries to pull out. It also means that you can use the security for the offer to lease as well as the lease. Above all else, it is easier for you to avoid a lease. If the tenant takes possession and then fails to give the security, all sorts of problems may arise. It is best to avoid this risk. Waiting for the tenant to give the security before you sign is the best option.
What kind of bank account do you use for a security deposit?
The bank account for the deposit should be in your name. It should not be in the tenant’s name or held jointly. You want to avoid any chance that you do not have authority to withdraw the money. The lease should allow you to hold the deposit in an interest bearing account. This is crucial because you want the interest to cover bank fees relating to the account. The lease should also make sure the interest forms part of the deposit. At least then the deposit should grow over time.
What should be the terms of the bank guarantee?
The lease should say that it must be unconditional. This means there are no conditions that you must fulfil before you call on the guarantee. The lease should say that it must have no expiry date. This is so you can hold on to it for so long as you need to. In most cases, the lease should say it must be from an Australian bank. There can be issues calling on a guarantee with foreign banks. The lease should also consider the standard of bank. It should say the bank must be an authorised deposit-taking institution. It should also allow you to approve the bank. This way, you can make sure that the bank is suitable.
What happens when the tenant is in breach of the lease?
You need the power to claim the security the moment a breach occurs. You should not have to issue a default notice first. This avoids you paying the cost of a default notice. You should not have to prove a breach either. The lease should say this. Else, the tenant may be able to claim against you for a wrongful claim. Many leases do not have these features, or the drafting of the lease is vague. This may then restrict your power to enforce the lease. And the tenant may then lock you into costly legal battles. The issue becomes whether you had the power to claim the security.
The lease should allow you to claim the security any number of times. This includes relating to the same breach. This is because you can rarely foresee all your loss straight away. The lease should allow you to apply the security to any breach in any order. This gives you some flexibility in how you allocate the money. The lease should also make it clear what you can use the money for. This should include not just rent and other money. It should also include other loss such as damages, costs and indemnities. It should also include amounts the tenant must pay at law.
The lease should also say that your rights relating to the security do not limit the tenant’s liability. The last thing you want is the tenant saying that all they have to do is give up the security. You should have the right to pursue the tenant for any shortfall amount the tenant owes. This also helps rebut the tenant’s view that the security is a buffer for them. As I mention above, the lease should say the tenant cannot allow a breach to occur to use the security. What happens if you do claim the deposit or part of it? There should be a clause that requires the tenant to replace the amount. This is to ensure that the tenant maintains the amount of the security.
When should the landlord return the bank guarantee or security deposit?
This is an area where poor drafting can lead to big problems. A lot of leases just say that you must return the security within 3 or 6 months after termination. But what if the tenant is still in breach? Or the tenant has not vacated the site? Or the parties are in a dispute as to whether the tenant is in breach? In these cases, the security is the only pull you have with the tenant. If you return the security, the onus is on you to sue the tenant in court for your loss. As I mention above, this is not always a worthwhile thing to do. I solve this problem by saying in the lease that you will return the security if certain things occur. For instance, the tenant is not in breach and has vacated the site etc.
What happens when the tenant assigns the lease?
The lease should require the tenant to procure the security from the new tenant. And you should be able to refuse consent to the assignment if the tenant does not do this. The lease should also allow you to replace a guarantee with a deposit and vice-versa. This would be when for some reason you want to switch between the two. This is more relevant to long term leases. Who is to say that industry practice will be the same in 10 years? Rarely do leases include this right.
What happens when the landlord sells the land?
A lease forms part of the value of the land. So does your rights under that lease. This includes the security. In most cases, this means that the value of the land should be higher if:
- there is a paying tenant;
- the lease is in your favour. That is, the lease transfers risk to the tenant; and
- there is effective security.
This is why part of me fails to understand why a landlord would use a standard form lease. They grant too many rights to tenants. And they fail to cover off on key issues that are a common source of disputes. A good lease adds value. Far more value than what the lease costs.
The lease should make a tenant give the same security to the new landlord. This is something that lawyers often miss. How else would the buyer get security? If the lease does not require this, it creates a risk for the buyer. This risk may affect the price the buyer is willing to pay for the land. The lease should make a tenant give a new guarantee in favour of the new landlord. Or the lease should allow you to transfer the deposit to the new landlord. This way, the buyer knows that they are going have the same security.
What happens when the amount of the security varies?
The lease should require the tenant to provide more security. As I discuss above, the value of money will decrease over time. As a result, your exposure will increase if you fix the amount of the security. One benefit of allowing the security to vary is that it can reduce your exposure. But the lease needs to require the tenant to top up the deposit. Or it should require the tenant to provide a new guarantee for the higher amount. Another thing that lawyers often miss is what happens if the rent decreases. This is mainly for a retail lease where ratchet clauses are void. The lease should say that the rent portion of the security amount will not decrease.
Want to know more?
I hope you have found this guide to be valuable. Keep an eye out for more articles and guides on our website here. If you want to know more about this or leasing in general, please contact us here or below.