Tanuja Sellahewa, a Senior Associate Solicitor in our Commercial Property team explores why it is important for a landlord to have security when letting out a commercial property, drawing on the two most popular options, rent deposits and personal guarantees.
A landlord’s main objective when letting commercial property is usually to secure an income stream, so the tenant’s ability to pay the rent throughout the term is fundamental.
It is therefore important for landlords to carry out thorough background checks on a prospective tenant at an early stage, including obtaining references (usually at least one financial), insolvency checks and a search of the Companies House register for limited companies. Following these investigations, and where there are doubts about a tenant’s financial standing, landlords should consider asking for some form of security to be provided. The two most common forms of security are a rent deposit or asking the tenant to provide a personal guarantee.
Landlords may look to request either of these, or perhaps both, in instances where the prospective tenant is unable to provide strong trading records or references to demonstrate its financial capabilities, for example, where the prospective tenant is a start-up company, looking to rent property for the first time.
What is a rent deposit?
A rent deposit is a sum of money held by the landlord, usually until the end of the lease. Depending on the nature and length of the letting, and financial standing of the tenant, a rent deposit can be anything from one months’ worth of rent to twelve months’ rent, generally calculated as a multiple of the monthly rent taking into account current market conditions.
The deposit remains the property of the tenant but the landlord will usually hold this sum in a separate, interest bearing account, with the interest being paid to the tenant on an annual basis.
If the tenant defaults on the lease, for example fails to pay the rent, then the landlord can deduct money from the deposit. It also protects the landlord from losses and expenses incurred as a result of a tenant’s breach or non-performance of the tenant’s covenants under the lease.
If the landlord withdraws monies from the deposit then the tenant is required to top up the deposit again to the full, original amount.
Once the lease comes to an end, a landlord must return the rent deposit to the tenant together with any interest accrued, subject to any agreed deductions.
The advantage of a rent deposit is that the landlord will usually control the money. The disadvantage for the tenant is that a lump sum of cash will be tied up for a period of time.
The terms on which a rent deposit is held should be property documented in a rent deposit deed to avoid any disputes between a landlord and a tenant at a later stage.
What is a personal guarantee?
An alternative to a rent deposit, is to request a personal guarantee. A personal guarantee is a promise by a third party to make sure that the tenant complies with its obligations under the lease. There is usually also an obligation to indemnify the landlord for any losses suffered as a result of a breach of the lease by the tenant.
If a tenant is a limited company, then a director of that company may be willing to act as a personal guarantor for the tenant company, especially if the company is newly incorporated.
A guarantee is usually an attractive option for a tenant as it does not require any upfront cash. From a landlord’s perspective it has the advantage that the third party guarantor can be required to step into the shoes of the tenant and will be liable for compliance with all lease covenants if the tenant defaults under the lease.
It is important for a landlord to ensure that the guarantee is uncapped and not limited in time.
Can a landlord seek both a rent deposit and personal guarantee?
Yes! Where the prospective tenant is seen to be a considerable risk, then a landlord could look to secure both a rent deposit and personal guarantee.
The level of concessions and the amount of security provided will vary depending on the various bargaining powers of both parties. For example, a landlord eager to let a property quickly will not be able to hold a tenant company to ransom with unreasonable demands of security.
Guarantees and deposits, offer a popular and effective form of security with different advantages for both landlords and tenants. However, it is essential that the agreed form of security is properly documented to ensure that the guarantor or deposit is not unintentionally released while the tenant’s obligations are ongoing. If you would like to discuss any of these matters please do not hesitate to contact any member of our commercial property team.
Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position.