A rent deposit is part of landlords' armoury for protecting themselves from tenant default. Other options include surety covenants given by individuals or companies associated with the tenant and, less often, bank guarantees. The landlord will generally insist on some form of security where the tenant is perceived to be a risky covenant. Newly incorporated companies without a proven track record and foreign corporations will often prompt the landlord to insist on additional security before granting a lease or consenting to the disposition of an existing lease. Once the tenant recovers from the indignity of being labelled a weak covenant they need to consider the implications of entering into a rent deposit deed.
Pros and cons
A rent deposit is a sum of money that will be available to the landlord if the tenant fails to pay the rent or otherwise defaults. The most obvious disadvantage from the tenant's perspective is that the money tied up in the rent deposit is not free to be used for the purposes of the tenant's business. Unfortunately, companies that are required to provide a deposit are often those companies with cash flow problems.
How much?
The amount of the deposit is a matter for commercial negotiation and is generally calculated by reference to the annual rent. It will often be a year's or six months' rent The tenant should try to limit this to the principal yearly rent. The landlord may seek to link the deposit to rent reviews and to extend it to cover insurance premiums, service charges and other sums reserved as rent. In addition, if VAT is payable on the rent , the landlord will wish to add 17.5 per cent onto the deposit in respect of VAT.
Drafting deposits
There are various ways in which the mechanics of a rent deposit can work. These range from simply handing over the money to the landlord, to complicated arrangements where the deposit is placed in a special account and charged to the landlord. The main disadvantage with the former is that the tenant is at risk of losing his money if the landlord becomes insolvent or defaults. The tenant's money is protected using the charging route, but the implementation of complicated arrangements can cause practical problems and delays particularly where the bank's co-operation is required.
Getting the deposit back
The tenant will not want the rent deposit money to be tied up longer than is absolutely necessary. There are circumstances where they will wish to regain use of the deposit. These could include the tenant being able to produce evidence that they no longer constitute a weak covenant, the tenant offering suitable alternative security and, most commonly, the tenant assigning their interest in the lease. The tenant will be concerned that they should be able to recover the deposit. The Landlord and Tenant (Covenants) Act 1995 provides that the landlord's repayment obligations are now enforceable against the landlord from time to time in respect of new leases. There is also often a debate as to what should happen to the interest accruing on the deposit. The tenant will argue that it should be paid to them.
Although deprived of the capital sum, they should be entitled to use the interest earned.
The tenant should also try to ensure that the landlord does not simply withdraw funds from the rent deposit where there is a genuine dispute, for example about a service charge.
The charge
Many rent deposit deeds include a charge entered into by the tenant. The problems associated with a failure to register this charge at Companies House are generally perceived to be the landlord's. However, it should be remembered that it is the chargor company's responsibility to effect the registration and failure to do so may result in a fine.
Conclusion
Once a rent deposit has been agreed in principle, there is a danger that the mechanics of the deposit will be overlooked as the parties concentrate on the terms of the lease. Bearing in mind the significant sums of money involved, the form of the deposit is of fundamental importance.
Graham White, who also contributes to TheFB's sister publication Property Week, is a solicitor specialising in property law at Slaughter and May. Tel: 020 7600 1200 Email: graham.white@slaughterandmay.com
Source
The Facilities Business
