On entering into a lease, a lessor (landlord) will often require the lessee (tenant) to provide some form of security (financial assurance) that incentivises the lessee to comply with their obligations under the lease. An effective and common way for lessors to impose this type of financial obligation on the lessee if they were to default on the lease, is to request a security deposit or to provide a guarantee to the lessor.

Types of Security

The most common types of security used to secure obligations of the lessee are a security deposit, personal guarantee or a bank guarantee.

1. Security Deposit

A security deposit is a sum paid by the lessee to the lessor on or before commencement of a lease, which can be called upon if the lessee defaults on their obligations under the lease. The terms of the lease will dictate when a security deposit can be called upon. Generally, the amount of the security deposit will be the amount equivalent to three to six months of rent payable under the lease although they do vary outside of that range in certain circumstances also. Importantly, a security deposit cannot be non-refundable and if it is not called upon during the lease it must be returned to the lessee once the lease term expires.

2. Bank Guarantee

A bank guarantee is a tripartite agreement between a lessor, lessee and a third party (such as a lessee’s bank). Practically speaking, a bank guarantee means that the third party agrees to be responsible for certain financial obligations of the lessee and will agree to pay a sum of money should the lessee default on their obligations under the lease. Bank guarantees must contain the following details:

• The party for whom the bank guarantee is made in favour of (the lessor);
• The purpose of the guarantee i.e. to secure obligations of the lessee under the relevant lease;
• A description of the leased (demised) premises;
• The amount of the guarantee (inclusive of GST); and
• The date at which the bank guarantee will expire.

It is recommended a lessor or their solicitor review the conditions of the bank guarantee to ensure the terms of the guarantee meet their requirements. It may eventuate that a condition of the guarantee restricts the lessor’s ability to call upon the guarantee if the lessee defaults. Parts of the guarantee that should be checked include:

• The bank guarantee being unconditional. This means it can be called upon, as allowed for under the lease, and there will not be any extenuating circumstances which might impede the lessor’s ability receive the guarantee amount from the bank;
• The bank guarantee being issued by an Australian Bank. If an overseas bank issued the bank guarantee, this can create difficulties when it comes to releasing the guarantee amount to the lessor;
• The bank guarantee’s purpose. The purpose of the guarantee should encompass allowing for the guarantee to be called upon for default under the lease, or any other related documents which impose obligations on the lessee, such as a car park licence. Covering the obligations of the lessee under these ancillary documents will broaden the ability of the lessor to call upon the bank guarantee.

3. Personal Guarantee

Rather than a bank guaranteeing an amount of money if the lessee defaults, a personal guarantee will make another entity personally liable for rectifying a default of the lessee under the lease. If a lessee is a company, it is generally the case that director/s of the company will provide a personal guarantee(s). Due to the liability of default of the lessee being personal, personal guarantees carry a high degree of risk for the person or persons who provide them. A guarantor’s personal assets can be drawn in order to compensate for the lessee’s default. It should be noted that if a guarantor does not hold any individual assets, it can become difficult for the lessor to enforce the guarantor to compensate for the lessee’s breach.

If you have a query regarding the form of security under a commercial lease as either a lessor or tenant, or require assistance with any property or leasing matter, we will be happy to assist.