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.
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.
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:
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:
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.
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The information in this blog is intended only to provide a general overview and has not been prepared with a view to any particular situation or set of circumstances. It is not intended to be comprehensive nor does it constitute legal advice. While we attempt to ensure the information is current and accurate we do not guarantee its currency and accuracy. You should seek legal or other professional advice before acting or relying on any of the information in this blog as it may not be appropriate for your individual circumstances.