Commercial Leases - I feel a need for security!
A major issue of discussion in many leasing transactions is security – a landlord’s need and desire for as much as possible versus the tenant’s need and desire to provide as little as possible.
From the landlord’s point of view, the quantum and longevity of the security provided by the tenant may give the landlord comfort that they may otherwise be denied, given that the tenant may either be a company of limited value or an individual tenant without a track record.
However, if you are a tenant the quantum and longevity of the security may have an impact on your financial position because you will need to tie up capital to provide the security.
In this article we will walk you through some of the issues that we encounter when advising clients in relation to security in commercial tenancy matters.
What are we talking about?
When we talk about security in the tenancy context, we mean either a bank guarantee or a cash deposit. A bank guarantee is effectively a blank cheque which a bank or other financial institution will provide to a landlord that requires the bank or other financial institution to reimburse the landlord for all or part of the amount of the bank guarantee upon presentation. A cash deposit is a bond which is held in an interest bearing account on behalf the tenant for the life of the lease and will be returned upon expiry of the lease and satisfaction of relevant obligations, whichever is the later.
Why and how much security is required?
Security provides some cover for the landlord for the risk in the event of a tenant not honouring their obligations under a lease. The default may be failure to pay rent or to make good in accordance with the terms and conditions of the lease. In our experience we see differing levels of security depending on the nature and risk associated with the tenant – it could be as little as an amount equal to one month’s rent and outgoings or as high as 12 months and with departures from the norm, such as reductions in the amount following the establishment of a good track record with the landlord by the tenant.
What should the tenant consider?
Many of our tenant clients are faced with the following issues, which they need to consider carefully when negotiating their leases. Some of the issues you need to cast your mind over include:
What is going to be more cost effective to provide for the landlord – a bank guarantee or a cash deposit? In the case of a bank guarantee the tenant will usually be required to pay an establishment fee to their bank, make an application to the bank’s credit department and provide some form of security for the bank to hold to cover their risk. This may be in the form of a fixed term deposit of cash or additional security over another asset such as a home, commercial property or business.
It takes time to obtain a bank guarantee. If you are required to provide a bank guarantee, you should arrange this as early as possible as your landlord is unlikely to grant access to the premises without the bank guarantee being provided.
You need to consider what expiry date your bank will require. Landlords will often prefer an open ended bank guarantee – with no expiry date. However if you are a tenant you would prefer there to be some closure on the bank guarantee and it is common for the bank guarantees to have expiry dates 6 or 12 months after lease expiry. However you should as a tenant ensure that there are appropriate mechanisms built into the lease to have the bank guarantee returned upon the later of the expiry of the lease or satisfaction of all terms and conditions under that lease.
You need to consider what the lease says about increases in the bank guarantee. It is common for leases to provide for the bank guarantee to increase as rent increases. The problem with such a mechanism is that you will need to make an application to your bank for an increase in the bank guarantee for each increase – this could be annually. Your bank will usually require an exchange of the old bank guarantee for the new bank guarantee and you may be charged additional fees by your bank and have to go through the whole application process each time. We suggest to counter this, that you ask your landlord for the bank guarantee to be an amount based upon the rent and outgoings payable in the final year of the lease - this may give the landlord the comfort they need and avoid the need to replace the bank guarantee each year!
If you use an overseas bank, check whether your landlord will accept the bank guarantee. Some landlords have objections where they do not have the ability to attend to a local branch to call upon that bank guarantee.
What if you want to call on that bank guarantee?
If you are a landlord and you want to call on the bank guarantee you need to be very careful about doing so, depending on what your lease says. For example, if the lease states that you cannot call upon the bank guarantee or cash deposit unless there is breach then you need to be clear in your mind that there has actually been a breach before you can call on that security. There have been cases where the courts have held that the landlord is not permitted to call on the bank guarantee or cash deposit where they believe a breach of the lease has occurred but it has not been proven. So, our advice to all landlords is read the lease carefully and seek legal advice before calling on the bank guarantee or cash deposit.
Timing of provision of security?
Our tenant clients often encounter difficulties where they are keen to get access to a premises but the landlord will not grant them access because they have not yet provided a bank guarantee or cash deposit.
Leases will usually state that the bank guarantee is to be provided upon either execution of the lease or commencement of a lease. Sometimes a lease is executed well ahead of the lease commencement date. From a tenant’s perspective, if they are not going to be granted access to the premises for some time, then why should they provide security so early?
We all want security to cover risk. However there are implications if the wording in the lease and the structure of the security is not adequate for the circumstances at hand. Therefore you should consult with an experienced property lawyer to seek advice in this regard.
For further information contact:
Andrew Grima, Principal
Phone: +61 2 9895 9271