Rent Deposits in Commercial Leases

Rent deposit requirements are commonplace in modern commercial leases and should not, in themselves, be a significant cause for concern to a prospective tenant.

The purpose of such a deposit is to protect the landlord against rent default or breach by the tenant of other tenant obligations in the lease.

The tenant (if he has complied fully with his obligations) will usually be entitled to have the rent deposit returned to him at the end of the lease term.

The status and ownership of the rent deposit is generally defined in the lease (or, more commonly, in an ancillary deed).

At first glance, this would seem to be an unimportant point – the rent deposit cannot be accessed (save in the case of default) until the lease term ends, and may only be used meanwhile for defined purposes. Why then does interim ownership of the deposit matter?

The answer becomes clear if one party to the lease finds himself in financial difficulty.

A shrewd landlord will insist that, throughout the term, the deposit is to be his property. If he is able, successfully to negotiate such a clause, and the tenant enters into liquidation or bankruptcy, the landlord will be able to use the rent deposit against any losses suffered. The money is deemed to belong to the landlord and, therefore, is out of the reach of creditors (subject to the Court finding otherwise).

Without such a clause, and with increasing tenant insolvency, the landlord may find himself unable to remove money from the rent deposit account without leave of the Court, inevitably a lengthy and costly process.

The tenant, conversely, will want the deposit to belong to him, or at the very least he will want the lease or ancillary deed to be silent on the question of ownership. He will also insist that the deposit money be held in a separate, identifiable bank account - should the landlord become bankrupt or enter into liquidation, and the money is held in the landlord’s general trading account, it will be lost.

Here are the some of the questions which may arise on landlord insolvency:

• Is the tenant able to set off, against future rent, the amount which he has paid as a deposit, even though the same has been wrongly spent by an insolvent landlord?

• What happens when a new landlord takes over from the insolvent landlord– can he demand that a further deposit be paid?

• What will happen if a trustee in bankruptcy or liquidator of the landlord refuses to acknowledge that any payment of a rent deposit was ever made by the tenant?

It is important that issues such as these are anticipated, where possible in the lease or ancillary deed, and suitable provision made. Solid professional advice, before the deal is done, is absolutely essential.