A bank guarantee is a promise from a bank that it will pay up to an agreed amount on someone’s behalf if that person is unable to pay.
Security Deposits for Leases
Bank guarantees are a common requirement for a tenant entering into a commercial or retail premises Lease. If the tenant cannot pay their rent or if does something else to leave the landlord out of pocket, then the landlord can call on the bank to cover the amount owed.
There are a variety of different commercial transactions where a bank guarantee may be required. For the purposes of this article, bank guarantees as a security deposit/bond for Leases will be discussed.
The guarantee will be for a specified amount of money. It is often secured against an asset the tenant owns or a term deposit. If the bank has to pay under the guarantee, then they will be entitled to recover their expenses from the tenant and have recourse to that asset. The tenant will be required to pay an upfront establishment fee and then ongoing fees for the bank guarantee which will often be a percentage of the amount guaranteed.
The bank guarantee will specify whether it’s valid for a fixed period of time or if it’s indefinite. Landlords will generally want a bank guarantee without an expiry date. Difficulties can arise if the bank guarantee is only valid until the end date of the Lease because the tenant can ‘hold-over’ under the Lease and may not vacate until after the set end date. If that happens and the tenant fails to comply with their make-good obligations, then the landlord cannot call on the expired bank guarantee to fund the cost of the make-good.
Some banks will not offer a bank guarantee without an expiry date. Therefore, as a compromise, landlords will often accept the expiry date being the date which is 6 months after the end of the last option period under the Lease.
A landlord will generally want the bank guarantee to specify that it is unconditional and covers all obligations of the tenant under the Lease. This means that if the landlord is ever left out of pocket for something, they can call on the bank guarantee. Examples can be unpaid rent, unpaid outgoings, alteration works the landlord has agreed to do but the tenant has not paid for, and de-fitting and making good the premises at the end of the Lease if the tenant has not done this. This means that the bank guarantee must be properly drafted.
A Lease will generally specify that the landlord can call on the bank guarantee at any time. This means that a landlord doesn’t need to give a tenant prior notice that the landlord proposes to do this. The law generally requires the landlord to act in good faith when calling on a bank guarantee. Once a bank guarantee is called upon, the Lease will usually require the tenant to provide a replacement for the same amount.
Many Leases require a tenant to ‘top-up’ and provide a new bank guarantee annually each time rent increases. What this means is that the Lease may state that the amount of the bank guarantee must total a certain number of months’ worth of rent (for example, 3 months’ rent). What is 3 months’ worth of rent will change each year of the Lease when rent increases annually.
The Lease will specify when the bank guarantee must be returned to the tenant. This is usually once the tenant has complied with all their obligations under the Lease to the landlord’s satisfaction. Once the bank guarantee expires, or is returned to the bank (if it has no expiry date), the bank guarantee will cease to be of legal effect.
Another form of security which may be provided under Leases is a cash deposit, which is held by the landlord and then returned upon expiry of the Lease. Cash bonds should be treated with caution. If the landlord becomes bankrupt or insolvent, then tenants may experience difficulties getting them back.
Tips and Takeaways
If you are a landlord, you should:
- set the amount of the bank guarantee based on your assessment of the tenant’s risk level;
- ensure that the bank guarantee doesn’t have an expiry date, or otherwise, that the expiry date is a sufficient length of time;
- ask for a draft copy of the bank guarantee and carefully check to ensure it’s properly drafted;
- for your own security, don’t allow a tenant to access the premises until the bank guarantee is provided; and
- when a tenant exercises their option to renew/extend the Lease, always double check that the bank guarantee is current and will be valid for that length of time.
If you are a tenant, you should:
- assess the costs you will incur if the Lease requires you to replace the bank guarantee whenever rent increases, and try to negotiate this to be changed where necessary;
- ensure the Lease is clear on when the landlord needs to give back your bank guarantee:
- once the Lease ends; or
- if you sell your business and transfer the Lease to someone else;
- if the landlord ever sells the premises, double check that your bank guarantee has been passed on to the new owner; and
- always be conscious of what can happen if you breach your Lease.
The team at Salerno Law are experienced in acting for both landlords and tenants in all leasing matters.
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Luke is part of Salerno Law’s commercial and business law team. His days involve providing advice on a wide variety of commercial issues that arise in operating small to medium businesses, where he assists clients who are growing their business or wanting to protect what they’ve established.
DISCLAIMER: This article is only meant to give you general information and should not be relied on as legal advice. Speak to one of our lawyers for more information.
