Property Law: Rent deposits

When considering granting a lease to a prospective tenant, a landlord will naturally wish to consider the financial strength of the tenant and to have some comfort that he or she will be able to fulfil their obligations (particularly payment of the rent, service charge etc.) in the lease. In doing so, landlords will take account of the trading history of the prospective tenant as well as their financial standing.

Often, prospective tenants have experience of managing pubs and are thus able to satisfy the landlord in relation to any concerns that he may have.

However, the tenant is not always able to satisfy the landlord's criteria in terms of its financial standing. This may be because the tenant has a weak financial status, has few or no assets or simply does not have a track record of generating funds necessary to settle debts (for example, rent or other sums that may fall due under a lease).

In such circumstances, landlords often require the tenant to provide a rent deposit, effectively a sum of money that the tenant provides to the landlord as security for payment of the sums due under the lease and its performance of the tenant covenants in the lease.

The rent deposit deed lays out the circumstances in which the landlord may withdraw sums and the terms that must be satisfied in order for the deposit to be repaid to the tenant.

There are various ways that the deposit may be held, the most popular methods being the deposit money held by the landlord on express trust for the tenant or the tenant creating a fixed charge over the deposit monies in favour of the landlord as security for performance of its obligations under the lease.

Both methods have their advantages and disadvantages. Tenants should seek specific advice from their legal advisor as to the method to be adopted and its implications.

The following practical matters should be considered before terms for a rent deposit are finalised:

1. Amount of the deposit

There are no prescribed levels or restrictions as to what the amount of a rent deposit should be. It is usual that the figure will be negotiated and fixed between the parties or their agents.

The parties may wish to base the amount on the equivalent of three, six or 12 months annual rent, estimated service charge and insurance rent for that period.

2. Withdrawal from the rent deposit

The rent deposit deed must clearly set out the circumstances in which the landlord can make deductions, and the procedure that the landlord must follow before making a deduction.

As a minimum, landlords will require unpaid annual rent, service charge, insurance rent and VAT to be defined as authorised deductions. Modern rent deposit deeds tend to have a broad definition of an 'event of default' which triggers the landlords' ability to make a deduction.

Tenants must be aware of the events of default and ensure that landlords have followed the correct procedure when making deductions.

The rent deposit deed will usually include a top-up clause requiring the tenant to add monies to the rent deposit account in certain circumstances (for example, where the landlord has made an authorised deduction from the deposit or where the rent has been increased following a review).

3. Return of the deposit

Again, this is a matter of negotiation between the parties. A landlord would like to hold on to the deposit for as long as possible, whereas a tenant will want the deposit released at the earliest opportunity.

The common triggers for repayment include the following:

• Lease term expiry

• Early termination of the lease by agreement

• Lawful assignment of the lease

• Net profit test where the parties agree that upon the tenant achieving a certain level of profit over a certain period of time, the rent deposit will be released.

4. Interest

The rent deposit deed should make it clear what the position is with regard to the interest accruing on the account (e.g. how often is it to be paid out; can it be added to the balance of the rent deposit where the amount of the deposit is below the minimum amount?).

Rent deposits deeds are important documents, and where a rent deposit is being provided, tenants should ensure that this part of the deal is not neglected during lease negotiations.