Cracking the code on your security deposit.

31 July 2020 | Reading time: 2 minutes

Commercial leases typically include provisions that require the tenant to provide security to secure the performance of its obligations. Typically, a tenant may be required to provide security in the form of:

  • a cash security deposit;
  • a bank guarantee; or
  • a personal / corporate guarantee.

If the tenant defaults, a landlord may rely on the security to ‘fund’ unpaid rent or other monies and any other obligations of the tenant.

Cash security deposit.

Where a cash security deposit is provided, it is typically placed into a trust account with the landlord’s agent so that it is available:

  • for refund to the tenant on expiry of the lease, where the tenant has performed all of its obligations; or
  • for application by the landlord against any unpaid rent or other obligations of the tenant.

The deposit does not become (in part or in whole) the property of the landlord. The tenant continues to have an interest in the moneys and will be entitled to recover those moneys if it performs all of its lease obligations. This arrangement creates a ‘security interest’ in favour of the landlord under the Personal Property Securities Act 2009 (Cth) (PPSA).

This security interest can, and should be, registered on the Personal Property Securities Register (PPSR) to protect and ‘perfect’ the landlord’s security interest.

Where this security interest is not registered on the PPSR and the tenant becomes insolvent, the rights of the landlord in relation to the cash security deposit are likely to ‘vest’ in the tenant. In such an event, a liquidator (or trustee in bankruptcy) may require the landlord to hand over the cash security deposit to pay other higher-ranking creditors of the tenant.

As a result, the landlord becomes an unsecured creditor and may lose the benefit of the security deposit.

Bank guarantee.

Bank guarantees, on the other hand, are not affected by the PPSA because a bank guarantee is a contractual promise to pay money which creates contractual rights against the bank guarantor. They do not give the landlord an interest in the tenant’s personal property.

Recommendation.

To avoid the administrative burden of registration on the PPSR, landlords may wish to request that tenants provide a bank guarantee as opposed to a cash security deposit. However, to the extent that a cash security deposit is provided, registration on the PPSR is vital.

If a cash security deposit is unavoidable, it is important for landlords to:

  • seek additional personal or corporate guarantees;
  • ensure that the lease provides the appropriate consent for registration of the security interest on the PPSR (including the right to recover any associated costs from the tenant); and
  • complete registration on the PPSR as soon as possible.

The Bespoke Property Team has experience in all aspects of commercial leasing and the PPSA. If you require assistance with these please contact us.