Rent deposits are becoming increasingly common in commercial lease transactions. They are sometimes used alongside or instead of a guarantor. As the name suggests, the rent deposit is a sum of money, usually calculated as a certain amount of months’ rent e.g. 3 months, held by the landlord (or sometimes a third party) as security of the tenant’s obligations under the lease.

Whist the attractions of a rent deposit to a landlord are obvious, an immediately accessible source of funds which can be withdrawn as soon as the tenant is in breach of its covenants in the lease. A tenant company, newly formed, may prefer to offer capital as security rather than request its directors to personally guarantee and indemnify the landlord against any breach of the lease by the company.

There are numerous arrangements in which a rent deposit deed can be configured. The most common forms seen in the commercial property market are the landlord holding the rent deposit in a separate account on trust for the tenant or the tenant creates a fixed equitable charge over the rent deposit in favour of the landlord. There are benefits and drawbacks between each form.

The circumstances in which the landlord will be able to withdraw from the rent deposit must be strictly in accordance with the rent deposit deed. By way of example, a “default” under the rent deposit deed may be any failure by the tenant to:

  • pay the whole or any part of the rents due to the landlord under the lease;
  • observe and perform any tenant covenants in the lease or the rent deposit deed; and
  • pay any costs arising out of the enforcement of the obligations of the tenant under the lease or the rent deposit deed.

Usually, if the landlord withdraws any amount in accordance with the rent deposit deed, the tenant will be obliged to “top up” the sum to the level of the initial deposit. Some rent deposit deeds can provide for “topping up” when there has been a rent review under the lease.

An important consideration for the tenant is when the rent deposit becomes repayable. Common triggers for repayment are lawful assignment of the lease by the tenant to an assignee (selling the leasehold interest) and expiry of the term of the lease (including the operation of any break notice.) other trigger events could be the tenant proving to the landlord by producing accounts or evidencing its profitability and net asset position that it has reached an agreed level in order to remove the need for a rent deposit.

The tenant will also want to ensure that if the landlord sells/assigns its reversionary interest in the lease, the buyer/assignee is bound by the terms of the rent deposit deed. Whilst it may not be necessary, the tenant may require that the buyer/assignee enters into a direct covenant with the tenant to observe and perform the obligations of the landlord within the rent deposit deed.

Please note that this is a very short summary of the various considerations the tenant and landlord should take into account when entering into a rent deposit deed. There are various other considerations such as the effect of insolvency on a rent deposit.

If you are considering entering into a lease in which the landlord requires a rent deposit or you are wondering how you can protect yourself against a prospective tenant, please contact our commercial property team on 01264 363 354 or email simonw@talbotwalker.co.uk or roberth@talbotwalker.co.uk.