It is typical for landlords to require tenants to provide security under a lease, to secure the tenant’s obligations under the lease. There are various types of security that may be provided, including bank guarantees, bonds and – where the tenant is a company – personal guarantees from the directors of the tenant entity.
The purpose of this blog is to consider the pros and cons of bank guarantees and bonds and which is preferable for a landlord or tenant of a commercial or retail lease.
It is not unusual for a lease to include a requirement for a tenant to provide a bank guarantee in the amount of three months’ rent plus GST on that amount. If the lease is subject to the Leases (Commercial and Retail) Act 2001(the Leases Act), this is the maximum amount a landlord can request for a bank guarantee.
Bank guarantees are payable on demand. Theoretically, payment should be immediate. However, our experience has been that in practice, banks have various criteria that must be satisfied for a bank guarantee to be paid out and this often takes some time. It is not unusual for a bank to retain the guarantee and have the payment dealt with by a guarantee/security team. In reality, payment of bank guarantees by banks can take from a few days to a month.
It is important to ensure that the bank guarantee does not expire on the expiry date of the lease. For landlords, ideally, bank guarantees should have no expiry date. However, some banks do not agree to provide such bank guarantees. In this case, it is typical for bank guarantees to expire no earlier than six months from the expiry date of the lease. This is to ensure that the landlord remains secured if, for example, the tenant fails to make good the premises.
Landlords should ensure that if the lease contains an option term, the expiry date of the bank guarantee is no earlier than six months from the expiry of the latest option term. The alternative to this is that the tenant provides a replacement bank guarantee on exercise of the option, however this is high maintenance and may be forgotten.
The bank guarantee should also:
- describe the premises;
- clearly state that it is in favour of the landlord;
- be from an Australian trading bank;
- correctly state the amount, including the GST payable on that amount;
- be payable on demand without reference to the tenant (i.e. the bank’s customer).
Bank guarantees are required to be returned to tenants on the satisfaction of the tenant’s obligations at the expiry of the lease. If the lease is subject to the Leases Act, the landlord must return the bank guarantee to the tenant within thirty days of the expiry of the lease.
As an alternative to a bank guarantee, a landlord may require a tenant to provide a bond (also referred to as cash deposits or security deposits) for a specified amount. Usually, this amount is three months’ rent plus GST on that amount.
The benefit of a bond over a bank guarantee is access to the funds. There is no requirement to call on a bond; rather, the funds are available to the landlord as cash. In the event of a default by the tenant – for example, non payment of rent, which has not been remedied after the tenant received reasonable notice – the landlord is able to apply the funds from the bond to satisfy the outstanding rent.
However, for leases that are subject to the Leases Act, the landlord is required to invest any bond in an interest bearing account and the lessor must account to the tenant for the interest earned on the bond. The interest accrues for the benefit of the tenant and is to be returned to them at the end of the lease. For many landlords, this requirement is onerous.
As with bank guarantees, bonds are required to be returned to tenants on the satisfaction of the tenant’s obligations at the expiry of the lease. If the lease is subject to the Leases Act, the landlord must return the bond (and any interest accrued on it) to the tenant within thirty days of the expiry of the lease.
Which is preferable?
Naturally, the preferred option for security typically differs between landlords and tenants.
For landlords, the general preference is towards bank guarantees, as they are a lower maintenance option for security.
Many tenants, however, prefer to provide bonds, as bank guarantees are subject to ongoing or annual bank fees.
If you require any assistance with your retail or commercial leasing needs, either as a tenant or a landlord, please contact our leasing team.