Turkalert lease security

Madeleine Perrignon & Samantha Jones | March 2014 | Commercial Disputes and Transactions

What a landlord should be aware of when considering the type of security to accept from a tenant It is common for landlords to require tenants to provide security for the performance of their lease obligations. Tenants, for reasons of convenience or cost, will sometimes seek to comply with this obligation by providing a cash bond (otherwise known as a security deposit) rather than a bank guarantee. Landlords should be fully informed regarding the characteristics of both types of security before they decide what security they will accept.

Bank Guarantees Unfair preferences usually involve transactions that discriminate in favour of one creditor at the expense of other creditors. In an insolvency situation (such as an administration or a liquidation), a cash bond can be clawed back by a trustee in bankruptcy or a liquidator if they believe that the payment to the landlord is a preference payment. This is because the money held as a cash bond is considered to be money held by the landlord on behalf of the tenant.

On the other hand, a bank guarantee is a guaranteed third party payment between the landlord and the bank, and it cannot be recovered as a preference payment. This is because it is not considered to be money held by the landlord on behalf of the tenant.

Disadvantages of security deposits for a landlord In addition to the insolvency concerns outlined above, there are a number of administrative requirements which may make cash bonds less attractive to landlords than bank guarantees.

The Retail Leases Act 1994 (NSW) requires a landlord to lodge any cash bond with the Director General of the Department of State and Regional Development (“the Department�) within the later of twenty days of receipt of the bond from the tenant or the lease start date. If landlords do not comply with these requirements, they may be liable for a penalty of more than $2,000.

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If a landlord wishes to call on the bond for any reason, they must lodge a claim form with the Department. The claim form must be signed by both the landlord and the tenant. If the tenant does not agree to release the bond, then the Department will issue a notice to the tenant, allowing them fourteen days to either agree to the release of the bond or to contest the claim.

Obviously, this is more complicated than a landlord simply being entitled to draw down on a bank guarantee without consent from a tenant.

Advantages of security deposits Banks can take several weeks to issue a bank guarantee. There is also a lot of paperwork to complete in order to apply for one. For a tenant, a security deposit is easier, as it is faster to obtain, and requires less paperwork. For non retail leases, it is simply a matter of writing a cheque. Retail leases also require the simple completion of a bond lodgement form.

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So, if speed is an issue due to imminent lease handover, a wise strategy may be to accept a cash bond until a bank guarantee can be provided.

However, there are some risks to landlords in accepting an interim cash bond: • The impetus for the tenant to actually provide a bank guarantee may be lessened when the tenant is already in possession of the premises.

• If the tenant’s bank imposes further conditions on the bank guarantee which are not acceptable to the landlord, the landlord’s bargaining position may be reduced if it has already allowed the tenant into occupation.

• Insolvency could become an issue even in an interim situation, and the interim cash bond could be clawed back by a trustee in bankruptcy or a liquidator.

• Even interim cash bonds need to be lodged with the Department of State and Regional Development if the lease is a retail lease and if the landlord holds them for longer than the allowed 21 day period from the earlier of the date that the bond is received, and the lease start date.

What terms need to be included in a bank guarantee?

Landlords and tenants should give careful consideration to the actual terms of a bank guarantee.

Description of Purpose From a landlord’s perspective, the bank guarantee should cover all the obligations of the tenant under the lease, not just rent or a “rental bond”.

They should be stated to be for “all obligations of [named tenant] under the lease for the premises located at [insert address of premises] and any licensed area or other rights ancillary to the lease.”

Expiration Date From a landlord’s perspective, a bank guarantee ideally should not contain an expiry date.

However, if a bank insists on an expiry date, then the landlord should check that the date covers all intended lease periods. The longer that the expiry date is after the lease expiration date, the better it is for a landlord. A landlord should aim for twelve

months after the lease expiration date, but might accept a shorter expiry date.

The reason why the landlord should insist that the bank guarantee not contain an expiry date, or should insist on the longest expiry date possible, is because tenants often hold over pursuant to the lease. A landlord could find itself in the situation whereby the bank guarantee has expired, the tenant is in breach of the lease, and the landlord no longer has valid security.

This is why, if the bank guarantee does contain an expiry date, the landlord should carefully diarise the date, so it is not left with a defaulting tenant – and no valid security.

Location of draw down Landlords should pay attention to any recovery provisions detailed in the bank guarantee. Some banks insist on draw down only at locations that are inconvenient to a landlord. Landlords should seek to amend such requirements so that they can draw down at bank branches convenient to themselves.

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Madeleine Perrignon and Samantha Jones | March 2014

Recovery provisions From a tenant’s perspective, a bank guarantee would ideally prohibit a landlord from drawing down on a bank guarantee until a tenant had been served notice as to the landlord’s intent and had been given opportunity to remedy the breach or for a court or tribunal to be required to make a ruling before the landlord could draw down on the guarantee.

However, forcing a landlord to engage in dispute resolution before drawing down on a bank guarantee would be unattractive to a landlord.

A compromise might be that a landlord agrees to notify the tenant prior to draw down, so that the tenant can inform the bank that there is an imminent draw down. This might reduce embarrassment for a tenant if they are offered an opportunity to inform their bank that they are in dispute with their landlord, and the reasons why, rather than the bank first learning of this fact when a landlord seeks to draw down on the bank guarantee.

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Madeleine Perrignon and Samantha Jones | March 2014

In Otter Group Pty Ltd v Wylaars & Anor [2013] VSC 98, the court accepted that “reputational damage may be caused by a call on a…(bank) guarantee, as that may call into question a person’s ability to perform their obligations under a contract, as well as their financial viability.”

In the Otter decision, the tenant sought an extension of interlocutory relief to prevent the landlord drawing down on the bank guarantee until the substantive dispute regarding make good was resolved.

However, Justice Hollingworth refused to extend the interlocutory relief, on the grounds that provision of security means that the parties implicitly agree that the party giving the security allows the security to be drawn down pending the resolution of the underlying dispute.

Justice Hollingworth referred to the decision of Clough Engineering Ltd v Oil and Natural Gas Corporation Ltd & Ors (2008) 249 ALR, whereby the court held that “clear words will be required to support a construction which inhibits a beneficiary from calling on a performance guarantee where a breach is alleged in good faith, that is, non-fraudulently.”

Therefore, if a landlord is not acting fraudulently or unconscionably, and if the bank guarantee does not contain any contractual limitation on its draw down, a landlord will be entitled to draw down prior to resolution of the dispute.

Things to keep in mind Obtain a copy of the bank guarantee prior to issue Having the landlord’s lawyer sight the bank guarantee prior to it being forwarded to the landlord is usually helpful to the tenant, their bank and the landlord. It is surprising how many bank guarantees contain errors, and it is much easier to correct them prior to issue of the guarantee.

Issue an “Information Sheet” Once lease negotiations are concluded, issuing an information sheet to the tenant that contains all the landlord’s requirements regarding the bank guarantee can be helpful to avoid later issues with the bank guarantees. Such information can simply be handed to the tenant’s bank.

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This opportunity may or may not be important to a tenant.

For more information, please contact: Madeleine Perrignon Partner T: 02 8257 5710 M: 0438 253 653 madeleine.perrignon@turkslegal.com.au

Here, Justice Hollingworth held that the bank guarantee was unconditional and was payable on demand to the landlord.

A landlord therefore needs to ensure that wording is included in the bank guarantee to the effect that the bank guarantee is unconditional. For example, it might include wording to the effect that the bank is required to pay the moneys to the beneficiary (being the landlord) without reference to the tenant, and notwithstanding that any notice has been given by the tenant to the bank not to pay it.

Samantha Jones Lawyer T: 02 8257 5750 M: 0451 159 577 samantha.jones@turkslegal.com.au

www.turkslegal.com.au Syd | Lvl 44, 2 Park St, NSW 2000 T: 02 8257 5700 | F: 02 9264 5600 Melb | Lvl 10 North Tower, 459 Collins St, VIC 3000 T: 03 8600 5000 | F: 03 8600 5099

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