Australia: Bank guarantees vs cash bonds - what is the difference for landlords?

It is common for commercial and retail landlords to require tenants to provide security for the performance of their obligations under the relevant lease. While it is usual to request that the security take the form of a bank guarantee, landlords may not be aware of the specific reasons for this preference.

This article highlights the advantages of seeking a bank guarantee over a cash bond (also referred to as a security deposit) and looks at some of the procedural issues that parties should consider concerning bank guarantees.

Why a bank guarantee?

The trend in commercial and retail leases over the past decade has been to compel tenants to provide lease security by way of a bank guarantee rather than a cash bond.

A bank guarantee is an undertaking from a banking institution to make a payment to the landlord (up to the amount nominated in the guarantee), without reference to the tenant (at whose request the guarantee has been issued).

The advantage of a bank guarantee is that it provides the landlord with an undertaking from a third party securing payment under the lease. This is particularly beneficial in the situation where a tenant becomes insolvent. A cash bond would usually be categorised as money held on trust for the benefit of the tenant so that, if the tenant experienced an insolvency event (such as being placed into administration or liquidation), then the party appointed to manage the tenant's affairs could potentially recover the cash bond from the landlord as a "preference payment". This may include the ability to claw back any part of the bond disbursed to the landlord in the period immediately before the insolvency of the tenant.

On the other hand a bank guarantee can be called upon before or after the tenant's insolvency, without significant risk to the landlord that the funds received may be recovered as a preference payment.

Pitfalls of cash bonds

In addition to the preference payment concerns outlined above, there are a number of administrative requirements which may also make cash bonds less attractive to landlords.

In New South Wales, the Retail Leases Act 1994 requires a landlord to lodge any cash bond with NSW Fair Trading within 20 days of receipt from the tenant or from the start of the lease (whichever is later). If landlords do not comply with those requirements, they may be liable for a penalty of more than $2,000.

A landlord who intends to call on the bond, either following the tenant's default or at the end of the tenancy period, must lodge a claim form with NSW Fair Trading. That form must be signed by both the landlord and the tenant for the bond to be paid to the landlord without delay. If the tenant does not support the landlord's claim for the bond to be released, the landlord can still lodge the form, but NSW Fair Trading will then issue a notice allowing the tenant 14 days to agree to the release of the bond or contest the claim.

The retail legislation in Queensland allows lawyers and real estate agents to hold cash bonds in their trust accounts. The terms of the lease will dictate the basis upon which these funds are held and when they may be called on by a landlord. Alternatively, the security bond may be held in a separate bank account on behalf of the parties. The landlord's and the tenant's authority will be required to withdraw funds from the account.

In the ACT, pursuant to the Leases (Commercial and Retail) Act 2001, any cash bond should be held by the landlord in a trust account which attracts interest and the landlord must account to the tenant for the interest earned. Under section 43, the landlord may only deduct amounts from the bond to recover a sum owing by the tenant under the lease where the deduction is not contrary to the Act.

Effect of changes to the Banking Act

Recent changes to the Banking Act 1959 have reduced the timeframes in which bank accounts become "inactive". If an account is inactive for three years, the funds are deemed to be "unclaimed" and are transferred to ASIC.

Given that most commercial and retail leases run for terms longer than three years, if a tenant provides security by way of a cash bond that is held in a separate bank account, then the landlord and tenant run the risk that the funds will be transferred to ASIC after the statutory period of inactivity.

While those funds are not actually forfeited to ASIC as there are procedures to recover them, inactive accounts add a further administrative aspect and a potential pitfall to landlords in holding cash bonds.

Landlords should also be aware that, just because an account is earning interest and/or fees are being charged, this does not automatically "activate" the account to avoid the time period for transfer of the funds to ASIC.

Procedural considerations concerning bank guarantees

Possession pending provision of a bank guarantee

The procedural and administrative requirements of some banks means that the turn-around time for issuing a bank guarantee may be a number of days or even a number of weeks. This can lead to a situation where, for reasons of urgency regarding fitout or occupancy requirements, the tenant requests that the landlord provide access to the premises prior to receiving the bank guarantee, where the tenant is willing to provide a cash bond in the interim.

Some risks to landlords in accepting interim cash bonds are:

• The impetus for the tenant to actually provide the bank guarantee may be lessened where 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 where it has already allowed the tenant into occupation.
• As set out above, if the tenant becomes insolvent before the bank guarantee is actually received, then the landlord may be left in a position where it holds no security, as the bond may be clawed back by the administrator, liquidator or other appointed party.
• For a Retail Lease in NSW, the cash bond may need to be lodged with NSW Fair Trading, even if it is intended that it will only be held for a short period.

Terms of a bank guarantee

Parties may spend significant time and expense negotiating the terms of a lease, but are often more relaxed when it comes to checking a bank guarantee's provisions. Although it is often seen as a mere administrative task, landlords and tenants should give careful consideration to the actual terms of the bank guarantee.

Consideration needs to be given to the description of the agreement in the bank guarantee. 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". Expiry dates are quite common these days and landlords should check that what is set out in the bank guarantee matches the lease agreement. Landlords should also pay attention to which bank is issuing the guarantee and any procedures which are set out in the guarantee itself, particularly branch locations and the steps which must be taken to draw down the funds.

Key considerations

Landlords should give serious thought to the form of security they require under a lease. Where a bank guarantee is specified, landlords will be better placed if they make the receipt of the bank guarantee a pre-condition to handing over possession of the premises. It may also assist with the process if, at the outset of the lease negotiation, the proposed tenant is given an 'information sheet' which sets out the landlord's requirements for the bank guarantee.

Tenants should commence the process of applying for the bank guarantee early on and should always seek clarification from landlords about their specific requirements regarding the bank guarantee.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.