Rent deposits are a popular form of security for landlords as they provide immediate access to funds in the event that the tenant is in breach of the lease: the tenant provides an agreed sum of money and the landlord is able to draw on this in specified circumstances.
A rent deposit can be structured in various different ways: there is no "right" way which works for both parties, and there are advantages and disadvantages to all approaches, so always consider what's going to be most appropriate in any given situation. The landlord and tenant will usually have conflicting interests, and while we would always advise a landlord to maintain control of the money, this wouldn't necessarily be in the interests of a tenant.
PICKING THE RIGHT STRUCTURE
The main concern for a landlord is that he has ready access to the deposit money throughout the term, while the main concern for a tenant is that that he gets the money back at the end of the term or when the lease is assigned to a third party (or by an earlier agreed release test). In addition, both parties are concerned that, in the event of the other's insolvency, the money is safe from an insolvency practitioner (ie the insolvency practitioner cannot access it or demand its return and use it to pay off creditors). There is also a concern that money held in a bank account cannot be used by the bank to set-off a credit balance on another account held by the same party. The key is striking the right balance between these concerns, while keeping administration and cost to a minimum.
HELD AND OWNED BY THE LANDLORD IN HIS GENERAL ACCOUNT
From the landlord's perspective, this is generally the best option. He has ready access to the funds and it keeps administration to a minimum. However, tenants will want to resist this structure for two reasons: if the landlord becomes insolvent, the money is indistinguishable and can be used to meet the claims of the landlord's creditors; and if the landlord owes money to the bank, the deposit money can be set-off against the credit balance. This will only ever be acceptable for small deposits held by very reliable landlords.
HELD AND OWNED BY THE LANDLORD IN A SEPARATE ACCOUNT
This brings with it essentially the same issues for the tenant as if the money were held in a general account, but is administratively more difficult for the landlord. If the account is in the name of both the landlord and the tenant it is arguable that the bank is on notice of the tenant's interest and can't exercise its right of set-off, but this is questionable if the deposit deed makes it clear that the money is owned by the landlord. Again, the structure will only be acceptable for small deposits held by very reliable landlords.
HELD BY LANDLORD IN A SEPARATE ACCOUNT BUT OWNED BY THE TENANT AND CHARGED TO LANDLORD
This structure leaves the money in the ownership of the tenant but gives the landlord control over it. He has sole rights to operate the account, combined with a charge over the account.
From the tenant's perspective, this structure should keep the money safe in the event of the landlord's insolvency, provided that it is clear that the money is still owned by the tenant (this should be express in the deposit deed, and also in the naming of the account). Provided that the bank has notice of the tenant's ownership of the money, it will be unable to exercise its right of set-off.
From the landlord's perspective, provided that the charge is valid and enforceable, the money will be safe from the tenant's insolvency practitioners and they will be unable to demand its immediate return. However, as the tenant has no control over the money it is not clear what asset the landlord is charging, so it's not certain that he has a valid, enforceable charge. Prior to 6 April 2013, when it was still possible to register such charges, registration in itself gave the landlord some comfort that it would be enforceable. Without this it is possible, though unlikely, that this structure is open to challenge by the tenant's insolvency practitioners.
HELD AND OWNED BY THE TENANT IN A SEPARATE ACCOUNT AND CHARGED TO LANDLORD
Landlords are usually uncomfortable with money being held by the tenant as they fear that there is a risk they will lose the deposit if the tenant becomes insolvent. With proper controls in place this is not necessarily the case, but a landlord should always be cautious in agreeing to this.
From a landlord's perspective, he will still have control over the account if he is given a mandate for this. Provided that the bank has notice of the landlord's interest (which is reinforced if the account name refers to the landlord) it will not be able to exercise set-off. The tenant's insolvency practitioners will not have any right to use the deposit money to pay off the tenant's creditors: however, as the charge is no longer registrable it is important that some other steps are taken to put the insolvency practitioner on notice of this (for example, within the name of the account), otherwise they may use the money without realising it is charged to the landlord, leaving the landlord with a valid claim, but the time and expense of pursuing it.
From a tenant's perspective this structure keeps the money in the tenant's own bank; even if the tenant gives the landlord a mandate for sole control off the account there is still some influence and involvement by the tenant. The money will be completely safe in the event of the landlord's insolvency. In addition, any interest earned on the account can be paid directly to the tenant.
HELD BY THE LANDLORD ON AN EXPRESS TRUST FOR THE TENANT
The landlord is legal owner of the money, but can only use it in accordance with the terms of the trust: the tenant remains beneficial owner of it. The landlord will have sole control, but will owe certain duties to the tenant.
From the tenant's perspective, provided that the money is placed in a separate designated account, it is safe from a landlord's insolvency practitioner as he is bound by the terms of the trust. However, if the money is placed into the landlord's general account it will be available to meet the claims of the landlord's creditors. There is also a risk that even if the money is placed in a separate account which is in the landlord's sole name an insolvency practitioner will be unaware of the trust and use the money in breach of this; the tenant should therefore insist that he is named on the account, to avoid this situation arising. However, if the money is wrongfully used for other purposes the tenant is able to trace it into any physical asset purchased with it, which means it will be easier to get it back. The bank will not be able to exercise its right of set-off provided that they have notice of the tenant's interest.
From the landlord's perspective, there's no need for a charge, he'll have control over the account, and there are some associated tax advantages as compared to him owning the money outright. However, he will be subject to enhanced trustee duties in respect of the money, which he may prefer to avoid. There is also a risk that the tenant's insolvency practitioner would be able to demand the immediate return of the money, on the basis that beneficial ownership lies with the tenant.
HELD BY A THIRD PARTY STAKEHOLDER
The money is held in a separate account by an independent third party (such a solicitor or managing agent) who acts as agent for both parties. It keeps the money safe from insolvency practitioners and neither party can access the money without input from the third party. However, this structure requires the third party to take on the administrative burden and there is likely to be a fee to pay. In addition, there is a risk that the tenant's insolvency practitioner could disclaim the rent deposit deed as an onerous contract, or argue that the landlord has been given a preference, and demand the immediate return of the money; it's not clear whether this would be successful but it increases the risk of this structure from the landlord's perspective.
Whenever it agreed that a rent deposit will be given, both parties need to consider what structure will be most appropriate. Where the money is held by either the landlord or the tenant (rather than a third party) it should be placed in a separate account and the name of the account should reflect the interest of the other party. This gives notice to both the bank and any insolvency practitioner and reduces the risk of the money being wrongly taken for other purposes. Whatever structure is agreed upon, this should be made explicit in the deed, including who owns the money, the requirement for a separate account and the name that will appear on the account. The deed should also impose an obligation to provide evidence that the account has in fact been set up, and the money paid in, as required.
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.