Residential Bonds and Commercial Leasing Bank Guarantees
When renting a residential home, the tenant is required to pay a bond. If the tenant damages the property or breaks the lease, the bond can be used to compensate the landlord. Commercial leasing bank guarantees are often used in a similar way to how a bond is used in residential leasing.
With a bank guarantee, a bank undertakes to pay the landlord a certain amount. If you breach the lease or damage the property, the landlord can draw down funds in accordance with the bank guarantee to repair the property or recoup rent that has not been paid.
Is there an alternative to a bank guarantee?
A security deposit is an alternative to a bank guarantee. This is essentially a cash bond that is paid directly to the landlord. There is no requirement that this bond be held by a third party and is often held directly by the landlord. One disadvantage of this is that the landlord is in possession of the deposit. If there is a dispute over whether there has in fact been a breach of the lease or whether damage has been sustained, this could cause some issues.
What is the governing law for these types of agreements?
There is no statutory law relating to commercial leasing bank guarantees or security deposits. The relevant contracts relating to the lease and the bank guarantee will govern their operation.
What is an “unconditional” bank guarantee?
This is something a landlord can request. An unconditional bank guarantee means that upon certain events happening according to the lease, the bank can provide funds to the landlord regardless of other events, e.g. a dispute between you and the landlord that is ongoing.
There has been a case where a tenant has successfully prevented a landlord from drawing down funds on a bank guarantee that was purportedly unconditional. In this case, the lease contained a clause about the bank guarantee that purported to make it unconditional. However, the court found that the landlord was not entitled to draw down on the bank guarantee as there was a serious question to be tried as to whether in fact, the tenant had breached the tenancy agreement. An injunction was granted to prevent the landlord from obtaining funds through the bank guarantee.
Advantages of bank guarantees
Some of the advantages of commercial leasing bank guarantees include:
- The “bond” for the transaction is held with a bank rather than one of the parties to the lease;
- For the lessor they can earn interest on the amount of the bank guarantee while it remains with the bank; and
- Bank guarantees support business growth as smaller companies can enter into commercial leases where a lessor may have otherwise been unwilling to enter into one with the lessee were it not for the bank guarantee
Disadvantages of bank guarantees
Some of the disadvantages of using bank guarantees are:
- The involvement of a bank may add a layer of complexity to a transaction that would otherwise be more simplistic; and
- For the lessee, it may be required to pay fees both once-off and ongoing in order to maintain the bank guarantee.
Be aware of your obligations
It is important, whether you are the landlord or the tenant in a commercial leasing agreement to ensure that the clause relating to the bank guarantee or security deposit is drafted appropriately to suit the circumstances.
It is also important that if you are a tenant applying for a bank guarantee that you review the agreement with your bank for the bank guarantee so that you ensure you understand your obligations to the bank. Among other things, you may be required to pay an upfront fee and ongoing fees for the maintenance of the bank guarantee for the duration that it remains in place.
Bank guarantees may be made with or without an expiry date
One further thing to be aware of, especially if you are a landlord where a bank guarantee is attached to a lease, is that bank guarantees can be either ongoing or have an expiry date. As a landlord, it is advisable that you log all dates relevant to the expiry of bank guarantees and request replacements are obtained before their expiry.
If you require legal advice or representation in any legal matter, please contact Armstrong Legal.
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