In the current climate, both landlords and tenants could be forgiven for wondering what would happen if the other became a victim of the recession. For both parties, a rent deposit deed can provide some comfort. Such a deed would mean the landlord has immediate access to cold hard cash if the tenant fails to pay the rent, while a struggling tenant may get valuable breathing space before the landlord turns to other remedies.
A rent deposit is a sum of money provided by the tenant as security for the payment of rent and performance of their obligations under the lease. A landlord can draw down on the deposit in specifi ed circumstances: generally when a tenant fails to pay the rent or otherwise breaches the lease. Rent deposits are commonly structured either as a charge (where the deposit is still legally owned by the tenant but is charged in favour of the landlord) or as a trust (where legal title to the deposit passes to the landlord, but the landlord may only draw on the deposit in certain circumstances).
If the worst happens and the tenant becomes insolvent, can a landlord draw on the rent deposit? The answer to this is not an automatic “yes.” Much will depend on the precise terms of the rent deposit deed. There are also several different insolvency regimes and the landlord’s rights will vary depending on which of these applies.
Tenant in receivership
The appointment of a receiver (either under the Law of Property Act or an administrative receiver), will not prevent the landlord from drawing on a rent deposit.
Tenant in liquidation
A landlord may continue to use the deposit throughout the liquidation process, even after a winding-up order has been made. If the liquidator disclaims the lease, the position depends on the terms of the rent deposit deed.
In practice, the deed will often provide that the landlord can keep what remains of the deposit after disclaimer and use it to cover any costs incurred. Where the deed is silent on this point, a landlord could still argue that the rent deposit is ancillary to the lease and therefore if the liquidator disclaims the lease, it must also disclaim the rent deposit. However, the case law on this point is not clear, so it is best to spell out what will happen on liquidation in the rent deposit deed.
Tenant in administration
Administration aims to rescue insolvent companies. To facilitate this, an interim moratorium takes effect as soon as the relevant papers have been fi led at court. This is followed by a further moratorium once the administrator is appointed. This means that, once the moratorium is in place, all creditors – landlords included – need permission from the court or the administrator before they can enforce any “security”, including a rent deposit.
However, at the end of 2003, the Financial Collateral Arrangements (No 2) Regulations 2003 came into force. Broadly, these apply where one party (in this case the tenant) owes fi nancial obligations to another (the landlord) and there is an agreement to secure these obligations by giving the landlord a security interest in “fi nancial collateral” (in this case cash).
The signifi cance of this is that, if the regulations apply, the usual moratorium is lifted – so the landlord can draw down on the rent deposit without fi rst having to seek permission. However, the regulations remain largely untested and there is some debate as to in which circumstances exactly they will apply. It seems likely that a deposit which is charged to the landlord will be covered by the regulations. The position with a deposit held on trust is not so clear. One of the key considerations is whether the deposit is in the possession or under the control of the landlord, which will largely depend on the exact terms of the rent deposit deed. Insolvency is a two-way street
Despite the restrictions imposed by the various insolvency regimes, a rent deposit remains a valuable source of security for a landlord. However, in the current market incoming tenants are in a position to drive a hard bargain and may simply refuse to tie up a substantial amount of money in this way.
Those tenants who are willing to enter into a rent deposit deed should also think carefully about how the deposit will be held. If the deposit becomes mixed with the landlord’s own money and the landlord becomes insolvent, the tenant will be an unsecured creditor, with a real risk of not getting their money back. One way to avoid this is for the deposit to be held by a third party as stakeholder. This will ensure that it is protected from the landlord’s creditors, although it does place a greater administrative burden on the stakeholder.