When landlords own property, they are looking to achieve a decent investment. They want regular rent, and no problems. To achieve that, they need to satisfy themselves that the tenants will be reliable.
If the prospective tenants are rich individuals or companies with a long trading record, then the landlords may take a view that they are acceptable tenants with nothing further required. But if the prospective tenants are a newly created limited company – often called a “shell company” – or individuals with no substantial assets behind them, then the landlords will look for ways of protecting themselves against the risk of a tenant going bust.
One very usual solution is to require a rent deposit. This is a sum of money which is held by the landlords and can be used by them to meet any outstanding rent or other costs incurred during the course of the lease. If the tenants cease trading and the landlords forfeit the lease, the rent deposit provides some cushion for the period during which they can’t get rent until they re-let the premises.
The amount of the deposit is subject to negotiation at the start of the lease. Often it is three months’ or six months’ rent.
The rent deposit has to be paid at the same time as completion of the lease. The tenants may also be required – unless there is a rent free period – to pay the first quarter’s rent at that time. So, if you agree a rent deposit, you should bear in mind that the hit to the cashflow at the start of your business can be significant. You should make sure you can afford it.
The money is held by the landlord. It may be agreed that the money will be put in a joint bank account, or a separate bank account in the landlord’s name. Many landlords will expect to hold it and not have administrative trouble of opening new bank accounts for a single letting. There is always the risk of landlords going bankrupt and the deposit being lost, which you have to weigh up.
The landlords solicitors will prepare a rent deposit deed at the same time as the draft lease, and your solicitors will be able to scrutinise and amend its terms.
Usually, a rent deposit deed entitles the landlords to deduct money from it when monies are due to them. The landlords will require the tenants to replenish the deposit with the amount which has been taken out of it. Normally it will be stated in the rent deposit deed that the landlords’ rights to recover rent under the lease and to take actions such as forfeiture of the lease, will also apply to failure by the tenants to replenish the rent deposit to its full amount.
If the agreement is that the rent deposit should be a certain number of months rent, then, if there is a rent review, and the rent is increased, the rent deposit will also have to be increased. It can be agreed at the start, however, that the deposit will remained capped at the original figure.
If you agree to pay three months’ rent deposit, it will actually be three months’ rent plus 20% VAT on it. There is in fact no VAT due at this stage. But it will become due you as soon the landlords have to use the funds in the event that there are any arrears of rent. That is why it is added to the basic rent deposit amount.
The deposit is usually required to remain for at least as long as the initial tenants remain the tenants, or perhaps even for the term of the lease – but that should be resisted. It would be reasonable for any deposit to be refunded to the tenants when they no longer have an interest in the property – for example, when they assign the premises to new tenants, with the landlords permission. In that situation, the landlord should negotiate appropriate protections specific to the new tenants.
If the rent deposit is to remain for the term of the lease, the rent deposit is not personal to you, it’s to cover the obligations of the tenants whoever they are. So, if you assign the lease to new occupiers, you need to negotiate with your replacement tenants for them to refund the rent deposit to you, because the landlord will continue to hold it in relation to them.
Personal circumstances may change. Your new company may become an established company. You may become wealthy from the business. It would be reasonable to anticipate that situation and negotiate a provision at the start that there are circumstances in which the rent deposit will be returned while the lease is still ongoing. For example, it might be agreed in the case of a company, that if and when annual turnover exceeds a certain amount for a period of three years, the rent deposit will be returned.
Tenants should receive interest on the deposit. This is often added to the deposit.
The rent deposit is normally not only security for the payment of rent, but also for the performance of the other obligations of the tenants under the lease. When the lease comes to an end, the tenants will not automatically receive the rent deposit back. First, the landlords will probably carry out an assessment of whether the tenants have complied with their repairing obligations and returned the premises to them in the required state. If not, the landlords will expect to charge for doing the necessary works themselves, and that also can be deducted from the rent deposit before any balance is finally returned.