Rent Deposit - Common pitfalls

Rent Deposit – Common pitfalls

Rent deposits are often used as a form of security by commercial Landlords. However, most Landlords are not getting the most out of their rent deposit agreements.

Unlike the residential sector, which is heavily regulated and where deposits are held by statutory providers to guard against disputes, commercial rent deposits remain a matter of contract between the parties.

Deposits are commonly requested where the Landlord is not wholly satisfied with the Tenant’s covenant and ability to pay, often due to a lack of trading history on the part of the Tenant. They will usually be held for the full term of the lease, but may also be returnable when the Tenant is able to demonstrate a suitable trading history. The standard commercial test here is that the Tenant can show three consecutive years of audited accounts, where the net profit is more than three times the total amount payable for rent, rates, and service charge/insurance.

In most cases, the Tenant simply pays their deposit at the start of the lease, and if all goes well, they hopefully remember to ask for it back at the end. If things don’t go so well, the Landlord may look to dip into the deposit to meet any arrears of rent or other charges which the Tenant has accrued.

However, the most commonly used form of deposit agreement contains a number of additional provisions which benefit both Landlord and Tenant, and are often overlooked:-

Deposit Account

The Landlord is to place the deposit in an interest-bearing account (but only where interest-bearing accounts are generally available on the market). While interest rates have been low, there has been little point in placing deposits in interest accounts, but, as they begin to rise, there is a benefit in placing deposits so that they start to earn interest. The account should be in the name of the Landlord; however, the Landlord holds the money in trust for both parties (since the Landlord may use the deposit to meet arrears, but the Tenant is ultimately entitled to receive the balance of the deposit at expiry).

Deposit Amount

The Tenant is generally to keep the deposit funds maintained in not less than the stated amount. Where, for instance, the Landlord utilises the deposit to offset Tenant arrears, then the Tenant is not necessarily off the hook for those arrears. The Landlord is entitled to call on the Tenant to top up the deposit amount back up to its original level.

The same applies where the deposit is expressed as being the sum equivalent to e.g. three or six months’ rent. Where this is often overlooked is where the rent under the lease is reviewed. If there is a deposit held for a five-year lease, but the rent increases at year three, then often the Landlord is entitled to call for the Tenant to top up the deposit to be six months at the revised rent. Landlords often fail to follow up here, and this can leave them short if they ever have to call on the deposit.

Likewise, where the deposit is stated to cover a sum equivalent to VAT, the Landlord can ask for the deposit to be varied if the rate of VAT changes. Note that the deposit itself is not subject to VAT as it is not a “supply” of goods or services. However, a portion of the deposit can be stated to be held in relation to any arrears of VAT liability on rent properly invoiced to the Tenant.

Interest accrued

Since the Tenant is entitled to return of any unused deposit at expiry (or permitted assignation), interest accrues for the benefit of the Tenant. The Tenant is entitled to ask the Landlord for an annual statement showing the amount of the deposit and any interest accrued.

Crucially, this also means that the annual interest accruing on the deposit is “income” for the Tenant’s benefit. The Tenant is entitled to request an annual payment of the income accrued, and to account to HMRC in respect of the income. The commercially standard form of agreement also provides that the Landlord is entitled to advise HMRC of the Tenant’s details and the amount of interest accrued. By failing to make enquiries of the Landlord regarding the interest on the deposit fund, the Tenant could be unwittingly providing incorrect information to HMRC in respect of their income or corporation tax return.

Rent deposits are a useful tool for securing Tenant obligations under a lease, but in most cases, they can work harder for both parties, and it is always wise to read the agreement in full to ensure your position is protected.

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The information and opinions contained in this blog are for information only.  They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice.  Before acting on any information contained in this blog, please seek solicitor’s advice from Gilson Gray.