Guarantees and rent deposits

Statute of Frauds 1677, s 4 requires:

• a memorandum or note in writing,

• signed by the guarantor or by some other person lawfully authorised by him

Landlords frequently seek a covenant from the guarantor as 'principal debtor' or 'primary obligor' so that its liability is not merely secondary to that of the tenant. Even with this wording, the guarantor's liability can never exceed the tenant's. Its value is that the guarantor may remain liable even if the landlord's claim against the tenant is unenforceable.

Release

A guarantee can be lost where changes are made (expressly or by conduct) to the underlying contract. Guarantee clauses must contain protective wording to avoid release in the case of:

• 'giving time' - the guarantee should expressly prevent release despite 'any time or indulgence granted by the landlord to the tenant, or neglect or forbearance on the part of the landlord in enforcing the payment of rent and the other covenants in the lease'

• variations - variation of the contract between landlord and tenant releases the guarantor unless the guarantor consents, or the variation is 'self-evidently insubstantial or non-prejudicial to the guarantor' (Holme v Brunskill (1878) 3 QBD 495)

Protective wording can preserve but not increase a guarantor’s obligations. The guarantor will assume enhanced obligations only if it expressly agrees to do so. When reporting on a lease that has been assigned, highlight differing levels of liability between the current tenant, its predecessors and their guarantors.

Authorised Guarantee Agreements ('AGAs')

An AGA is subject to the general law of guarantees and must include protective wording to prevent release on any variation, or if the landlord gives time or indulgence to the assignee.

An AGA can be required if the lease permits the landlord to impose it as a condition of consent to assignment, or if it is reasonable in view of the assignee's covenant strength. If consent is not required there is no opportunity to seek or obtain an AGA.

Disclaimer

Disclaimer by the tenant's liquidator or trustee in bankruptcy does not release the guarantor, or the guarantor of any former tenant who remains liable. The guarantor's liability continues as though the lease still exists. However, future liability and any obligation to accept a new lease end if the landlord retakes possession of the property after disclaimer.

Rent Deposits

Rent deposit agreements usually cover 'any' default or breach by the tenant, and not just rent arrears.

The tenant is usually obliged to 'top up' the deposit if the landlord has made a withdrawal or if the rent increases at review.

Where the landlord has 'opted to tax' the deposit will be equal to 120% of the rent for the relevant period. The element taken on account of VAT does not become VAT until it is withdrawn in connection with a taxable supply. If the tenant's breach is non-payment of rent the landlord must issue a VAT invoice within 30 days of making the withdrawal.

If the landlord withdraws sums to cover a breach of covenant other than non-payment of rent - such as disrepair - then as damages they are outside the scope of VAT. The landlord cannot issue a VAT invoice, even if the sum withdrawn includes VAT payable to third parties, such as contractors called in to carry out repair works.

How is the fund held?

Either:

• by the landlord as trustee, and on terms allowing the landlord to withdraw sums in the event of tenant default, or

• it remains the tenant's money but is protected by a legal charge in the landlord's favour

Where the deposit is held on trust there is a separate charge to VAT when the money is paid to the landlord. For that purpose any sum taken 'on account' of VAT will count as part of the VATable deposit. So, if a landlord took a deposit of £100 plus a sum 'on account' of VAT, the deposit would amount to £120. The VAT payable when the deposit is handed over would be 20% of £100.

Is registration required?

Companies Act 1985, s 395 was superseded on 1 October 2009 by Companies Act 2006, s 860.

The validity of a charge created by a corporate tenant may depend on registration at Companies House within 21 days after creation. For rent deposits created before 26 December 2003 the need for registration was clear. For rent deposits created on or after that date it depends on the Financial Collateral Arrangements (No 2) Regulations 2003.

Under those Regulations charges over cash no longer need to be registered where:

• the purpose is to secure the relevant financial obligations owed to the collateral-taker (the landlord)

• the collateral-provider (the tenant) creates a security interest in financial collateral to secure those obligations

• the financial collateral is delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral-taker or a person acting on its behalf, and

• the collateral-provider and the collateral-taker are both non-natural persons

A rent deposit provided by a corporate tenant to a corporate landlord falls within this definition. Nonetheless, it remained widespread practice to register the charge.

Registration was still required where the landlord is an individual or partnership (as both parties must be 'non-natural persons').

If a charge should have been registered, but was not, then it was void against a liquidator, administrator or administrative receiver. However, in Obaray v Gateway (London) Ltd (2000) EGCS 149 the court held that, while the charge was void, contractual provisions entitled the landlord to withdraw sums where (and to the extent that) the tenant was in breach before the liquidation.

SDLT

For SDLT purposes a rent deposit may be treated as a premium for the grant of a lease if it is greater than two years' rent.

Repayment

Any part of the deposit not validly withdrawn by the landlord must be repaid to the tenant at the end of the tenancy or earlier if required by the rent deposit deed. Rent deposit agreements often direct repayment when the tenant can show three consecutive years' pre-tax profits of at least three times the annual rent. That is no more than a 'rule of thumb'. As lease terms reduce (and economic conditions deteriorate) it is likely that landlords will seek to retain deposits until the end of the term.

For 'new' tenancies, the obligation to repay a deposit (along with the right to make withdrawals) automatically passes to the new landlord when the landlord's interest is sold. The former landlord is not automatically released from the obligation to repay, but may either:

• provide that the obligation will end when the landlord sells its interest, or

• apply for release under Landlord and Tenant (Covenants) Act 1995, ss 6-8

For 'old' tenancies there is no automatic transmission of the obligation to repay. The original landlord remains liable and must protect itself against the possibility that its successor will default. This was often achieved by providing for a new rent deposit agreement when the landlord's interest was sold, and obliging the tenant to join in that agreement. Where that was not done, liability to repay may have remained with the former landlord.

Interest on the account forms part of the deposit and must usually be returned to the tenant when the deposit is released.