assignment of rent deposit deed

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• 19 December 2022
• Commercial Real Estate

Commercial Rent Deposits – A brief overview

What is a rent deposit.

A rent deposit is money provided by a tenant to its landlord as security for payment of the rent and performance of the tenant’s covenants contained in the lease. A rent deposit deed will specify the circumstances in which the landlord can draw on this money and the conditions that must be satisfied for the deposit to be repaid to the tenant.

Landlords like rent deposits because they are easily accessible sources of money that can be drawn upon as soon as the tenant is in breach of a relevant covenant in the lease. Court action is not required to recover the debt or enforce performance of the obligation. Tenants are not generally too keen on rent deposits as they lock up capital, often for a lengthy period.

When will a rent deposit be taken?

A rent deposit will be put in place on the grant of a lease or on assignment of an existing lease. If the landlord does require a rent deposit it will usually be for one of the following reasons;-

• The tenant’s covenant is weak and therefore unsatisfactory to the landlord without some additional comfort
• The tenant may be an overseas company with few, if any, UK assets
• The tenant is a new business and so is unable to provide evidence of its past good behaviour as a tenant.

As many tenants will not want to lock up the capital required to fund it, the possible alternatives include;-

• A bank guarantee or bond
• A parent company guarantee
• A guarantee from a director
• A letter of credit from a bank

All of these alternatives have potential disadvantages, for example both the bank guarantee or bond and a letter of credit will require a payment to the bank from the tenant to secure the payment and the value of a guarantee will depend upon the strength of the party providing the guarantee.

Points to be considered when negotiating a rent deposit deed

How much should the landlord require .

There is no prescribed level and no statutory constraints on the size of the sum. However, the amount put down usually reflects the rent payable under the lease, the likely period that it would take for the landlord to re-let the property and the landlord’s perception of the risk that the tenant poses.

Rent deposits are generally equivalent to between 6 & 12 months’ rent due under the lease. The amount is usually related to the yearly rent payable but may also include insurance rent and service charges.

VAT on rent deposits is often a contentious point a deposit in respect of the sum representing the amount of VAT that will be payable is often a contentious point. The parties may not consider VAT when negotiating the amount. VAT is not payable on the sum deposited with the landlord as a supply is not being made at that time, but once the landlord draws on deposit as a result of tenant’s default and if the landlord has exercised the option to tax, VAT will be payable on the amount drawn down.

Accordingly, where the landlord has exercised the option to tax or is likely to do so, the negotiated deposit should be an amount that includes a sum equivalent to the VAT that will be payable if the tenant is in default.

Simon Ralphs

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A rent deposit is money provided by a tenant to its landlord as security for payment of the rent and performance of the tenant’s covenants contained in the lease.

When will the rent deposit be returned to the tenant?

It will generally be returnable in the following circumstances;-

• Assignment under the lease in accordance with the lease. (On such an occasion the landlord may, if appropriate, want to require a new rent deposit from the assignee.)
• Expiry of the lease term without any holding over under the landlord and tenant Act 1954
• Early termination of the lease by agreement (such as by way of surrender or exercise of an option to break). Early termination by agreement would exclude forfeiture and disclaimer

The landlord may also agree to return the rent deposit if the tenant demonstrates that its financial position has sufficiently improved to render the rent deposit unnecessary to reassure the landlord that it will meet its financial obligations under the lease. Examples of this trigger are the “net profit” test where the net profits of the tenant are shown to equal or exceed a multiple (usually 3 times) of the rents reserved by the lease for up to 3 years and the “net assets” test where the net assets of the tenant are equal to a multiple (often 5 times) of the rents reserved by the lease.

Tax on rent deposits

Sdlt on the rent deposit.

In the past, rent deposits did not form part of the “consideration” on the grant or assignment of a lease so no SDLT was charged on. However, the Finance (No.2) Act 2005 contains provisions to enable SDLT to be charged on premiums that are disguised as rent deposits.

Under these statutory provisions, rent deposits are held to be “consideration” for the purpose of the grant or assignment of a lease (and therefore potentially liable for SDLT) unless the rent deposit is less than twice the highest amount of annual rent payable in any 12 month period in the first 5 years of the term or, in the case of an assignment, in the first 5 years of the term remaining outstanding at the date of the assignment.

It is argued by some advisors that these provisions only apply to the type of the rent deposit structure where the tenant actually transfers ownership of the deposit monies to the landlord. However, most rent deposits are drafted to provide that the money is held by the landlord but owned by the tenant.

VAT ON RENT DEPOSIT MONIES

Where a landlord has opted to pay VAT, VAT is payable on the annual rent. As mentioned above, it is therefore usual where the option has been exercised, for the landlord to ask that the money deposited incorporates a figure equivalent to the VAT on the rent deposit to ensure that the landlord will be able to claim the full amount due if the tenant fails to pay rent.

VAT is not actually payable when the money is put on deposit, since the landlord is making no supply at that date. It is only if and when the Landlord makes a deduction from the deposit monies that a taxable supply is made that is liable to VAT.

No VAT invoice is required when a rent deposit deed is entered into if a sum equivalent to VAT is paid.

Further information

This article contains some initial points to be considered in relation to rent deposit deeds. These documents are often drafted in a complex way and questions will arise on each form of rent deposit deed used for example whether a landlord can draw against a rent deposit if a corporate tenant becomes insolvent, and what happens when the landlord sells its interest in the property.

If you have any queries on any of these points or the point referred in this note or any other matters relating to rent deposit deeds please contact our Commercial Real Estate team.

About this article

• Subject Commercial Rent Deposits – A brief overview
• Author Simon Ralphs
• Expertise Commercial Real Estate
• Published 19 December 2022

Disclaimer This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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Home » News & publications » Latest news » Why commercial rent deposits are not quite so simple

Why commercial rent deposits are not quite so simple

Posted: 28/08/2019

In today’s insecure commercial lettings market, it is becoming increasingly common for landlords to take a significant rent deposit when granting a new lease and to enforce their rights under the rent deposit deed. This is putting the drafting and enforcement of rent deposit deeds under scrutiny. How do the parties to a rent deposit deed protect their positions when the landlord assigns the reversion to the lease? In this article, we assume that the rent deposit account is in the landlord’s name and that the tenant’s interest in the account - and the monies in it - are charged to the landlord.

What happens when:

• The landlord transfers or assigns its interest?
• The landlord grants an intermediate lease?

Transfer or assignment: new tenancies

A rent deposit deed that relates to a “new” tenancy is a “collateral agreement” to the tenancy, as defined in section 28(1) of the Landlord and Tenant (Covenants) Act 1995 (the 1995 Act). Covenants contained in collateral agreements are “covenants” for the purposes of the 1995 Act.

Section 3(3) of the 1995 Act says that, where a landlord transfers or assigns its interest, the transferee or assignee will become bound by the landlord’s covenants whether they are covenants contained in the tenancy or in the rent deposit deed (except where they are stipulated to be personal) and will become entitled to the benefit of the tenant’s covenants. This is a statutory exception to the established principle that the burden of a contract cannot be assigned. In these circumstances, the covenants contained in the rent deposit deed are enforceable by and against the new landlord.

Transferring the charge

The charge on the rent deposit account does not fall within the definition of a “covenant” under the 1995 Act. A charge is not a “term, condition or obligation”; it is an encumbrance on the asset that is subject to the charge and gives the landlord the right to appropriate the charged property.

The fact that the benefit and burden of the rent deposit deed covenants have transferred to the landlord’s successor by virtue of the 1995 Act does not mean that the benefit of the charge has also been transferred. If the parties do not take further action, the beneficiary of the charge may be the old landlord even though he is no longer able to enforce the covenants under the deed.

Defining the “landlord”

If the deed is personal to the named landlord, a new rent deposit deed containing a new charge is required. A new charge will create a chargee/chargor relationship between the new landlord and the tenant. Without a new charge, although the new landlord can enforce the tenant’s covenants in the deed, it will be an unsecured creditor with no priority in a tenant insolvency.

The central purpose of a rent deposit deed is to protect the landlord in the case of tenant insolvency. In a worst-case scenario, a new landlord may find that the deposit is entirely swallowed up by the creditors ranking above it, resulting in the total loss of its security.

It is common for rent deposit deeds to define the “landlord” to include successors in title, so that the tenant’s charge of its interest in the deposit account is to the current and all future landlords. The benefit of the charge will automatically transfer when the landlord transfers or assigns its interest.

Release under the 1995 Act

Under section 6 of the 1995 Act, the outgoing landlord will remain liable for the landlord’s covenants in the rent deposit deed until it obtains a release from the tenant.

The landlord is released if it serves notice on the tenant telling the tenant of the proposed assignment and requesting that it is released from the landlord’s covenants and:

• the tenant does not serve a written notice objecting to the release within four weeks of service of the landlord’s notice;
• the tenant serves such a notice but the court makes a declaration that it is reasonable for the covenants to be released; or
• the tenant serves written notice consenting to the release (and withdrawing any prior notice objecting to it, if applicable).

If this procedure is not followed, a landlord remains liable for the performance of the landlord covenants. However, owing to complications arising if some (but not all) tenants release the landlord, it may not be appropriate in every case to seek such a release.

If a rent deposit deed to a “new” tenancy incorporates the landlord’s successors in title, no action needs to be taken. Where appropriate, a landlord should consider following the procedure in section 8 of the 1995 Act to release its liability to the tenant.

If the deed does not incorporate successors in title, a new rent deposit deed will need to be entered into between the tenant and the landlord’s successor. The covenants will be extinguished and the successor will offer new covenants.

Transfer or assignment: old tenancies

One of two different sets of rules will govern:

Sections 141 and 142 of the Law of Property Act 1925

If the lease and/or the rent deposit deed define covenants given in the rent deposit deed as lease covenants, then sections 141 and 142 of the Law of Property Act 1925 (the 1925 Act) apply. As lease covenants they are enforceable by and against the landlord’s successor in title automatically. To pass on the benefit of the charge automatically, the charge must be drafted to refer to successors in title.

Common law rules

If the covenants in the rent deposit deed are not lease covenants, the common law rules for the assignment of contractual obligations and privity of contract apply.

The benefit of a contract may be assigned. The assignment must be absolute, in writing and signed by the assignor, and notice of the assignment must be given to the tenant.

The burdens of a contract may not be assigned. When the rent deposit deed relates to an “old” tenancy, the parties must create privity of contract between the new landlord and the tenant. Two methods are available:

• Assignment from old landlord to new landlord and deed of covenant from new landlord to tenant: The assignment can be completed within the suite of sale documents, and the deed of covenant can be entered into unilaterally by the new landlord on completion. If the deed does not incorporate successors within the definition of the “landlord”, the benefit of the charge will not transfer.
• Novation of the rent deposit deed: The new landlord and the tenant enter into a new rent deposit deed on identical terms to the previous deed. This could be dealt with as a condition subsequent, so as not to interfere with time pressures or confidentiality obligations relating to a sale. Consideration should be given as to whether the tenant may not comply or may delay and to which party should bear the tenant’s costs. A prudent landlord should ensure that the tenant is in a financial position to give the new charge before completing the new deed.

Grant of an intermediate lease

The 1995 Act does not apply where the landlord grants an intermediate lease of the property. The granting of a new lease is not an “assignment” and the intermediate tenant is not treated as stepping into the landlord’s shoes.

The grant of an intermediate lease may qualify as a disposition of the reversionary estate immediately expectant on the determination of the term of the lease to which the rent deposit deed relates. The provisions of sections 141 and 142 of the 1925 Act may apply as above and, if they do not, the common law rules apply.

Registration

Charges created by companies on or before 5 April 2013 had to be registered at Companies House within 21 days of the date of execution or they are void. If the charge created by a rent deposit deed is not registered, a tenant’s insolvency practitioner will assert that the charge is void and the landlord is an unsecured creditor.

The landlord has two options:

• Argue that the charge did not require registration at Companies House.
• Enter into a new rent deposit deed with the tenant.

Charges created on or after 6 April 2013 are not required to be registered at Companies House.

In summary, rent deposit deeds should be given appropriate consideration both during the drafting process and during due diligence relating to the disposition of the landlord’s interest.

This article was first published in Estates Gazette in June 2019.

Giorgia Mayes

Email Giorgia +44 (0)1223 465425

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Deed of assignment of rent deposit(s) | Practical Law

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