Lease Security: Cash Bond vs Bank Guarantee
It is a common requirement that, when entering into a commercial lease, the landlord will require a tenant to provide security for the lease. While the tenant is under a contractual obligation to meet all the lease’s terms and conditions, the security provides an immediate avenue of recourse for a landlord in the event that the tenant damages the property, fails to pay rent or commits other breaches of the lease.
There are two common forms of a lease security payment: a cash bond or a bank guarantee. So, the question inevitably rises, what is the better option?
Cash Bond
A cash bond is a direct payment of funds from the tenant to the landlord. The amount of the cash bond must comply with any applicable state or territory retail leasing legislation regarding maximum security deposits but is typically 3 months’ rent plus GST.
Some landlords and tenants prefer a cash bond for its simplicity – the tenant simply makes a payment to the landlord, and the landlord holds the cash bond for the term of the lease. This simple arrangement though is not without its risks.
From a tenant perspective, once the cash bond has been paid they have no visibility of the funds or whether the bond has been drawn upon by the landlord.
From a landlord perspective, just because they have been paid a cash bond doesn’t mean the funds are theirs to do with as they want – they are required to hold those funds on behalf of the tenant. Because the funds don’t belong to the landlord, it means that a party appointed to manage the tenant’s financial affairs (eg. a liquidator) can recover the cash bond from a lessor if the tenant becomes insolvent, leaving the landlord without any security for the lease.
There are ways to prevent this, however. Registering a cash bond on the Personal Properties Securities Register makes it a perfected security interest, and so the landlord’s interest in the bond will have priority over other parties. This is also not without it’s complexities, but the topic of priority when it comes to security interests on the Personal Properties Securities Register is for another day.
Bank Guarantee
A bank guarantee in contrast is a piece of paper issued by a bank which promises to the landlord that they will pay to them the security amount should they call on the guarantee. Obtaining a bank guarantee usually involves a tenant paying funds into a term deposit with their bank, with those funds then being locked away until the bank guarantee is cancelled.
From a tenant perspective, because the funds are held in a term deposit the balance in this account is usually visible through their online banking platform. This means that the tenant can monitor the balance, and will know immediately if the bond has been called on by the landlord.
A bank guarantee is seen as the more secure option than a cash bond because a bank guarantee gives a landlord confidence that even if the tenant cannot pay, the bank will be able to. Unlike a cash bond, no other party can assert an interest in the proceeds of the bank guarantee.
However, a bank guarantee is significantly more complicated than a bond. It typically takes several weeks to set it up, and there will be an initial establishment fee as well as ongoing fees payable by a tenant while ever the bank guarantee remains in force. While the funds held in the term deposit generally earn interest, that is almost never enough to cover those fees.
Generally, bank guarantees are the preferred form of lease security by lawyers and landlords alike. This does not mean that a cash bond is never a good option, however. Making a decision that is right for your matter involves talks between the tenant, landlord, a reputable lawyer and any other parties involved.
If you have any questions about what type of lease security is right for you, please do not hesitate to contact me. I am here to help.
DISCLAIMER: This article is for informational purposes only and does not constitute legal advice.