When entering into a lease, the lessor may require the lessee to give some sort of financial assurance that would incentivise the lessee to comply with lease obligations. The most effective way lessors implement this is to impose a financial obligation on the lessee in the event they default on the lease, by way of paying a deposit or guarantee. It is imperative that any person who is willing to make a guarantee on behalf of the lessee is aware of the implications that may arise if the lessee does not comply with their lease obligation.
A guarantee is an agreement between the
- lessee and
- a third party
who agrees to be responsible for the lessee in the event they breach a lease obligation. It serves as protection in the event the lessee cannot meet an obligation under their lease. If this occurs then the third party can be called upon by the lessor to fulfil the obligation the lessee cannot meet.
Under a bank guarantee, no money has to be paid upfront to the lessor, the guarantee will only be paid out if the lessee fails to meet a lease obligation.
In a bank guarantee, the third party agreeing to be responsible for the lessee is the bank. Therefore, if the lessee fails to meet an obligation the bank will compensate the lessor for the lessee’s failure. A bank will provide a confirmation to be provided to the lessor, agreeing to pay a sum of money if the lessee defaults under a lease obligation.
The bank guarantee form must provide details of:
- the party the bank guarantee is made in favour of (the lessor);
- the purpose of the guarantee;
- a description of the leased premises;
- the amount of the guarantee (GST inclusive); and
- the expiry date of the guarantee.
Lessors should review the bank guarantee conditions before accepting it to ensure whether it meets their requirements. The conditions of the bank guarantee may restrict the lessor’s ability to call upon it when the lessee defaults.
Therefore, lessors should check if the bank guarantee:
- is unconditional
- – if it is conditional then there may be only some circumstances where the lessor can call upon the bank guarantee;
- is issued by an Australian bank
- – a bank guarantee issued by an international bank may present difficulties in contacting the overseas bank to release the guarantee amount to the lessor, and
- the purpose of the guarantee
- – it should cover not only the tenant’s obligation under the lease but any other documents that may be related to the lease agreement (e.g. a car parking licence). If the guarantee’s purpose is limited, then the lessor will be limited in the situations in which it can call upon the guarantee.
A personal guarantee differs from a bank guarantee, instead of a bank agreeing to pay a certain sum if the lessee defaults under the lease, another entity agrees to be personally liable for rectifying the lessee’s default.
Typically, personal guarantees are required in the event the lessee is a company and the personal guarantees come from the directors of the company. In this scenario, if the lessee company cannot complete an obligation under the lease then the directors who gave the personal guarantee will become personally liable to complete the condition.
Personal guarantees are very risky for the person who provides them. The large risk of giving a personal guarantee is the personal liability that arises in the event of the lessee’s default. If the lessee defaults under the lease, then the guarantor becomes legally liable for compensating the lessor for the default. This may require drawing from the guarantor’s personal assets including cars and family homes. Lessors also have a risk in accepting personal guarantees. If the guarantor has no individual assets then it may become difficult for the lessor to enforce the guarantor to compensate the lessee’s breach.
Instead of providing a guarantee to complete an obligation if the lessee breaches the lease, there is an option to pay a sum when the lease commences that can be used if the lessee defaults under the lease.
This option is referred to as a security deposit, and it is a sum of money paid by the lessee held in case the lessee defaults under the lease. The lease terms will provide when the security deposit can be used and how it must be managed during the lease term.
There is no limit to what the lessor can set as the security deposit amount, however, security deposits are typically the amount equivalent to three to six months of rent under the lease. However, the security deposit must be refundable to the lessee if it is not used during the lease period. If the security deposit is not refundable, then it is not considered a security deposit and is instead considered as key money.
Opting for payment of a security deposit means the lessee must pay a sum to the lessor upfront in case they breach the lease. A security deposit provides the benefit of having a fixed sum that must be paid, whereas payment under a guarantee will depend on the seriousness of the lessee’s default as to the amount that is recovered.
If you have any questions or require assistance with drafting, renewing or amending your lease in Queensland, please contact the property team at NB Lawyers for more information.
Kayleigh Swift, Associate
Chloe Skubis, Graduate Law Clerk
About the authors
Kayleigh Swift is an associate in our Commercial and Property team who assists with Employment Law matters. With a high level of experience in commercial and retail leasing, voluntary and involuntary purchase and sale acquisitions, property development and employee relations, Kayleigh provides practical advice to ensure smooth business transactions.
Chloe Skubis is a Graduate Law Clerk in our Property team who assists with various conveyancing transactions. Chloe is very experienced in residential conveyancing and is a problem solver. She always provides efficient service to all her clients.