In my time as a lawyer, I’ve worked on a lot of transactions and disputes which include leases of property. One of the most common areas that causes confusion for tenants are the different types of security required under leases.
In this post, I want to explore:
- Why security is required in commercial leases
- Typical circumstances where a security will be applied to satisfy a tenant’s obligations under a lease
- Common forms of security instruments
- The options tenants (and landlords) have when they negotiate a commercial lease
If you’re entering a lease, understanding the typical security for a retail lease or typical security for a commercial lease can help you negotiate better terms and avoid unexpected financial strain.
Why Lease Security Exists
It’s very typical for a commercial lease to include security provisions, which are mechanisms or instruments through which the tenant provides the landlord with financial comfort in relation to their obligations — mostly to pay their rent but also other obligations like what are commonly referred to as “make good”.
“Make good” refers to the need to return the property in a similar fashion to what the tenant originally took it in. For example, removing fit-outs or repairing damage caused during the lease term.
From a landlord’s perspective, security helps protect against risks like:
- Unpaid rent
- Unpaid outgoings
- Damage to the property
- Failure to perform make good obligations
For tenants, the key is understanding what type of security is being requested and whether it’s reasonable.
Typical Security for Retail Leases in Victoria
In retail leases, what I typically see in the Victorian market are bank guarantees.
Here, the tenant gets their bank to essentially provide a limited guarantee in favor of the landlord, which can be called upon in circumstances where the tenant fails to fulfill their obligations under the lease, up to the value of the bank guarantee. This normally equals the value of the security required under the lease.
In the past few years, I’ve typically been seeing security provisions require the equivalent of between 2–4 months’ rent.
This amount may vary depending on:
- How ‘premium’ the location is and the quality of the building
- Strength of the tenant’s business
- The lease term
- The landlord’s risk appetite
- The nature of the tenant’s premises
How Do I Get a Bank Guarantee?
One of the most common questions tenants ask is “how do I get a bank guarantee?”
Bank guarantees are not that complicated conceptually, but in practice can be a little bit unusual if you’re not accustomed to them.
And how you acquire one might differ depending on your bank and the types of facilities you have.
For example:
- If you have an active overdraft facility, your bank may issue the guarantee against that facility.
- If you only hold cash accounts, the bank may require you to place the equivalent funds on hold.
- Some banks treat guarantees as part of a broader business lending facility.
Because of this, it’s usually worth speaking with your bank early in the leasing process so the security requirement doesn’t delay your lease commencement.
What if I Can’t Get a Bank Guarantee?
Occasionally tenants ask “what if I can’t get a bank guarantee?”
There are a few possible alternatives that sometimes appear in leases.
Cash Deposits
I sometimes see cash deposits.
However I advise my tenant clients to avoid these where possible. One reason is cashflow but there are a range of others.
Locking up several months of rent in cash can place unnecessary pressure on a business, particularly during the early stages of trading.
Please reach out if you need advice.
Director Guarantees
Another relatively common form of security is having directors of the tenant company provide personal guarantees.
This means the directors are effectively putting up their own assets as security if the tenant company fails to perform its obligations.
This might make sense in certain circumstances but needs to be considered carefully.
Again, please reach out if you need advice on whether this is a reasonable security approach in your circumstances.
What Is the Best Type of Lease Security?
From a tenant perspective, the best type of lease security is often a bank guarantee, because:
- It typically does not require cash to leave the business
- It limits exposure to the value of the guarantee
- It avoids personal liability for directors
However, the right approach always depends on the circumstances of the business and the terms of the lease.
Final Thoughts
Security provisions are a standard part of most leasing arrangements. Whether you’re currently considering clauses and instruments relating to security for a retail lease (under the Retail Leases Act 2003 (Vic)) or a non-retail commercial lease, understanding your options can help you manage risk and improve your cash position.
If you’re currently negotiating or about to conclude a lease and have questions about:
- whether the lease falls under the Retail Leases Act 2003 (Vic) (or the equivalent for another state);
- whether the security requirement(s) is reasonable — and what the relevant implications are;
- how to get a bank guarantee or what to do if you can’t obtain one;
- what you need to do to get your security back (at the conclusion of a lease),
It’s worth getting advice. The “right” approach will depend on your circumstances and what terms the Landlord is willing to offer, which together can make for a tricky balance — and that’s where an experienced lawyer becomes valuable.
If you would like to discuss your lease or any other contract requiring security, you are welcome to get in touch.