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It is common practice for a landlord to request a tenant to provide security for performance of their commercial lease obligations by way of a cash bond or bank guarantee. However, many landlords accept either form of security without considering the relative advantages and disadvantages of each.

Bank Guarantee

A bank guarantee is a hard-copy document whereby the bank promises to pay the landlord if the tenant defaults under the terms of the lease (e.g. if the tenant fails to pay rent).

The bank guarantee is a third-party guarantee, which means it is neither the landlord nor the tenant’s document, but a document of the bank. This form of security is very convenient, as it dispenses with the administrative requirements of lodging the cash bond and having to account to the tenant for interest accrued.

It has been argued that bank guarantees are more secure if the tenant goes into bankruptcy or liquidation. When a bank guarantee is called upon it is the bank’s money being paid, which cannot be “clawed back” by creditors of the tenant. Contrast this with a cash bond paid by the tenant, which creditors can claw back as a preferential payment if the tenant goes under.

However, some doubt has been cast on the status quo. In Commissioner of Taxation v Kassem and Secatore [2012] FCAFC 124 the Federal Court found that, where a payment is made by a third party, including a bank, in accordance with the direction of their customer (tenant) or by or on behalf of their customer, the proceeds of the call on the bank guarantee may be treated as an unfair preference and be subject to clawback. Depending on the circumstances at the time of the call, the landlord should be able to defend the claim of unfair preference. The timing of the call on the bank guarantee will be crucial. If, at the time of making the call, the landlord had no reasonable grounds to believe the tenant was insolvent, the landlord should be able to rely on this defence to defeat the claim of unfair preference.

The main disadvantage of requesting a bank guarantee is that it comes at some cost and it may take time to call upon. This is normally due to the tenant or their banking institution’s own administrative procedures which can take days to finalise.

Cash Bond

A cash bond is monies provided by the tenant, usually by way of bank cheque, to guarantee performance of the tenant’s lease obligations.

The main advantage of accepting a cash bond is that it is easy to collect and avoids the tenant having to deal with a banking institution which can delay security being provided.

However, a cash bond does come with some disadvantages, for example:

  • the landlord needs to be proactive to ensure the cash bond is not declared unclaimed under the Banking Act 1959. If a bank account has had no withdrawals or deposits within a three-year period the account will be deemed inactive and the monies will be transferred to ASIC or the Commonwealth. Although the monies are not lost, recovery can involve a lengthy and protracted process;

  • the administrative burden placed on the landlord in lodging the cash bond, recording same in the books and having to account to the tenant for interest accrued;

  • usually a cash bond is held on trust by the landlord for the tenant. The risk that this poses for the landlord is that if the tenant becomes insolvent, the liquidator may be able to reclaim the cash bond and use to it to pay out the tenant’s creditors in order of priority.

Application of the PPSA to Bank Guarantees and Cash Bonds

The Personal Properties Securities Act 2009 (Cth) (PPSA) has application to a cash bond. The receipt of a cash bond under a lease creates a security interest in favour of the landlord, and the landlord becomes a secured party under the PPSA.

The security interest in favour of the landlord can and should be registered on the Personal Property Securities Register (PPSR). If the landlord does not register its interest then, in the event of insolvency of the tenant, the cash bond is likely to vest in the tenant and the landlord will have to join the queue as an unsecured creditor.

A bank guarantee provided on behalf of a tenant in favour of the landlord will not fall within the scope of the PPSA. This is because a bank guarantee is a contractual promise to pay and it does not confer a security interest in personal property.

In order to avoid the administrative burden of registration on the PPSR, landlords should insist that tenants provide a bank guarantee as opposed to a cash bond. However, to the extent that a cash bond has been provided, registration on the PPSR is important.

Summary

In order to maintain the value of the security provided by a tenant under the terms of the lease, the landlord should, wherever possible, spread the risk by using different forms of security. Where appropriate, the landlord should obtain a personal / director or inter-company guarantees in addition to the traditional forms of financial security (where the bank guarantee should be preferred). Hopefully this strategy may ensure the landlord can recover or limit its loss in the event of a default by the tenant. Written by Righardt Allers

This publication is provided as general information only and should not be considered or relied upon as legal advice. The law is complex and you should always obtain specific legal advice about your circumstances from a qualified legal practitioner.

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