News & Insights

Are insolvent tenants’ rent deposits fair game?

If a commercial tenant goes into administration, or is about to, can a landlord look to deduct unpaid rent from the rent deposit?

Often commercial leases require a tenant to provide a rent deposit when taking on a lease. The size of deposit depends on what is negotiated, but often amounts to a sum equivalent to 3-6 months’ rent – this can, therefore, be a sizeable sum, and particularly attractive to a landlord with an unpaid rent demand. If a withdrawal is made a well drafted rent deposit deed will require a tenant to ‘top up’ a deposit so in theory a landlord could raid the deposit as soon as a sum becomes due.

Given that the present restrictions imposed by the government due to Covid-19 do not prevent a landlord from using a rent deposit to pay unpaid sums due, using a rent deposit is even more attractive – typical remedies such as forfeiture, commercial rent arrears recovery (CRAR) or statutory demands and winding up are not available to landlords at the moment. Recent guidance released by the government states that although landlords can draw on rent deposits, it suggests that they can do so on the understanding that they will not require them to be topped up before it is “realistic and reasonable” to do so.

That said, once a corporate tenant (please note that individuals are not within the scope of this article) has gone into administration there are restrictions on withdrawals that can be made. This is because of the impact of the moratorium.  The Insolvency Act 1986 provides that no measures must be taken to enforce security over a company’s property when they are in administration, without the consent of the administrator or permission of the court.

Not all landlords are affected by a moratorium; if the deposit is held as part of the landlord’s general funds then the tenant’s insolvency will not affect it.  If the rent deposit deed is drafted in such a way as to give the landlord control of the deposit (most forms of rent deposit deed commonly used do provide this), the rent deposit will be considered a ‘financial collateral arrangement’ under The Financial Collateral Arrangements (No 2) Regulations 2003.  In these cases, a landlord would not need to obtain an agreement of the administrators or the court prior to drawdown of the deposit.

Even with the benefit of a rent deposit which is not affected by the restrictions imposed by the moratorium, a landlord may want to hold off using the deposit in case the property ends up being used by administrators ‘for the purposes of the administration’.  In this situation, rent and other sums due under the lease can be treated as an expense of the administration, and paid to the landlord.  As indicated above, a rent deposit will not presently be ‘topped up’ in the situation if the landlord has made a rent deposit withdrawal; neither are administrators are obliged to pay for other liabilities, such as dilapidations.  A landlord may therefore wish to hold onto the deposit and use it to cover those costs and not the unpaid rent and other sums, which may in fact end up being paid by the administrators as expenses of the administration.

If a landlord is concerned that the rent deposit agreement is not drafted in such a way as to be free from restrictions, then drawing down the deposit before the tenant goes into administration is perhaps preferable to running the risk of not being able to, due to the moratorium.

Care is therefore needed when considering making a withdrawal from the rent deposit, and especially on the timing of the withdrawal.  If you are facing such a situation, we can advise you on the terms of your rent deposit and assist you in making sure that you take the most appropriate action at the right time.