Bank Guarantees
What is it?
Sometimes tenants provide a “bank guarantee” rather than a cash bond to secure their obligations under the lease. These obligations include the obligation to pay money (rent, outgoings, GST) and to undertake repairs/make good obligations on vacate.
A bank guarantee is a banking product which is, in effect, a promise by the bank who gives it to pay the amount of money set out in it at a future time. The parties to a bank guarantee are the issuing bank, the tenant (usually referred to as the “applicant” or “customer”) and the landlord (the ‘beneficiary’).
Landlords should prefer bank guarantee to a cash deposit because of the administrative difficulties and costs associated with holding cash in a trust account, as well as to avoid any risk that a cash bond might belong to a liquidator if the tenant becomes insolvent. However, for shorter term or lower value tenancies, tenants are unlikely to want to incur the cost of obtaining a bank guarantee, and landlords may not want to instruct solicitors to examine or hold one so cash bonds tend to be preferred in those cases (and easier to adjust when a property is sold).
Tricks and traps
Expiry Date
Most leases require that the bank guarantee is issued without an expiry date. This protects a landlord if the lease term extends due to a holding over period.
Some banks won’t issue an open-ended bank guarantee and in those cases, the landlord needs to keep a reigster of all guarantees provided by all their tenants and ensure that replacement guarantees are provided before the current guarantee lapses.
It’s Like Cash
Bank Guarantees are payable on demand without reference to the tenant. This means that, if the landlord decides to make a demand for payment, the issuing bank is not required to contact the tenant to let them know. Nor will the bank buy into the dispute between landlord and tenant. between the lessee and lessor will interfere with the payment obligation undertaken by the bank.
Essentially it’s like cash, and the guarantee document should be treated as securely as cash.
Lost Documents
The landlord or its solicitor will usually hold the physical copy of the bank guarantee, which must be produced to the bank to be enforced or returned to the tenant once the lease ends and all obligations have been met. The best storage is in a fire-proof safe, and guarantees should be treated with the same care as a Will or a title deed.
Not Capable of Assignment - Beware When Buying a Property
Bank guarantees are usually personal to the landlord (beneficiary) named in them and are not capable of being assigned. This can be a problem when the property is being sold because the new buyer can’t use a bank guarantee if they aren’t named in the document as a beneficiary.
The sale contract should contain a condition requiring the seller (departing landlord) to arrange a replacement bank guarantee in the buyer’s name as beneficiary prior to settlement. The practice can be to simply handover the original document and then rely upon the seller to assist in the future if the guarantee needs to be enforced. However, after settlement, the seller has no incentive to assist, nor does the tenant so a replacement bank guarantee is the best practice in that case.
Needs a lawyer
Property managers, whilst they do hold cash bonds in trust, do not tend to obtain or hold bank guarantees where they exist because:
- They aren’t qualified to check them for validity
- They aren’t qualified to enforce them
- They don’t have the fire-proof document storage facilities that legal offices tend to have to hold an original bank guarantee (solicitors tend to hold them with their “safe custody” documents like Wills and title deeds for that reason).
A solicitor acting for the landlord (or the buyer of a property as the incoming landlord) would normally check:
- That the bank guarantee is valid (eg has no expiry date, has the party’s correctly identified etc)
- That the bank guarantee is assignable (they usually are not)
- If not assignable, that there is a clause in the sale contract obliging the seller to assist a buyer to enforce a bank guarantee if ever needed in the future, or arranging a replacement bank guarantee in the buyer’s favour, or arranging to cancel the existing and replace it with a cash bond. (It is not uncommon for funds to be withheld or retained after settlement until outstanding matters are sorted out.)
A solicitor would also usually keep the guarantee document safely stored in a fire-proof document safe and give advice on enforcing if the need arises.
Published by: Michelle Lember (Commercial Property Lawyer)