A Bank Guarantee vs. Security Deposit in Commercial Leases

When entering into a commercial lease, landlords must consider how to protect themselves against default by a tenant and in particular protection in the event of tenant insolvency or bankruptcy. Two common forms of protection are security bank guarantees and security deposits. Each offers different levels of protection and priority in payment, especially in cases of financial distress.

Protection Against Tenant Insolvency and Bankruptcy

Bank Guarantee

A bank guarantee provides significant protection against tenant insolvency and bankruptcy. It is a contractual agreement between the landlord and a bank, ensuring that the bank will pay the landlord a specified amount if the tenant defaults. This arrangement offers several advantages:

• Direct Claim Against the Bank: In the event of tenant insolvency or bankruptcy, the landlord can immediately call upon the bank guarantee. This means the landlord deals directly with the bank.
• Certainty and Reliability: Since a bank guarantee is a contract with the bank, the landlord’s claim is not subject to the delays and complications of insolvency or bankruptcy proceedings. A call on a bank guarantee is not considered to be a preference payment in insolvency or bankruptcy and therefore is not subject to a claim that it is a preference payment and therefore repayable to the liquidator or trustee of the tenant.  The bank guarantee provides certainty and reliability, as the bank is obligated to pay the guaranteed sum.

Security Deposit

A security deposit, typically held by the landlord or property manager, offers less protection in cases of tenant insolvency or bankruptcy. As indicated above, a claim on a security deposit is considered in insolvency to be a preference payment and if so, is then required to be paid to the insolvency practitioner or bankruptcy trustee. Then the landlord becomes an unsecured creditor and may have limited chance of recovering any amount owing due to the tenant’s default.

For landlords, a bank guarantee is a more reliable and secure option, as it gives you priority access to funds, protects against claims of a preference payment and ensures quicker recovery of unpaid amounts.

If you are a landlord negotiating a commercial lease a bank guarantee is a far better option than a security deposit.

For further advice or assistance in negotiating commercial leases, please do not hesitate to contact Solari and Stock’s experienced team of Lawyers on 02 8525 2700, or click here to request an appointment. Our Commercial team includes Michael Solari and Valentina Abouzeid.

Article by Valentina Abouzeid
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