According to the Victorian Small Business Commissioner (VSBC), an increasing proportion of the disputes referred to the VSBC under the Retail Leases Act 2003 relate to security deposits (or bonds) – including their return to a tenant on completion of a lease, the accrual of interest on a security deposit and landlords’ concerns with make good of the premises.
Recently there have also been a number of disputes referred to the VSBC about security deposits when a lease is transferred.
So why do security deposits cause so many problems between landlords and tenants?
Outlined below is some information about how to deal with security deposits and some tips about how to avoid disputes.
So what is a security deposit?
A security deposit is an amount of money paid by a tenant as surety to a landlord before a tenant is given access to the retail premises. It may take the form of a set amount, a period of rent (e.g. one month’s rent) or it could be a bank guarantee.
It is not compulsory for a landlord to request a security deposit, however most do – they provide some level of protection for a landlord if the tenant fails to meet their obligations under the lease.
Negotiating the security deposit
The security deposit requested by a landlord is often the equivalent to a period of rent, however, a landlord can set any dollar amount, as the amount is not regulated by retail leases legislation. Landlords and tenants should therefore negotiate a mutually agreeable amount.
Before the lease commences
Unlike a residential lease where a condition report must be completed by law, there is no statutory requirement for the completion of a condition report. However, it is highly recommended that a condition report be drawn up between retail landlords and tenants in order to reduce the likelihood of a dispute at the end of the lease. Likewise, both parties may wish to take photographs of the premises prior to the commencement of a tenancy, further averting any issues that may arise at the end of the lease.
What happens to the security deposit?
There is no bond authority retaining security deposits for commercial tenants in Victoria (as is the case with residential tenancies). However under section 24 of the Retail Leases Act 2003, a landlord, or an estate agent acting on behalf of a landlord, is required to hold a security deposit in an interest-bearing account.
There is no special type of bank account required to hold a tenant’s security deposit either. Some banks have developed special products for the purposes of holding security deposits, however most can usually accommodate the landlord’s requests with mainstream banking products. Landlords should discuss their needs with their bank or credit union.
What happens to the interest?
The landlord must account to the tenant for interest earned on the deposit, and the landlord is to keep the interest and deal with it as money paid by the tenant to the landlord so it forms part of the security deposit. This means that the interest generated by the security deposit is to be passed on to the tenant at the end of the lease as with the initial payment, provided the tenant complies with their obligations under the lease. Likewise, if the tenant does not fulfil his or her obligations under the lease, the interest may be retained by the landlord (as with any other monies the landlord wishes to retain).
What happens at the end of the lease?
At the end of a retail premises lease, if a tenant has performed all of their obligations under the lease, the tenant is entitled to the return of the security deposit. Section 24 of the Retail Leases Act 2003 provides that this should occur as soon as is practicable after the lease ends (there is no set time for the return of the security deposit).
Whether the premises have been left in a condition as required by the lease often causes disputes between landlords and tenants – such disputes also usually involve the entitlement of the landlord to retain the security deposit.
Some of these disputes involve tenants’ lack of understanding of the extent of their ‘make good’ obligations, for example, if they have agreed to repaint the premises. However, ‘make good’ disputes generally centre on a disagreement about the condition of the premises at the commencement of the tenancy compared to the condition at the end.
This highlights the importance of completing a comprehensive condition report when the tenancy begins.
What happens to the security deposit when circumstances change during the lease?
Many security deposit disputes arise when a lease is transferred between an outgoing tenant (assignor) and incoming tenant (assignee), when the landlord sells the premises or when the landlord changes the management of the premises from one agent to another.
Sometimes when a lease is assigned (or transferred),:
- the incoming tenant pays a security deposit to the landlord; and
- the landlord pays the outgoing tenant their security deposit with any interest that has accrued.
Alternatively, if the outgoing tenant is also selling their business to the incoming tenant, the parties may agree that:
- as part of the contract of sale, the outgoing tenant will leave their security deposit with the landlord so that the incoming tenant does not have to pay this. The security deposit will then become the possession of the incoming tenant.
It is important that all of the above are discussed and agreed to in writing by the outgoing tenant, the incoming tenant and the landlord to avoid any confusion in the future. Landlords and tenants should consider obtaining their own legal advice concerning their specific situation.
If a retail premises is sold by the landlord, a retail lease will generally state:
- the outgoing landlord must transfer any security deposit held under the lease to the incoming landlord, with interest; or
- if there is a bank guarantee, the tenant provides a replacement guarantee in exchange for the existing guarantee if requested by the landlord. Depending on the terms of the lease, the outgoing landlord may be required to pay the reasonable fees charged by the institution for the issue of the replacement guarantee.
It is in the tenant’s interest to ensure that written evidence of the transfer of the security deposit is provided to it.
If the landlord changes real estate agents and the deposit is held by the agent for the landlord, the outgoing agent should transfer the deposit plus any accrued interest to the incoming agent, and provide written confirmation to the tenant. On advice that a new agent has been appointed, a tenant should immediately seek confirmation of security deposit transfer if not already provided. In the case of a bank guarantee in favour of the landlord, the tenant should confirm details of the guarantee with the incoming agent.
How to resolve a dispute
If you do end up in dispute over a security deposit, you can refer an application to the VSBC – a dispute can be referred to the VSBC by submitting an application which summarises the issues and the parties involved.
You can find further information on the dispute resolution process here.