Taking Security from Tenants

A recent decision of the New South Wales Court of Appeal (Hosking v Extend N Build Pty Ltd (2018) NSWCA 149) has highlighted the need for Landlords to give careful consideration to the nature of security given by a Tenant for the performance of the Tenant’s obligations under the terms of a lease.

In that case, security was provided by the Tenant in the form of a bank guarantee. The issue to be determined by the Court was whether or not a payment by the third-party Bank to an unsecured creditor (the Landlord) might be considered to be an unfair preference for the purposes of the Corporations Act 2001 (Cth).

This raises an interesting question for Landlords insofar as if a Landlord presents a bank guarantee to the issuing Bank for payment where a Tenant has become insolvent, could it be argued that the payment by the Bank to the Landlord under the Bank Guarantee constituted an unfair preference.

The short answer as a result of the NSW Court decision is “No”. Bank guarantees by their nature are either secured by a cash deposit in an account with the Tenant’s bank or treated as a contingent liability secured pursuant to a facility entered into between the Tenant and its Bank.

In either case, the terms of the bank guarantee generally require the Bank to pay out the guarantee from its own funds if demanded by the Landlord without regard to the Tenant’s direction (subject of course to a Tenant having a right to obtain an injunction from a Court restraining the Bank from making any payment to the Landlord). Once a demand for payment has been made to the Bank, and the Bank makes the payment, the Bank would ordinarily seek repayment from the Tenant pursuant to whatever its arrangement was, either pursuant to its “cashback” facility or the terms of its security.

The decision raises the broader issue as to the nature of the security a Landlord should seek from a Tenant as security for the performance by the Tenant of its obligations under the lease.

It is important when entering into a lease that a Landlord take into consideration the type of security required.

Since the introduction of the Personal Property Securities Act 2009 (Cth) (PPSA) the issue has become somewhat more complicated. If it is intended to seek security in the form of a cash bond, then it is necessary for the Landlord to register its interest over the Tenant and the account in which the cash bond is being held in order to ensure priority under the PPSA. Registering a security interest in circumstances such as these may be a cost that the Tenant is not prepared to meet and the Landlord does not wish to pay.

Our strong preference is for security to take the form of a bank guarantee; however, if the Tenant is not in a position to provide a bank guarantee then consideration should be given to taking a cash bond. In those circumstances, it is important to register a security interest under the PPSA to ensure that the bond is not subject to a claim from a liquidator in the event that the Tenant were to go into liquidation.