How to deal with cash bonds and commercial leases

Pointers for achieving the best result for your business

When approaching commercial property transactions involving a lease agreement, care must be taken in relation to the lease terms that concern a cash security deposit provided by a tenant to landlord.

Disputes can arise in circumstances where a tenant seeks to recover a cash bond from a subsequent purchaser of land subject to a lease. 

In this news post, MDL’s Matthew Hunter looks at the issues you should be aware of with cash bonds, and offers some pointers for achieving the best outcome for your business. 

What are the issues to consider with cash bonds?

In situations where a cash bond is provided by a tenant, whether you’re the tenant, the lessor, or the purchaser, consider the following questions:

  1. What is the nature of the bond transaction between the parties?
  2. Can the rights and obligations in relation to the bond be transferred to the purchaser?
  3. Have the rights and obligations in relation to the bond been effectively transferred?

What is the nature of a cash bond security?

The first thing to consider is the nature of the cash bond security. Simply put, the transfer of funds from one party to another to secure obligations pursuant to a lease will ordinarily create a debt owed by the landlord. The debt is created by the tenant transferring the sum of the funds constituting the cash bond to the landlord’s allocated account. 

However, the debt will only become due and payable by the landlord once the tenant has performed all obligations pursuant to the lease, and upon demand of the tenant, or as otherwise provided the lease.

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Can the rights and obligations with respect to the bond be transferred to the purchaser?

For a lease to be legal, it must be registered with the Titles Registry if the term of the lease is over three years in duration. Otherwise, the subsequent purchaser will not be legally bound by the terms of the lease.

The creation of a legal lease between a landlord and tenant creates two things:

  1. a contract between the parties (privity of contract);
  2. a legal interest of the tenant in the estate in the land (privity of estate).

N.B. Privity means a relation between two parties recognised by law. In context of the above, there will be a contractual relationship between the parties, in addition to a relationship created pursuant to Queensland property and land title law.    

When the land subject of the lease is purchased, the rights and obligations that ‘touch and concern’ the land (also known as covenants) will be transferred to the purchaser. The covenants that touch and concern the land will generally include those relating to: the payment of rent; repair; insurance; use; assignment; fixtures; guarantees; notices to quit; renewal; services; privacy etc.

However, they do not extend to obligations that are personal between the parties. The obligation of a landlord to repay a security deposit to a tenant is generally held to be personal in nature; it concerns the contractual agreement between the original parties, and will not run with the land merely because someone has purchased the land and become the new landlord.

Transferring rights and obligations via novation

As the rights and obligations with respect to the bond are contractual in nature, they must be transferred pursuant to contractual law principles. Generally speaking, benefits under a contract, such as rights to a debt, may be legally assigned, however, burdens cannot.

For example:

‘A’ obtains a loan from ‘B’ to be repaid with interest.

‘A’ has the obligation to repay, whilst ‘B’ is owed the debt.

Here, ‘B’ has the benefit under the agreement; therefore, he or she may assign the rights to the debt owed by ‘A’ to ‘C’.

‘A’ cannot assign the obligation to repay the loan to ‘C’

In the latter example, if ‘A’, ‘B’, and ‘C’ wanted the loan obligation to be transferred from ‘A’ to ‘C’, effectively, what must happen is a discharge of the agreement between ‘A’ and ‘B’ and the creation of a new contract between ‘B’ and ‘C’ on the same terms. This is called ‘novation’.

For a novation to be valid, the following must occur:

  1. the first contract must be discharged between the original parties;
  2. a subsequent contract must be entered into between one of the original parties and a third party, in substitution of the first contract; and
  3. all parties must consent to the novation. 

In the context of lease agreements, you will often see this done in practice by what is called a ‘Deed of Covenant on Assignment’. For a deed to successfully novate a contract, and thereby transfer the rights and obligations with respect to a cash bond, the deed must be precise and unambiguous in its statement of the terms to be agreed upon; they cannot to be inferred.

Accordingly, in order to ensure there is no ambiguity in relation to the transfer of the landlord’s obligation to repay the bond to the tenant (provided the tenant does not breach the obligations under the lease), any provision within a deed purporting an ‘assignment’ should clearly express the intentions of all parties involved. 

Avoid potential issues with cash bonds

In summary, great care must be taken when dealing with lease agreements which include provisions relating to a cash bond. In order to avoid any potential issues, whether you are the seller and landlord, the purchaser, or the tenant, it is prudent to ensure the intention of the parties is clear moving forward. 

Get advice and assistance with your commercial lease

Whether you need help in relation to the preparation of the agreement, transfer or assignment thereof, or if you are experiencing difficulty in recovering a cash bond pursuant to a lease agreement, contact the experienced Commercial and Litigation team at McCarthy Durie Lawyers on 3370 5100 or fill out the contact form here.