Commercial Landlords: A Lesson On Drawing From a Tenant’s Deposit
It may seem like a straightforward commercial decision for a landlord to deduct unpaid rent from a tenant’s deposit.
However, caution should be exercised in light of the decision of Re London Bridge Entertainment Parts LLP (in administration)  EWHC 2932 (Ch) (London Bridge), as any obligation for a tenant to ‘top up’ a rent deposit fund will rank amongst other unsecured debts, should the defaulting tenant end up in administration.
The principle set out in the case of Re Lundy Granite provides that where an administrator uses or retains leased property for the benefit of the administration, rent is payable as an expense of the administration and therefore a creditor landlord would have significant priority in an administration in respect of rent.
However, Insolvency and Companies Court Judge Barber held in London Bridge that by drawing on the deposit to cover an unpaid rent instalment, the creditor landlord closed this avenue off.
London Bridge centred on two documents; a lease with rent payable quarterly in advance and a rent deposit deed with an obligation on the tenant to ‘top up’ should the deposit be utilised to meet any unpaid rent.
Administrators were appointed on 29 September 2017 and on 1 October 2017, the tenant company failed to pay the rent instalment. On 9 October 2017 the landlord made the decision to draw from the deposit fund to meet that missed rent instalment and requested that the tenant company ‘top up’ the deposit in accordance with the terms of the rent deposit deed.
The administrators took the view that the landlord would now have to prove for that debt in the administration as an unsecured creditor without priority status.
The court found that the Lundy Granite principle could not extend to the ‘top up’ obligation in circumstances where the rent had been paid in full (via the draw down on the deposit) and therefore the administrators could not be expected to pay it twice.
More importantly, the court found that the liability incurring during the administrators’ use of the property was not enough to trigger the Lundy Granite principle; the liability must have been incurred as a result of an act by the administrators for the benefit of creditors as a whole.
Had the landlord not drawn down on the deposit, the unpaid rent would have been payable as an expense of the administrator with priority status over other unsecured creditors of the tenant company and the landlord would have still had the benefit of the total rent deposit.
What does this mean for Landlords?
The case of London Bridge reinforces the need for landlords to be wary of taking a robust approach with a deposit fund when dealing with unpaid rent. If landlords are concerned about a tenant’s ability to meet their lease obligations they should seek advice first on how to best protect their position before dipping into a deposit fund.
If you would like more information or have any questions in relation to any of the above, please contact a member of our Property Team today.