Security For Tenant's Obligations - Bank Guarantee vs Security Bond

Whilst a bank guarantee is the preferred form of security to secure a tenant’s obligations under a lease, a landlord can be reasonably comfortable in accepting a security bond from a tenant as security provided that the landlord registers its security interest in respect of the security bond on the Personal Property Securities Register (PPSR).

 A security bond should not be accepted as security under a lease where there are prior perfected securities in respect of the tenant.


Bank Guarantee v Security Bond

Bank Guarantees

Bank guarantees are the preferred form of security to secure a tenant’s obligations under a lease. A bank guarantee is a third-party guarantee and is a contractual promise by the bank to pay the landlord if the tenant defaults under the terms of the lease.  The Personal Property Securities Act 2009 (Cth) (PPSA) does not apply to bank guarantees as they are not a security interest in the property of the tenant. Accordingly, no other party can assert an interest in the proceeds of the bank guarantee.  

Where a tenant becomes insolvent, a landlord is still entitled to call up a bank guarantee that it holds to cover rent or other costs owed by the tenant.  As a bank guarantee is a guaranteed payment from a bank, who is a third party, it is not generally considered an unfair preferential payment to a creditor (which may be set aside by a court), because the tenant is not making the payment.

Security Bonds

A security bond (also known as a security deposit or a cash bond) may be taken by a landlord as security for the performance of a tenant’s obligations under a lease.  If a landlord (or its agent) holds a cash security bond, it generally holds the security bond on trust for the tenant.  The deposit does not become the property of the landlord, unless the landlord becomes entitled to call upon the security bond in the event that the tenant defaults under the lease.

Registration on the PPSR

A security bond creates a “security interest” in favour of the landlord under the PPSA which can be registered on the PPSR.

 Registration of the security interest:

  • prevents the secured party from losing its priority as against most other secured parties; and
  • ensures the secured interest survives bankruptcy or insolvency.

 A security bond which has not been registered on the PPSR is vulnerable as it is an unperfected security interest.  This means that the landlord’s rights in respect of the security may be outranked by another secured party with a perfected security interest.  Additionally, an unperfected security interest vests in the grantor (being the tenant) upon insolvency of the grantor.  The effect is that the secured party (being the landlord) is not entitled to the collateral and will fall into the pool of unsecured creditors.

The landlord should check for prior registered securities in respect of the tenant as any prior perfected securities will have priority, in which case the landlord’s interest could be defeated by an earlier security interest holder.  This should be done prior to accepting a security bond as the form of lease security, as a bank guarantee should be utilised where there are prior perfected securities over the property.

Additionally, whilst the risk is low and not something that we have seen in practice, it is possible that where a bank account is in the name of a person that has an existing liability to the bank at which the account is held, in the absence of an account control deed that alters the position, the bank may have a ‘super priority’ which allows it to offset balance in that bank account against the liability owed by that person to the bank.

Where a security bond is to be accepted as security under a lease, it is important to ensure that the lease contains appropriate provisions dealing with registration and that registration takes place as soon as practicable.

Disclaimer – the information contained in this publication does not constitute legal advice and should not be relied upon as such. You should seek legal advice in relation to any particular matter you may have before relying or acting on this information. The Lavan team are here to assist.