Insolvency and rent deposits held on trusts
Landlords often ask whether they can and should make withdrawals from rent deposits if they anticipate that tenant insolvency is likely or imminent.
This article considers broadly the position where a rent deposit is held on trust. It does not consider the position where it is held as stakeholder, charge or other structure nor does it cover the position where the rent deposit provisions are contained in the lease rather than a separate rent deposit deed. If the rent deposit is included within the lease (even if held on trust), then as a liquidator has the right to disclaim a lease it may result in a disclaimer of the rent deposit if the lease is disclaimed. A liquidator will have no right to disclaim the rent deposit if this is documented in a separate deed. The points below relate specifically to deposits held under a separate deed.
Is the landlord legally entitled to withdraw funds from the rent deposit?
Where the deposit is held by the landlord on express trust for the tenant the landlord is the legal owner of the money, but is bound by the terms of the trust as to how it may use the money. The tenant retains a beneficial interest in the money unless and until the landlord applies it in accordance with the terms of the deed.
Prior to the tenant’s insolvency the landlord will be able to make withdrawals in accordance with the deed, such as for non-payment of rents.
There are normally provisions relating to both forfeiture and disclaimer of the lease within the deed designed to protect the landlord
It is crucial for a landlord to follow the provisions within the deed in making withdrawals. These can include giving notice of the withdrawal to the tenant. The landlord must also not make withdrawals of monies from the deposit unless permitted under the deed.
If a withdrawal is made, the deed may require the tenant to top up the deposit so that the minimum deposit level set out in the deed is maintained. Whilst the tenant may not be in a position to do so, it is important that the landlord makes that request as it creates a breach of the deed and lease if the tenant does not comply.
If the tenant’s insolvency practitioner (IP) brings legal proceedings to recover the full rent deposit, the landlord would be entitled to raise the defence of equitable set-off. The defence would be likely to succeed and would allow the tenant’s IP to recover only the balance of the rent deposit after the landlord has deducted the sums owed under the terms of the deed.
Once the landlord has established whether they are legally entitled to withdraw funds from the rent deposit the landlord should also consider whether the withdrawal is the best course of action for it.
Landlords may be better off claiming the rent arrears as an expense of the tenant’s insolvency administration where possible, rather than draw down on a rent deposit, because the obligation to top up the rent deposit after a withdrawal is not an expense of the administration and can only be claimed as a debt but this depends on the exact circumstances of the insolvency.
If the tenant becomes insolvent, the ability to claim the rent as an expense of the insolvent estate would depend on the amount of rent owed, whether the administrators remain in the premises and rent continues to accrue. If that happens, the landlord can make a claim under the insolvent estate and any outstanding amount (if there are no funds in the insolvent estate) can be withdrawn from the rent deposit. If in doubt speak to your solicitors.