Deposit From The Introduction In the context of tenancies, the security deposit refers to a sum of money paid by the tenant to the landlord to secure the tenant s performance and observance of the covenants and conditions in the tenancy agreement. This sum is held by the landlord until the expiry of the tenancy. It will then be returned to the tenant less any deductions made by the landlord as compensation for any losses or expenses incurred by him arising from any breach by the tenant of the covenants and conditions in the tenancy agreement. Nature Of Security Deposit In the Singapore property-leasing scene, the provision of a security deposit usually the equivalent of two or three month s rental has become almost standard practice. Typically, the security deposit will be furnished in cash to the landlord. Meanwhile, the tenancy agreement will contain a standard clause stating only the purpose of the security deposit and when the security deposit is to be refunded to the tenant. In the absence of any further wording to the contrary, once the security deposit is paid, it becomes a debt due from the landlord to the tenant, the repayment of which is conditional upon the tenant s performance and observance of the covenants and conditions in the tenancy agreement. In the case of Hua Chiao Bank v Chiaphua Industries [1987], the Privy Council held that the landlord s obligation to return the security deposit was, by its nature, simply an obligation to repay money which it had received in the capacity of payee rather than in the capacity of landlord. In other words, the landlord s obligation to return the deposit was personal to it. As a result, it would page 16 of 44 pages
not pass to an assignee of the landlord s reversionary estate. For the tenant, this means that he will be in a vulnerable position as regards the return of its security deposit in the event of the landlord s bankruptcy or liquidation. In such a situation, title to the land will usually pass to the mortgagee of the property or, where the liquidator / official assignee has disposed of the property, the new owner. However, as the obligation to return the deposit does not also pass, the tenant will not be able to recover his security deposit from them. In essence, the tenant becomes an unsecured creditor of the landlord. Given the scenario, it is therefore surprising that tenants often do not seek to structure the security deposit so as to give themselves some protection in the event of the landlord s insolvency. Possible Structures That Can Be Adopted Trust The most effective means of protecting the security deposit from the consequences of the landlord s insolvency is to create a trust over the monies constituting the security deposit. Under such an arrangement, the landlord holds the security deposit as trustee for and on behalf of the tenant subject only to its right of deduction in the event of the tenant s breach of the tenancy agreement. As the beneficial interest in the monies remain with the tenant, the monies do not form part of the landlord s assets for distribution to creditors in the event of the landlord s bankruptcy or liquidation. No particular formalities are required to be observed to create a trust arrangement as long as the intention of the parties to create a such trust is clearly drafted into the tenancy agreement. However, the monies must be physically set aside in a separate account by the landlord and must not be intermingled with the landlord s own funds. Banker s Guarantee As an alternative to creating a trust, the tenant can instead request that, in lieu of cash being furnished for the security deposit, the tenant will arrange for a banker s guarantee to be issued in page 17 of 44 pages
favour of the landlord for the amount of the security deposit. This is a practice which has become increasingly common and popular, especially where the amount of the security deposit is substantial. Where a banker s guarantee is furnished, the landlord can call on it in the event of the tenant s breach of the tenancy agreement. As such guarantees are usually payable on demand, the landlord will be paid the amount guaranteed as compensation for its losses and expenses arising as a result of the tenant s breach. The advantage of this arrangement is that, arguably, until and unless the landlord calls on the banker s guarantee and is paid the monies constituting the security deposit, there is no debt due from the landlord to the tenant. This is because the landlord does not hold any actual monies which have to be returned to the tenant. More importantly, as the monies have not been paid out to the landlord, they should not form part of the landlord s assets to be distributed to the creditors on the landlord s bankruptcy or liquidation. The disadvantage of a banker s guarantee to the tenant would be the banking charges payable by the tenant to the issuing bank for the banker s guarantee. This may be the reason why a banker s guarantee is usually resorted to only where the security deposit amount is substantial. Stakeholding Arrangement Where the security deposit is to be paid in cash, an alternative to direct payment to the landlord is payment to an independent third party. This third party will hold the monies as stakeholder. The stakeholding arrangement is almost standard practice in sale of property transactions where the 10% deposit of the sale price paid by the purchaser on the signing of the sale agreement is held by the seller s lawyers as stakeholder until the completion of the sale transaction when it is then released to the seller. Similarly, under a transaction for a lease, the security deposit amount can be paid to an appointed third party as stakeholder who will hold the monies until the expiry or determination of the tenancy when the monies will then returned to the tenant less any deductions to be paid to the landlord. page 18 of 44 pages
As the monies are not paid to the landlord, they do not form part of his assets which are available for distribution to its creditors. The landlord merely has a contractual right to be paid the monies to compensate him for any losses or expenses incurred as a result of the tenant s breach of the tenancy agreement. In practice, however, it is unlikely that the stakeholding arrangement will find much favour with landlords as the monies, being controlled by an independent third party who is obliged to release the monies only upon certain conditions being met, are not readily accessible to the landlord for deduction. It is crucial to spell out clearly in the tenancy agreement the conditions which must be met before payment is made to the landlord from the stakeheld monies. For example, the tenancy agreement may state that the stakeheld monies will only be released to the landlord upon production of an order of court or the consent in writing by both the landlord and the tenant. Further, unless such conditions are clearly spelt out, it is unlikely that one will find a third party willing to act as stakeholder as a stakeholder has the responsibility of ensuring that stakeheld monies are not wrongfully released or retained and will be liable to the appointing parties if the stakeheld monies are misapplied. Insolvency Set-Off If the security deposit is not protected from the landlord s bankruptcy or liquidation by any of the above means, upon the occurrence of such an event, the tenant is not likely to obtain a full return of his security deposit upon the expiry of the tenancy. This is because he will only be paid such amount as is available for distribution from the landlord s assets. A tenant caught in that unfortunate position should therefore consider setting off his deposit against rental payments due to the landlord. Insolvency set-off as set out under section 88 of the Bankruptcy Act (which applies to both individuals and companies) is available where there have been any mutual credits, mutual debts or other mutual dealings between a bankrupt and any creditor. As the debt due from the landlord to the tenant (that is, the return of the security deposit) and the rental due from the tenant to page 19 of 44 pages
the landlord are clearly mutual debts, the tenant should be able to exercise insolvency set-off in such a situation. However, the tenant should also bear in mind that if it defaults in payment of rental, the landlord will have the right to forfeit the lease and exercise its rights of re-entry into the property. Therefore, a tenant, in seeking to set-off the amount of the security deposit against any unpaid rental, may risk having its lease forfeited by the landlord. Conclusion Traditionally, the terms of tenancy agreements signed in Singapore, particularly in respect of commercial and industrial properties, are usually For more information, contact: Lai Pui Ming Partner Property Practice Group 62320514 pui.ming.lai@rajahtann.com weighted in favour of the landlord. However, with the softening of the property market in recent years and the fact that it is now a tenant s market, tenants may find that they are in a better bargaining position in the negotiations on the terms of the tenancy agreement. For the reasons discussed above, the tenant who has the upper hand in negotiations should therefore seriously consider putting in place one of the above measures to protect its security deposit at the onset instead of relying on insolvency set-off when the landlord is made bankrupt or is liquidated. page 20 of 44 pages