End Security Deposit Concession for Undeserving Tenant

To entice a desirable tenant to sign your lease, you may be forced to give it a security deposit concession. The concession may be to forgo a deposit altogether or to have the tenant put up less money than you'd typically require in a stronger leasing market. Either way, a security deposit concession is a special perk that you wouldn't want to give to just any tenant—especially not to one that becomes undeserving or a deadbeat.

But many leases have a big loophole when it comes to security deposit concessions: They don't give you the right to end the security deposit concession if the tenant becomes undeserving or a deadbeat. For example, if a tenant with the concession habitually pays its rent late, you won't have the right to end the concession. That puts you at a great disadvantage. Getting the right to pull the plug on a security deposit concession helps deter a tenant from violating the lease as well as giving you the financial protection that a security deposit provides.

Set Four Conditions to Continue Concession

To plug this loophole, set four conditions in the security deposit concession clause that the tenant must meet to continue getting the concession, advises Toronto solicitor Joseph Grignano. (You may want to add more conditions to these four, if you have other concerns about the tenant, he adds.) The tenant's failure to meet these conditions gives you the right to end the security deposit concession. That means the tenant must give you a full security deposit or face eviction. The Model Lease Clause on p. 6 includes these conditions and can be adapted and used in your lease.

Before including these conditions in your security deposit concession clause, make sure the lease has a security deposit clause that sets the amount of the security deposit. The security deposit concession clause should then say that the security deposit clause won't be enforced—or will only be partially enforced—as long as the tenant meets these four conditions:

Tenant must be original tenant. The tenant shouldn't be allowed to transfer its security rent concession to anyone else. But that could happen unless the lease says otherwise. The security deposit concession is a special perk intended only for the original tenant, notes Grignano [Clause, par. a(i)].

Tenant must conduct business in entire space. The tenant must occupy and conduct its business in the entire space. A tenant that has gone dark or is subletting all or part of its space shouldn't have a security deposit concession, says Grignano [Clause, par. a(ii)].

Tenant may not chronically violate lease. It's exasperating to have a tenant commit the same lease violation over and over, but always cure—that is, fix—the violation before you exercise your remedies. You can avoid letting a chronic lease violator benefit from a security deposit concession. To do that, condition the concession on the tenant's not committing the same lease violation more than a set number of times—for example, once—within a 12-month period, says Grignano [Clause, par. a(iii)]. Because any kind of lease violation (not only a failure to pay rent) can mean the tenant must come up with security (or additional security), the tenant will be more careful to live up to all its lease obligations, he notes. This condition is especially useful against tenants who consistently pay rent a few days or weeks late, Grignano adds.

Tenant must stay financially sound. A security deposit concession should be given to a tenant that's financially sound. The more financially sound the tenant, the more able it will be to meet all of its monetary lease obligations, so you won't need a security deposit. But if the tenant's financial condition deteriorates, you want the right to get a security deposit to protect your interests. Condition the security deposit concession on the tenant's having not less than a specified net worth amount during the lease (verified by its current, audited financial statements), advises Grignano [Clause, par. a(iv)]. If its net worth drops below that amount, the concession ends.

If Tenant Doesn't Meet Conditions

If the tenant doesn't meet all four conditions of the security deposit concession, the concession ends and the terms of the security deposit clause are no longer suspended, says Grignano. The tenant must give you the security deposit required by the security deposit clause soon—for example, within five days after you've requested it in writing, he says. If the tenant doesn't meet that deadline, you have the same rights and remedies against the tenant as if it didn't pay its rent. For instance, you can terminate the lease if the lease's remedies clause permits you, he notes.

Practical Pointer: If a tenant wants to expand its space, its financial responsibilities and potential liabilities will increase as well. While you may have felt safe in giving the tenant a concession for its original amount of space, that may no longer be true if it expands, says Grignano. You may decide that you want a security deposit from the tenant to help protect your interests, he says. If you're negotiating a lease with a tenant that wants an expansion option, remember to note in the expansion option clause that the security deposit concession will end when the tenant exercises its expansion option, says Grignano. If you've already negotiated a lease without an expansion option but the tenant wants to expand its space, you'll be free to negotiate the fate of the security deposit concession, he notes.

Possible Tenant Exceptions/ Modifications to Conditions

Losing a security deposit concession could take a big chunk of money out of the tenant's wallet, so don't be surprised if the tenant wants you to agree to certain exceptions and modifications to your conditions. Your decision to accept these exceptions and modifications will depend on whether the tenant is a desirable addition to your center or building and has lots of negotiating power.

Exception to original tenant condition. The tenant may merge with another company or transfer its assets to a related company (such as an affiliate or subsidiary) or an unrelated company. Or it may assign its lease to an assignee that's as strong financially as the tenant. As a result, it may ask you to let the resulting merged, related, or unrelated company or assignee get the security deposit concession rather than ending the concession because it's not the original tenant.

Exception to conducting business in entire space condition. If the tenant is renting lots of space at your center or building, it may request that you not end its security deposit concession if it sublets only a small portion of its space or sublets for a short time. In that case, you might consider getting a security deposit from the subtenant, notes Grignano.

Modifications to chronic violation condition. A tenant may want you to make several modifications to the third condition, such as:

Giving tenant notice and waiting until cure period expires. A tenant may want you to give it notice and wait until its cure period expires before you end the security deposit concession. Don't agree to that. A tenant that chronically violates the lease shouldn't be entitled to keep a security deposit concession, even if it keeps curing its violations, says Grignano.

Increasing number of violations. While you should allow no more than one tenant lease violation in any 12-month period, a stronger or more desirable tenant may demand that you allow as many as three or more tenant violations—either of the same type or in total—in a 12-month period before ending the security deposit concession. If you agree to this, make sure you're not overly generous to the tenant in the number of violations allowed during a 12-month period. Otherwise, you won't deter its bad behavior, warns Grignano.

Limiting application to ‘material’ lease violations. Some tenants will try to have the clause apply only to “material”—that is, important—lease violations, arguing that it may work unfairly otherwise. For example, it may be unreasonable to make a tenant provide substantial additional security merely because on two occasions it paid its rent a day late. But this limitation may later require you to determine which lease violations are material and which aren't, says Grignano. This leaves room for disagreement, which could undermine the protection the clause gives you, he warns.

Insider Source

Joseph Grignano, Esq.: Blake, Cassels & Graydon, LLP; Toronto, ON