Nerissa Hatcher and Mark Reading discuss issues around deposits and if and when a commercial landlord can exercise a right to forfeit.
Where parties have entered into a lease and a separate rent deposit deed and the tenant falls into financial difficulty, it is not uncommon for the landlord to draw down on the rent deposit until depleted, and for the tenant to fail to replenish the deposit and fail to pay rent going forward.
In such circumstances the tenant is (i) in breach of the lease for non-payment of rent and (ii) in breach of the rent deposit deed for failure to replenish the deposit sum.
Can a landlord forfeit a lease on the basis of a breach of a separate rent deposit deed?
While this is a seemingly straightforward question, there is very little case law on the subject and there appear to be credible arguments on both sides.
The tenant may argue that, as a matter of principle, a landlord cannot forfeit a lease for the breach of a covenant contained in another agreement, including in a rent deposit deed. A lease will usually provide that the right to forfeit arises in the case of any breach of any condition of, or tenant covenant in, the lease.
This is reflected in the wording of section 146 of the Law of Property Act 1925, which refers only to: “A right of re‑entry or forfeiture under any proviso or stipulation in a lease for a breach of any covenant or condition in the lease.”
On the other hand, a landlord will say that section 146 does not provide a framework for determining whether a party has a right to forfeit. Rather, it provides for whether notice is required prior to any forfeiture being carried out.
It follows that, if section 146 does not apply to a breach of a rent deposit deed, it does not mean that the landlord cannot forfeit, instead it simply means that the landlord is not required to serve notice before doing so.
A landlord is likely to look at the specific wording of the rent deposit deed, which will often provide that the right to forfeit in the lease is exercisable if any of the covenants/conditions in the deed are breached by the tenant. If it does contain such a provision, the landlord’s position will be that the parties should adhere to that clear contractual agreement.
If a landlord forfeits a lease by reason of rent arrears alone, will the court order the replenishment of a rent deposit as a condition of relief?
Relief from forfeiture is a discretionary equitable remedy. From a landlord’s perspective, the parties agreed, as part of the bargain at the start of the lease, that the tenant would provide and maintain a rent deposit (replenishing it when required).
A landlord will argue that it is only equitable that the grant of a new lease on relief be on the basis that an equivalent replenished rent deposit is provided.
The case of Gill v Lewis [1956] 167 EG 278 offers the tenant credible arguments to the contrary. It provides that, if the basis of the forfeiture is the non-payment of rent alone, the conditions for relief will be payment of the arrears, interest and costs. Other breaches will be disregarded save for in exceptional circumstances.
The failure to top up the rent deposit will fall into the category of “other breaches” and the landlord will need to persuade the court that the circumstances are exceptional enough to justify a departure from the rule. As indicated earlier, a situation where a rent deposit is depleted prior to a forfeiture action on rent arrears grounds is commonplace. The burden on the landlord to demonstrate exceptionality is therefore likely to be a high one.
Landlords should therefore not assume that the replenishment of a rent deposit will be ordered as a condition of relief in these circumstances, simply because they perceive it as being equitable.
To be sure to secure the replenishment of the rent deposit as a condition of relief, a landlord should also forfeit on the basis of the breach of the rent deposit deed itself and not solely the arrears. For the landlord to validly forfeit on the basis of both the rent deposit and the arrears simultaneously, it will need to carefully consider its strategy and the timing of any steps taken prior to forfeiture, to ensure that it does not inadvertently waive its right to forfeit.
Landlords should not overlook strict provisions of the rent deposit deed
When dealing with the sums held under a rent deposit deed, it is imperative that a landlord considers and strictly adheres to the contractual mechanism in the deed. Otherwise, it could find itself in difficulties when it comes to forfeiture.
Often, a rent deposit deed will require the landlord to serve notices within specified timescales informing the tenant (i) that it intends to withdraw from the deposit if the arrears are not paid; and subsequently (ii) that it has withdrawn from the deposit, and that it requires replenishment.
If the deed sets out such a procedure and the landlord fails to strictly follow it, the tenant’s obligation to replenish the deposit will not be triggered and therefore there will be no breach for the tenant’s failure to do so.
As a consequence:
1. The landlord will not be able to forfeit for a failure to replenish the deposit.
2. If the landlord forfeited the lease on the basis of arrears only, there would be no present liability to replenish the rent deposit. Under the rule in Gill there would be no “other breach” for the court to consider when setting conditions for the grant of relief and the question of exceptional circumstances would be irrelevant.
3. Even if the court was persuaded to exercise its discretion in deciding whether to order the replenishment of the deposit as a condition of relief, in these circumstances it would arguably be unfair on the tenant to do so. The court would be allowing the landlord to circumvent the contractual mechanism in the lease, giving the landlord something to which it is not yet entitled.
Nerissa Hatcher is an associate and Mark Reading is a partner in the property litigation team at Mishcon de Reya