Q&A: Drawing down on a rent deposit where the tenant is in administration

What are the pros and cons of a landlord drawing down against a rent deposit before or after a tenant enters administration? Is there any risk that the administrator could seek to hand over the deposit balance on their appointment or is it the case that the administrator may, in certain circumstances (depending on how the deposit is held), just be asked to consent to the deposit draw down? Is a landlord prevented from drawing down on the deposit as a result of the moratorium in administration, and how do the Financial Collateral Arrangements (No 2) Regulations 2003 affect this?

Rent deposits are largely intended to protect a landlord in the event of a tenant's failure to pay rent falling due under a lease. Nonetheless, a landlord who suspects that its tenant may soon become insolvent may choose to take pre-emptive action in relation to any rent deposit held. For more information on rent deposits, see: Rent deposits for property disputes lawyers—overview.

Assuming the landlord has the right to drawn down under the terms of the rent deposit deed (for instance, the tenant is in arrears of rent), reasons it may decide to do so before the onset of administration are: 

• References: Hanak v Green [1958] 2 Q.B. 9 depending on the rent deposit structure, there is a risk of the administrators laying claim to the full balance. One example is where the rent deposit is held by the landlord as trustee for the tenant, implying that the monies form part of the insolvent estate (although, see Hanak v Green below)
• the effect of the moratorium created by the administration (see below)
• References: Re London Bridge Entertainment Partners LLP (in administration) Shinners and another v London Trocadero (2015) LLP [2019] EWHC 2932 (Ch) In a well-drafted rent deposit deed, the tenant will be required to 'top-up' the deposit following a withdrawal. If the landlord instead waits for the tenant to go into administration before drawing down, the administrators will not then be required to top up the rent deposit as an expense of the administration (Re London Bridge Entertainment Partners LLP (in administration) Shinners and another v London Trocadero (2015) LLP). However, if the landlord had not drawn down the rent deposit after the tenant had entered into administration, the administrator may have been liable to pay the rent as an expense of the administration and the rent deposit would have remained intact against other potential liabilities (subject to the terms of the rent deposit deed). For more information, see News Analysis: Administration Expenses—Lundy Granite principle (Re London Bridge Entertainment Partners LLP (in administration))
• the value of cash in hand

On the other hand, reasons for the landlord not to draw down against the deposit too quickly include: 

• where the deposit is structured as a charge in favour of the landlord, the landlord will not lose that security if the tenant goes into administration
• even if the landlord holds the deposit on trust for the tenant, the case of Hanak v Green shows that the landlord could raise the defence of equitable set off against an administrator seeking to use the funds
• the landlord is not normally obliged to use the deposit. It may wish to consider other enforcement options first, such as exercising CRAR or, if the landlord wants the property back, forfeiting the lease (although note the current restrictions contained in the Coronavirus Act 2020). See Practice Note: Coronavirus (COVID-19)—implications for property
• if the tenant goes into administration and the administrators continue to make use of the property, rent will remain payable as an expense of the administration. It therefore may benefit the landlord to leave the deposit in situ to cover other liabilities, such as dilapidations (subject to the terms of the rent deposit deed). For more information on the circumstances when rent may be paid as an expense of an administration, see Practice Note: Administration expenses 

The moratorium and impact of the Financial Collateral Arrangements (No 2) Regulations 2003, SI 2003/3226

Paragraph 43(2) of Schedule B1 to the Insolvency Act 1986 (IA 1986) provides that no step may be taken to enforce security over the property of a company in administration without the consent of the administrator or permission of the court.

This moratorium will not affect all landlords wishing to draw down on the deposit. For instance, where the landlord holds the deposit monies as part of its general funds, the tenant’s insolvency should have no impact.

In most cases, the landlord will need administrator’s consent or permission of the court to draw down on the deposit.

The position has improved for landlords since the Financial Collateral Arrangements (No 2) Regulations 2003 (FCA(No2) Regs 2003), SI 2003/3226 came into force in 2013.

FCA(No2) Regs 2003, SI 2003/3226, state that certain provisions, including IA 1986, Sch B1, para 43(2) shall not apply to any security interest created or otherwise arising under a financial collateral arrangement.

Whether any given rent deposit constitutes a financial collateral arrangement will depend on its form and further information can be found in the Practice Note: Key provisions of the financial collateral regulations. However, where FCA(No2) Regs 2003, SI 2003/3226, do apply, there are a number of beneficial consequences for landlords, including that they do not need the agreement of the administrator or the court before they may draw down on any rent deposit.

For further guidance, see also Practice Note: Rent deposit deed—effect of insolvency.

This content was first published on the Lexis Nexis Ask Forum on 27 April 2020.