Methods for Securing Against Tenant Defaults

Security Deposits. Security deposits are an age-old form of security for the performance of the tenant's obligations under a lease. In the simplest of transactions, the tenant deposits a fund with the landlord to be used to protect the landlord against the economic consequences of a tenant's default. The amount of the fund is the product of negotiations and usually involves a multiple of the monthly rent payable under the lease. In more sophisticated commercial transactions with other than the most creditworthy of tenants, the landlord wants the tenant to deposit a substantial sum, perhaps a multiple of the yearly rent payable under the lease, especially if the landlord pays for substantial tenant improvements.

An alternate to the security deposit may be to have the tenant pay directly some of the costs that would normally be paid by the landlord, rather than having the landlord finance those costs. For example, the tenant, rather than the landlord, may bear the costs of pricey tenant improvements (TIs), adding to its monthly financial burden, the cost of the TIs together with an interest factor. If this is done, the tenant will pay only the pure rent that will not include financing the additional amounts. In reality, this transfer of economic responsibility merely shifts a part of the risk of the tenant's default to the tenant who will bear the loss if it cannot remain operating as a solvent rent-paying tenant for the full term. Even with the “reduced” rent, the landlord may still want a security deposit to protect itself from the loss of economic rent if the tenant should default.