Commercial Lease Bonds

What are Commercial Lease Bonds?

Like Bank Guarantees, Commercial Lease Bonds are a financial instrument, rather than a financial product, and is a three-party contract.

Typically when entering a commercial lease with a landlord, the tenant is required to provide some form of surety equivalent to approximately 3 to 6 months rent just in case the tenant defaults on the lease or fails to make good the premises at the expiry of the lease.

A Commercial Lease Bond is therefore a contract between Party A, the landlord; Party B, the tenant; and Party C, the surety underwriter. The Commercial Lease Bond is held by the landlord in lieu of a cash security deposit, bank guarantee, letter of credit or a personal or corporate guarantee. It serves as security for the tenant’s full and complete performance of the financial terms of its commercial lease.

The key benefit of using Commercial Lease Bonds is to free up working capital by avoiding having to use cash or tie up working capital if using a bank guarantee or letter of credit, etc.

The bond term can be up to 5 years and is only currently available for applicants seeking Commercial Lease Bonds, single or cumulative between $1 million to $3 million.

The market availability of Commercial Lease Bonds has been severely impacted by the fall out from the Global Financial Crisis and continuing concerns about various country debt levels; international business uncertainty; and the changing face of how business is transacted. This is particularly evident in the ‘retail’ space.

Given the above financial environment and that Commercial Lease Bonds are ‘unsecured’ (i.e., the surety underwriter has no secured position against the tenant’s assets), the acceptance criteria will only suit those applicants that are not in ‘retail’ (unless a national chain) nor those without at least 3 years profitable trading history, healthy retained earnings, acceptable debt levels and have an open corporate operating structure, versus the use of trusts etc. that hold underlying assets.

As to the acceptance of Commercial Lease Bonds, it’s something that landlords need to be educated on as bank guarantees have been the traditional method of surety.

Commercial Lease Bonds carry the same wording as a bank guarantee and follow the Australian Standards template (such as AS2124, which requires an unconditional and on demand undertaking) and carry exactly the same obligations at law as a bank guarantee. Insurers are not able to call their offering a ‘bank guarantee’, as they are not a registered bank. Otherwise the offerings are identical.

Like bank guarantees, payment must be made by the insurer on demand, unless the bond specifically states otherwise and without any assessment as to the amount to be paid. The only assessment occurring is to ensure the claim is made in terms of the Commercial Lease Bond itself - a process identical to the payment of a bank guarantee.

Surety Bonds, which include Commercial Lease Bonds, have been part of the Australian market for over 60 years and are widely accepted by the private sector and Commonwealth, State and Local Government Authorities and Agencies.

Some self-interested parties push the line that Surety Bonds issued by insurers are not as secure as bank guarantees. The recent global financial crisis pretty well pushes that misconception out of the equation.

The reality is that the major international insurers, which include Lloyds of London, have credit ratings equal or greater than most global financial institutions.

One key aspect often overlooked by landlords is that Surety Bonds fall outside the Bankruptcy Act in Australia, therefore, in the event of the liquidation of a tenant, the landlord isn’t impacted as their call is against the insurer and not as an unsecured creditor, as is possibly the case with a bank guarantee or subjected to claw back provisions under the bankruptcy proceedings.


How are Commercial Lease Bonds offered & priced?

As stated above, Commercial Lease Bonds can be offered as a ‘one-off’ basis, i.e., required for a specific commercial lease or, the applicant may have multi tenancies and wishes to establish a pre-approved facility and have Commercial Lease Bonds issued against that pre-approved facility as various commercial leases are negotiated.

The latter is similar to an approved line of credit with a financial institution that can be drawn down/used/reused as required.

The bond amount is open, however, the business entity must have $10m+ annual turnover.

We provide an initial Assessment Service for $336 (being $300 fee, $30 GST & $6 merchant fee).

If the assessment is positive and the applicant wishes to take to the next stage, an additional $560, as we incur various statutory checks and search costs.

The pricing of Commercial Lease Bonds is in the vicinity of 3% per annum of the bond amount required, but can vary depending on the industry sector and fine print in the commercial lease agreement.

The required premium must be paid in full prior to the Commercial Lease Bond being released to the landlord, i.e., if the bond amount is $550,000 and required for 3 years, the upfront amount is $49,500, plus allow approx. $3,000 for documentation preparation.


What occurs if the landlord makes a call on a Commercial Lease Bond?

This will only occur if the tenant defaults on their commercial lease agreement.

The insurer will pay the landlord and then immediately seek recovery of the claimed amount from the applicant or any guarantees that may have been required at the time of application.

The recovery is either against the operating entity or the director’s personal guarantees.


What’s the application process?

Tenants (applicants) must be able to demonstrate that they have:

  • Operate a well-developed and profitable business for a minimum of 3 years
  • Consistently retain capital within the business

In addition,

  • We require an outline of the company structure.
  • Two (2) years company financials, plus YTD management accounts and full year forecasts. If a larger company, the financials must be audited.
  • Where company financials don’t meet the acceptance criteria, director’s personal guarantees are likely to be sought