Lease bonds: A new direction in lease security

While professional services firms are often deeply rooted in traditions and adhere strictly to rules and standards, they’re also embracing new digital practices and service delivery models.

Security is a fundamental part of every commercial leasing deal. Landlords require a financial guarantee to cover a tenant’s lease obligations, and this is often equivalent to between three and twelve months’ rent.

While bank guarantees have been the default solution, they’re no longer the only option. A new alternative, known as commercial lease bonds, is gaining traction across the market.

What is a commercial lease bond?

A commercial lease bond (including eGuarantee’s Lease Bond solution) is a way for businesses to provide lease security without tying up cash.

Instead of lodging funds with a bank, the tenant pays an annual fee for the guarantee. Approval is based on a financial assessment of the business and usually takes into consideration at least 12 months of trading history and a range of standard financial information.

Lease bonds themselves are backed by an insurance financial guarantee (rather than a bank), but from a legal perspective they still operate as a guarantee. So, if a landlord makes a claim under the lease, the bond will cover the claim unconditionally, irrevocably and payment is on demand.

Bank guarantees: security that can come at a cost

Bank guarantees have always been the gold standard, and for some businesses they still make sense. For instance, they may be the only option for businesses that have less than 12 months of financial trading history or a security value requirement of less than $20,000.

For many clients, the trade-offs are becoming harder to ignore. The biggest is cash.

Bank guarantees require funds to be locked away, which in turn can reduce a business’s borrowing capacity. In fact, across Australia, it’s estimated that up to $10 billion is tied up this way. That’s capital that could otherwise be used to operate and grow the business.

The process is also slow and paper-based. Simple changes, like adjusting the amount after a rent review, can mean going back to the bank and starting from scratch. Clients with multiple leases can find this an ongoing administrative burden.

How lease bonds differ

Commercial lease bonds are different across a few key areas. Here’s a snapshot:

• Capital. With lease bonds, businesses don’t need to lock away any cash upfront, which means their capital is free to use for running the business or growth initiatives.
• Process. Lease bonds are managed digitally, so the bond can be managed in one place by tenants, lawyers, landlords and agents.
• Ongoing administration. Any changes to the lease, like rent increases, can be handled automatically, rather than being made through the bank.
• Eligibility. Lease bonds aren’t available to everyone. Businesses are assessed based on their financial position and length of operation and are only available for bond sizes of more than $20,000.

Where lease bonds can work best

Commercial lease bonds can be great for a number of common situations.

Firstly, for growing businesses, a new lease may come at the same time as other costs like fit-outs, hiring or expansion. Using a lease bond can help keep cash free for these priorities.

Similarly, for clients with bank guarantees already in place, replacing them with a lease bond may free up borrowing capacity for other financing or investment opportunities.

For clients with multiple leases, using lease bonds offers a centralised, digital approach that makes it easier to track obligations, expiry dates and any changes over time.

How credible are lease bonds?

Lease bonds are increasingly accepted by institutional landlords, including groups such as Dexus, Frasers, Brookfield, Vicinity, Centuria and more.

In Australia and New Zealand, this adoption has largely been driven by eGuarantee, with more than 170 landlords onboarded and over $100 million released back into the economy through its Commercial Lease Bond solution.

From a security perspective, lease bonds are backed by a financial institution with a Standard and Poor’s rating of AA-, comparable to major Australian banks like Commonwealth Bank. Similar forms of financial guarantees have also been widely used in the construction and infrastructure sectors for many years.

If a landlord makes a claim under the lease, the claim is paid unconditionally, irrevocably and on demand. In addition, tenants are assessed upfront, adding a further layer of risk control.

Expanding options for your clients

For lawyers, commercial lease bonds should be viewed as another option within the broader mix of lease security.

Bank guarantees will continue to be appropriate in many cases. But lease bonds offer an alternative for clients who want to free-up cash or simplify how their lease security is managed.

The right solution will depend entirely on the client’s financial position, their commercial priorities and the landlord’s requirements.

An important shift in lease security

As commercial lease bonds become more widely adopted, they are likely to feature more frequently in lease negotiations and documentation.

As a legal practitioner, understanding how these instruments operate, and where they may be suitable, will help you support your clients with more informed and commercially aligned advice.

To learn more about how a Lease Bond solution could work for your client (or your own lease) eGuarantee can provide further information.