As a landlord, should you charge tenants holding deposits which they will forfeit if they change their minds about moving in?
When is a deposit not a deposit? Could a deposit be not necessarily money labelled ‘deposit’ but any money taken in advance of a tenancy?
Last year, a county court decided that taking rent in advance constituted the landlord’s acceptance of a tenant’s deposit, which therefore should have been protected. This decision was then reversed, but following an appeal by the tenant, the Court of Appeal is now to decide the case, Johnson v Old.
Here, six months’ rent in advance had been paid, along with a separate sum which was taken as a deposit and duly protected.
The advance rent was considered by the first judge to be a deposit, thereby raising considerable alarm in the industry over what might be considered a deposit.
This is an important point: if a deposit has not been properly protected, and if the prescribed information not given, then the landlord will not be able to gain possession.
In Johnson v Old, the first judge’s decision (at Brighton County Court) meant that the landlord’s Section 21 notice was invalid, because the advance rent had not been protected and treated as a deposit.
However, this judgment was overturned on an appeal, also in Brighton County Court but by a different judge, who decided that advance rent was not a deposit. As a result, possession and costs were awarded to the landlord – and the lettings industry breathed a sigh of collective relief.
However, this issue has not gone away. Solicitors for the landlords, Shoosmiths, confirm that it will now be determined by the Court of Appeal, due to sit around March 6. As is usual, the judgment may not be handed down for some time.
The Tenancy Deposit Scheme (TDS), which runs DepositGuard on behalf of the Residential Landlords Association, was not surprised at the earlier appeal ruling heard in Brighton.
Its view is that a deposit is money held as security against a tenant’s obligations in connection with the tenancy; rent paid in advance is just that – rent.
The TDS argues that paying rent in advance is meeting an obligation of the tenancy itself, and not paying a security against it. It was also, in this case, clear from the outset to both parties that this advance rent money would not be returned.
However, the TDS has also pointed out that some landlords have tried to avoid having to protect tenants’ deposits by calling the money rent in advance.
Landlords may court trouble if they do something like this purely to side-step the law. The TDS says that instead of labelling money taken from tenants, landlords should look at the purpose of that money.
However, it remains to be seen whether the Court of Appeal will agree with this view. But what about holding deposits, or reservation fees, which are commonly taken in the same way that deposits are paid to book holidays, and not refunded if the customer decides not to go?
Holding deposits are commonly taken by landlords – or their agents – from incoming
tenants. These deposits are often one, two or three weeks’ worth of rent, and are taken as a sign of good faith that the incoming tenant will indeed take up the tenancy once the incumbent tenants move out.
The distinctive feature of holding deposits is that they are non-refundable in the event of the incoming tenants changing their minds about the tenancy.
According to David Lawrenson, the buy-to-let author who is also a landlord, this is fair enough.
Reservation fees, he argues, are intended to ensure the new tenant is not ‘flaky’ and should they fail to take up the tenancy, then there will be compensation for landlords faced with a void period.
However, Lawrenson does point out that landlords should cover their backs. Clearly, reservation agreements should spell out that incoming tenants will be penalised if they do not take up the tenancy.
Reservation agreements, Lawrenson says, should also say that (1) in the unusual event that the existing tenant does not vacate and the incoming tenant therefore cannot take up the tenancy, then the incoming tenant will get their reservation fee back in full; and (2) providing the incoming tenant takes up the tenancy, the reservation fee is then deducted from the first month’s rent on move-in date, leaving just the balance to pay.
However, Lawrenson claims some letting agents are very reluctant to take reservation fees at all – even though looking after the landlord should be their priority.
He asked trade body the Association of Residential Letting Agents about their stance, and ARLA told him: “ARLA advises their members to make sure that the potential tenant is fully aware of the obligations and liability to such a penalty, and along with all other fees it is clear and transparent. They also remind their members of the risk of executing a tenancy if there is any doubt that the existing tenant does not move out.”
Lawrenson says that this reply does not really deal with the usual situation – ie, tenants in situ but coming to the end of their agreement, and a landlord who has already, sensibly, started marketing the property.
If agents are as reluctant to take reservation fees as Lawrenson claims, could it be for legitimate reasons?
First, is there a risk that a reservation fee could count as a tenancy deposit?
Lawrenson says not, and the TDS broadly agrees – but with the all-important caveat that a ‘holding’ deposit will convert into a tenancy deposit once the tenancy is taken up.
Ben Beadle, head of member relations at the TDS, says: “Reservation fees or holding deposits are not considered to be deposits under the Housing Act 2004 (as amended). The money that is being taken is not being taken as security for an obligation arising under a tenancy. “Instead, the money is being taken to show the tenant’s real interest in the property and as a compensation for the landlord if a tenancy is not, in fact, entered into.”
“The reservation fee will become a deposit once a binding tenancy agreement has been entered into, and the reservation fee is ‘converted’ into the tenancy deposit itself. This will often arise where the tenant has entered into a tenancy and paid their deposit but is not yet able to move in to the property.”
“The best example of this is with students who ‘top up’ their reservation fee, roll it over into the tenancy deposit, and sign a tenancy agreement several months before actually moving in.”
“Deposit holders should ensure that they register the tenancy deposit and serve prescribed information within 30 days of receiving the [balance of] the deposit.”
“The key point is that the ‘clock’ for doing this starts ticking once the deposit has been taken as a part of a tenancy which has been entered into even though occupation has yet to begin.”
In other words, landlords who take reservation fees should be very careful to ensure they do not breach tenancy deposit protection law.
Fees under scrutiny
But is a possible breach the only reason why agents, and possibly landlords themselves, might feel uncomfortable with taking such deposits?
The fact is that fees charged to tenants are under intense scrutiny and have already been banned in Scotland, whether charged by landlords or agents. In Scotland, it is illegal to charge a tenant anything other than the deposit itself and the rent. It is not legal to charge, for example, for tenancy referencing or inventories, with the whole idea of the tightened up legislation making it cheaper and easier for tenants to embark on a letting agreement.
In England, Shelter – which led the campaign in Scotland – is ramping up its efforts on fees charged to tenants.
Furthermore, the campaign is meeting with success, with Ed Miliband saying that tenancy fees are unfair and will be outlawed by any future Labour government.
The question of fees has also been highlighted in the current government’s own on-going review into the private rented sector.
So, with pressure mounting, when it comes to taking holding deposits from tenants, can anyone blame agents for wanting to steer clear?
Agents themselves seem undecided as to whether holding deposits could be regarded as tenancy deposits in need of protection.
However, at the very least, landlords who believe that holding deposits are the norm should instruct their agents clearly, while landlords who take holding deposits and plan to continue doing so, should ensure that agreements are very clearly worded and signed by the prospective tenant.
Those who argue in favour of holding deposits say, as Lawrenson does, that it commits the incoming tenant and protects the landlord against loss of rental income.
The practice also undoubtedly stops potential tenants offering on several properties at once, and therefore laying waste to landlords’ time and incomes.
But should a tenant pay compensation, if that is what it amounts to, to a landlord with an abortive tenancy on their hands?
It is entirely possible that this can only be decided only in future by a court. Indeed, it is possible that the Court of Appeal judgement in the case of Johnson v Old may have implications for holding deposits.
Author and landlord David Lawrenson and Ben Beadle of the TDS agree that reservation fees or holding deposits do not count as deposits and therefore do not need to be protected.
But a court could take a different view – and an important Court of Appeal case is coming up.