Tenancy Deposit Protection - the choices

Introduction:

In the first Factsheet on this series on tenancy deposits (Factsheet No. 24), we reviewed the legal requirements for tenancy deposit protection under the Housing Act 2004. 

In summary, the provisions require that any form of tenancy deposit, or money that is taken at the beginning of a tenancy on the understanding that it will be returned to the tenant at the end of the tenancy will be subject to the Government's Tenancy Deposit Protection (TDP) scheme, whether it is called a ‘deposit' or not. The tenancy deposit protection only applies to assured shorthold tenancies (AST).

The Act only applies where money, either cash or its associated forms, such as a cheque or a banker's draft, is passed to the landlord or his agent from either the tenant or a third party.  Third party guarantees or ‘promises to pay' are not deposits for the purposes of the Act and therefore may continue to be used.

For tenancies where such deposits are accepted by either landlord or agent, the following provisions will apply:

• The deposit will be required to be protected within one of three statutory schemes
• Landlords and agents will be required to operate strictly according to the scheme rules
• Tenants shall be furnished with prescribed information within 14 days of accepting the deposit

Infringement of any of these three requirements may lead to onerous penalties on the landlord.  These sanctions were detailed in the previous factsheet (Factsheet No.24).  In summary these are:

• That the landlord is prevented from regaining possession of his property under section 21 of the Housing Act 1988 (the most common and straightforward mechanism for legally evicting a tenant)
• That the landlord can be taken to court by the tenant, and the court is required to award compensation to the tenant comprising THREE times the amount of the deposit.

Taking Tenancy Deposits:

The introduction of these provisions for any deposits accepted for assured shorthold tenancies post April 6 2007 will lead many landlords and agents to review their policy of accepting tenancy deposits.

It is the writer's opinion that the Government's current TDP scheme is both flawed and unnecessarily complex.  The requirements of the TDP Scheme put an administrative burden on the letting industry which is not commensurate to the benefits and protection that it was designed to provide for tenants' deposits.

For example, it requires that tenants are given certain information in a prescribed form.  Like the operation of the Section 20 form (since withdrawn in 1997), it will mean that minor technical mistakes or infringements in the use of this form could lead to severe sanctions - such as the landlord no longer being able to regain possession of his property under section 21.  The prescribed information requirements are presently turning out to be one of the most difficult compliance areas of the TDP system and it is likely that thousands of landlords will end up with non-compliant tenancies under TDP.

Landlords and agents with carefully prepared tenancy documentation and well-organised procedures will be able to avoid some of the more onerous aspects of the legislation, but it is likely that many landlords could find themselves at a severe disadvantage under the new system and the loopholes that it leaves for the ‘wise' tenant.  For the moment, compliance with TDP is also likely to involve a substantial increase in the documentation required to set up a tenancy.

A first point, therefore, for all landlords to consider, is whether or not to accept tenancy deposits after April 6 2007, and whether alternative methods of protection can be use in their place.  This Factsheet aims to explore some of the more critical issues both for and against the taking of deposits.

Tenancy Deposit Scheme Alternatives:

There are four possible alternatives available to landlords who grant residential tenancies after 6 April 2007:

1)  DPS Custodial Scheme.  The majority of landlords who accept deposits are likely to join the custodial deposit protection scheme.  In this scheme, the tenant pays the deposit to the landlord or agent who then pays the deposit into the scheme.    The custodial scheme is run by the Deposit Protection Service (DPS), and has the major advantage of being free of charge to its users - the scheme is funded from the interest received on the tenancy deposits held by the scheme.

2) The Dispute Service (TDS).  This scheme is primarily aimed at letting agents and major landlords, and is an ‘insured scheme' which means that the tenancy deposit is protected by an insurance scheme, and that the agent or landlord can therefore continue to hold the tenancy deposit during the tenancy.  In the event of a dispute, the disputed proportion of the deposit is then forwarded to the TDS for adjudication and distribution.   The cost of using this scheme will be borne by the agent in terms of an annual fee.  With the exception of members of NAEA, ARLA, and RICS (the joint owners of the Dispute Service), the annual fees to join this scheme are relatively high and are likely to be prohibitive for the smaller independent agent.

3) Tenancy Deposit Solutions Limited (TDSL).  This insurance-based tenancy deposit protection scheme enables landlords, either directly or through agents, to hold deposits. Letting agents can also join the scheme.  The cost of using this scheme is recovered in the form of a charge made on a per tenancy basis.  There is also an annual joining fee, and discounted fees are available to members of the National Landlords' Association who jointly own the scheme.

4) No Deposits.  Landlords can avoid the requirements of the scheme altogether by not taking tenancy deposits when letting under an assured shorthold tenancy.   This alternative is now being pursued by a number of landlords where they are satisfied that the prospective applicant tenant has good previous references and that the risk of default is minimal, or has been covered by an appropriate rent guarantee or insurance policy.  The operation of ‘deposit free' lettings is discussed in more detail in Factsheet No.24.

DPS Custodial Deposit Scheme:

This scheme has the advantage of being free of charge and is, therefore, likely to be a popular alternative for many landlords and agents.

Landlords and agents will be required to register with the Deposit Protection Service and will be allocated a ‘Landlord ID' or ‘Agent ID' number.  The landlord or agent is then required to submit details of all properties owned or managed by the landlord that s/he wishes to bring into the protection of the scheme.  Information can be submitted directly using the internet, or by post or phone.  The DPS does not require the landlord or agent to make any alterations to the tenancy agreement (although a standard optional and additional clause can be provided upon request).

When a tenancy deposit it received, the agent or landlord will then supply the details of the tenancy to the DPS, along with the deposit - either by cheque, or by debit card payment.  A deposit reference number will be allocated to each deposit. Within 14 days of receiving a deposit, the landlord or agent must give the tenant the prescribed information about the scheme being used.

At the time of writing, there are some significant deficiencies with regard to the prescribed information aspects of this scheme:

• Only part of the prescribed information will be provided by the DPS.
• It will be difficult for the landlord to prove that this prescribed information has been supplied by DPS
• The landlord or agent will be required to supply further prescribed information in order to comply with the full legal requirements for Tenancy Deposit Protection

At the end of the tenancy, if the landlord and tenant agree how the deposit should be divided, they will tell the scheme, which will return the deposit, divided in the way agreed by both parties.  However, if there is a dispute, the scheme will hold the amount until the dispute resolution service or courts decide what is fair.  The deposit must be returned within 10 days of the end of the tenancy provided the landlord and tenant have agreed the amount.

The Dispute Service (TDS) Scheme:

This scheme is costly to join but has the advantage of allowing landlords and agents to continue to hold tenancy deposits accepted under the scheme.  The scheme protects these deposits by way of an insurance policy which guarantees to repay the deposit if the agent or landlord defaults.

A landlord or agent is required to apply to TDS for membership before tenancy deposits can be accepted under the scheme (whereas the custodial scheme allows immediate registration).  A firm can be required to give disclosure of  various details of the firm's business including bank account details, staff training and qualifications, credit ratings of the firm and its Directors etc.

The TDS scheme is the most prescriptive of the schemes with regards to the tenancy agreement.  The TDS requires that:

• certain prescribed additional clauses are incorporated within the tenancy agreement
• prescribed information pages are attached to the tenancy agreement by means of an attachment
• that certain prescribed additional clauses are incorporated to the agency agreement

The TDS scheme also contains certain onerous financial conditions:

• TDS reserves the right to revise a Member's annual fee upwards, and to also charge a joining fee.
• Members who decide not to renew may be charged adjudication fees to cover the costs of resolving disputes which arise from a tenancy granted during membership.
• TDS may carry out an audit at the Member's expense if it reasonably considers that this is necessary to verify the accuracy of their returns for the purposes of calculating their subscription.

At the end of the tenancy, if the landlord and tenant agree how the deposit should be divided, the landlord returns all or some of the deposit.  If there is a dispute, the landlord must hand over the disputed amount to the TDS scheme for safekeeping until the dispute is resolved.  If for any reason the landlord fails to comply, the insurance arrangements will ensure the return of the deposit to the tenant if they are entitled to it.

The TDS scheme provides an alternative dispute resolution (ADR) service to the parties in case of dispute at the end of a tenancy.  When a dispute occurs, and if landlord and tenant both agree to use the service, they will also have agreed to be bound by its decision with no recourse to the courts.  Disputes will only go to the courts if the landlord and tenant do not agree to use the ADR service.  ADR will be free of charge for landlords and tenants.

Tenancy Deposit Solutions (TDSL) Scheme:

In the same way as TDS above, this scheme has the advantage of allowing landlords and agents to continue to hold tenancy deposits accepted under the scheme.  The scheme protects these deposits by way of an insurance policy which guarantees to repay the deposit if the agent or landlord defaults.  The scheme is open to both landlords and agents.

At the time of writing we have no operational information or experience of using this scheme.

There is a cost to using this insurance-based scheme.  Costs are charged:

- as an initial joining fee to join the scheme - £58.75 per landlord  (£47 NLA members)
- as a fee per tenancy - £30 per deposit (£26 for NLA members) and £20 per deposit for agents
- as a annual membership fee - £14.70 per year
(see the TDSL website for full details of the membership costs for both agents and landlords)

In many cases, the costs of the scheme are unlikely to provide a significant advantage over the DPS custodial scheme.  On an average deposit (£700 for example), any interest earned by the landlord whilst holding the fee in a high-interest deposit account is likely to be exceeded by the scheme's fees, and therefore the scheme appears to offer little advantage over the custodial DPS scheme.  However, for agents, the ‘per deposit' costs are lower and this may make the TDSL scheme attractive.

Should I accept tenancy deposits after 6 April 2007?

Clearly, the final choice of accepting tenancy deposits, or not will rest with the individual landlords and agents:

YES:
There are advantages to accepting a tenancy deposit:

• Security.  By taking a deposit, the landlord receives a limited amount of protection both during, and at the end of the tenancy against the tenant defaulting on the rent, or leaving the property damaged or uncleaned at the end of the tenancy.
  
• Interest.  The agent or landlord can earn interest from the deposits - this income can be significant, especially where there are many properties under management. 

NO:
There are also significant disadvantages to accepting tenancy deposits under the Governments TDP rules:

• Prescribed Information.  The ‘prescribed information' requirements under TDP are both onerous and complex.  It is likely that many inexperienced landlords will inadvertently fail to comply with the requirements thus leaving themselves exposed to spurious claims from tenants, and an inability to recover possession of their property under the normal AST possession procedure (under section 21, HA88).
• Proof.  Not only will landlords need to supply the ‘prescribed information' to tenants, but they will need to be able to supply proof that the information has been supplied in case of dispute.  This means that signed receipts or certificates of compliance are necessary.
• Data Disclosure.  Landlords entering into one of the three schemes are required to agree to disclose the personal and financial details relating to all their lettings (properties held, type of property, rent payable etc.) onto a database held by the Department for Communities and Local Government (DCLG).  The DCLG may disclose details of scheme activities to other Government departments (including the Inland Revenue) or other industry bodies - with the proviso that the department or body has reasonable justification to wanting to examine this data and there are ‘concerns over your activities'.  In many cases, this will be a degree of disclosure of private financial information that many landlords will find unacceptable.
• Lack of Security.  The security provided by the schemes is somewhat illusory.  A landlord is only protected up to the level of his deposit (typically between 1 and 1.5 times the monthly rent).  The scheme, however, does not prevent the tenant reneging on the final month's rent.  In fact, the scheme makes it more likely that foreign nationals will withhold the last month's rent because of the likely delay, difficulty and extra cost in remitting the tenancy deposits back to overseas tenants at the end of the tenancy.  Arguably, better protection can be afforded for the landlord by insisting that tenants provide a guarantor for each tenancy (where the protection is no longer limited to the size of the deposit).
• Repayment IDs.  The custodial system (DPS) relies on the landlord and tenant each being issued with a Repayment ID in order the repay the deposit at the end of the tenancy.  There will be costly consequences if this information is mislaid - failure to provide the DPS with a valid repayment ID will result in the Joint Repayment Form being rejected by the scheme.
• Disputes.  Under the Alternative Dispute Resolution rules of TDP, a landlord or his agent will be obliged to furnish an arbitrator with paper-based evidence supporting any claim for damage or rent arrears.  The dispute will be resolved by the decision of an arbitrator whose experience of property disputes is uncertain, and who has never visited the property or met either the tenant or the landlord.  Landlords will be required to submit a claim involving a detailed and lengthy set of requirements irrespective of the size or nature of the claim on the deposit.  Neither the landlord, nor the tenant will have the right to meet the adjudicator, or put any points to him in person.  Lack of evidence will generally be construed in favour of the tenant, and a separate court action will need to be started for claims larger than the deposit.
• Abandonment.  Different schemes make different requirements where a tenancy has been abandoned and the tenant is not traceable.  The TDS scheme requires that a landlord obtains and furnishes the scheme with a court order before the deposit can be released.  The DPS schemes require that the landlord obtain a statutory declaration from a solicitor or Commissioner of Oaths at additional expense before a deposit will be released.
• Scheme Rules.  Users of the three TDP schemes will need to acquaint themselves closely with the rules of the scheme they have elected to join, or fall into a liability trap.  Non adherence to the scheme rules could result in the tenancy being non-compliant, and subject to the statutory sanctions, or the landlord being deprived of his damage claim and the tenant being awarded return of the full deposit.

Alternatives to deposits:

At present not every landlord requires a deposit, this is a brief examination of some possible alternatives.  They should not be seen as a recommendation of any or all of them but the introduction of the compulsory statutory deposit scheme may be a good time to look at what function deposits fulfil and whether there are any acceptable alternatives.

Guarantors
A contract of guarantee, in the context of lettings, is a contract whereby the guarantor promises the landlord to be responsible for the due performance by the tenant of his obligations under the tenancy agreement if the tenant fails to perform these obligations.  This will normally cover the payment of rent and other tenant's obligations.

It will be necessary to find an appropriate guarantor.  Similar credit checks and references should be taken on the guarantor as would normally be taken for a tenant in order to establish the guarantor's ability to meet any defaulted rent payments or other costs.  Many landlords and agents insist that a guarantor must own their own home so that, if all else fails, then a legal charge can be registered against that property.  It would be important, if a guarantee is to be used instead of taking a deposit that the guarantee agreement is both comprehensive and binding.  As the courts have held that guarantors can resign from the guarantee, having given a reasonable period of notice that tenancies are granted for the same fixed term as the guarantee.  So after the initial fixed term of, say, six months the tenancy should not be allowed to become periodic but, if continued, should be by way of a new fixed term with a new guarantor agreement.

Insurance
There are a number of providers of insurance to the private rented sector which cover either non payment of rent or breaches of the tenancy agreement which would cover dilapidations issues.  Indeed the new deposit proposals might encourage new policies to be developed by new players to this market.  An example of an insurance provision covering the later situation might be as follows-
"An incident or the first of a series of incidents where the Tenant fails to perform his obligations set out in the Tenancy Agreement relating to the rightful occupation of the Insured Property."
The costs involved in taking out insurance policies would then become part of the set up costs of the tenancy and could be passed on to the tenant.

Rigorous tenant vetting
Most insurance providers will require tenant vetting either carried out by himself or herself in-house or by an approved provider.  Thorough tenant referencing will not prevent a change of circumstances to the tenant; for example, they may lose their jobs or suffer marital breakdown.  Tenant referencing would probably only protect the landlord's interests when used in combination with another of these alternatives.

Sources for Further Information:

• The Letting Centre website: www.letlink.co.uk
• The Communities and Local Government website: www.communities.gov.uk
• Custodial scheme website: www.depositprotection.com
• Insurance schemes websites: www.tds.gb.com & www.mydeposits.co.uk