Forfeiture of rental deposit and other consequences following termination by the tenant's breach

XV. Forfeiture of rental deposit and other consequences following termination by the tenant’s breach

It is common practice in Hong Kong for tenancy agreements to include payment of a ‘rental deposit’ in the amount equivalent to two months’ rent (or more in commercial premises) as security and as an ‘earnest of performance’ of obligations under the tenancy agreement.

However, it is often the case that most pro-forma agreements used might not contain an express provision for a right to forfeit the deposit as a consequence of breach. Very often, it is even more unclear as to the following matters which frequently arose in disputes between landlords and tenants regarding the treatment of the deposit:-

1. Whether the deposit could be ‘used’ or ‘deducted’ by the landlord to satisfy the actual losses suffered as a result of tenant’s breach (e.g. unpaid management fees);
2. Whether the deposit could be forfeited by the landlord absolutely and/or in full regardless of the degree and extent of the tenant’s breach (e.g. partial non-payment of rent for one month only);
3. Whether the landlord must ‘give credit’ to the amount of deposit as forfeited in claiming damages against the tenant for losses sustained as a result of the breach;
4. Whether the deposit shall be construed as ‘liquidated damages’ and/or whether landlord is entitled to recover any extra losses against which was suffered on top of to the deposit forfeited (e.g. repair costs);
5. In the event that the tenancy continues, whether the tenant was obliged to replenish, top-up and pay to the landlord the amount of deposit as forfeited;
6. When disputes arise after termination of the lease, whether the landlord is entitled to withhold return of the deposit until final resolution of Court proceedings.

The resolution of the above issues is case-specific which highly depends on the proper construction of tenancy agreements. There is no standard answers to the above matters. To avoid any unnecessary dispute between parties, it is recommended that the tenancy agreement do expressly address the above matters in relation to treatment of the rental deposit.

More importantly, it is a common misconception on the part of tenants that, after termination of the tenancy agreement upon breach of the tenant (i.e. non-payment of rent which resulted in ejection), the compensation payable to the landlord shall be confined to the amount of the deposit and there shall be a ‘clean break’ between the parties after termination. This is wrong because a landlord might have sustained further losses (e.g. loss of rent due to the inability to find a replacement tenant for the remainder of the unexpired term of the lease) as a result of the tenant’s wrongful termination (i.e. repudiation).

In such event, assuming the landlord had taken reasonable steps to mitigate his losses, even the tenant did NOT occupy the property after termination, he may become prima facie liable to compensate the landlord the outstanding rent for remainder term as ‘consequential losses’. This may end up in a very harsh result for the tenant in the event that the unexpired term is a long one (See: Goldon Investment Ltd v. NPH International Holdings Ltd HCA 5457/1999 (10th August 2004) A tenant was held liable to pay to the landlord an amount of HKD 17 million as a result of non-payment of 2 months rent).

For such reason, wrongful termination of the tenancy agreement on the part of the tenant is a very serious matter which must not be taken lightly.