Damage deposits, paid by tenants at the beginning of a tenancy, have always been a bone of contention, with tenants frequently complaining that some or all of their deposit has been unfairly retained by the landlord.

The Housing Act 2004 sought to sweep all this aside and put in place a system that would be totally transparent, protect the deposit from the beginning to end of the tenancy and provide a fair system of arbitration when all else fails. The deposit schemes took effect from 6 April 2007 and apply to all assured shorthold tenancies (ASTs). Other tenancy agreements are not affected.

TENANCY DEPOSIT SCHEMES (TDSs)

The most important change, introduced, by the Act, is the requirement for the landlord to use one of two tenancy deposit schemes (TDSs) when taking a deposit from a tenant. If the deposit is not covered by a TDS, the landlord is not allowed to take one at all. In addition, if he fails to comply with the rules of the chosen TDS, the landlord will not be able to recover possession of the property in the normal way (i.e. by serving a section 21 notice) until all the scheme requirements have been fulfilled. The landlord has 14 days from the date he receives the deposit (not from the start date of the tenancy which could be some time later) to comply with his obligations and to inform the tenant in writing of the details of the scheme (the prescribed information).

Scope of TDS

The following points should be noted:

• Only ASTs require a deposit protection scheme. A tenancy with a rent of more than £25,000 a year is not an AST and would therefore not be affected. Likewise, neither a company let nor a holiday let would come within the scope of the Act, and the deposit for these would not need to be protected.
• AST agreements entered into before the deposit scheme was introduced are not affected while they remain in place, so long as they continue as periodic tenancies (i.e. without a new agreement being drawn up at the end of the tenancy term). If, however, a new tenancy agreement is drawn up, then the original deposit will need to be protected at the same time.

Types of TDS

The landlord has a choice of two types of scheme.

Custodial

In this case the landlord collects the deposit in the normal way but must then pass it on, in full, within 14 days, to the scheme administrator. It is held within the scheme, gathering interest over the term of the tenancy, until it is paid out to the tenant, with interest, at the end of the tenancy. The scheme cannot contain any cash from any other source and the interest rate is set by the government.

Insurance based

In this case the landlord keeps the deposit in the normal way and undertakes to reimburse the insurance-based scheme if it is has to pay the deposit to the tenant before receiving it from the landlord. Normally it is only in the event of a dispute that the landlord will be obliged to transfer the deposit (or the disputed part of a deposit) to the chosen deposit scheme. The scheme then holds it until the dispute is resolved. If the landlord fails to transfer the deposit to the scheme, the scheme administrator will pay the tenant and then claim the money back from the landlord. If the landlord fails to comply with his obligation in this regard, the scheme will claim the money back from the insurance company underwriting the scheme.

In the absence of any dispute, the landlord will be expected to return the deposit to the tenant within 10 days of the tenant asking for it. If the landlord fails to comply with this request, the tenant can complain to the scheme administrator, who will direct the landlord to pay the outstanding amount into the scheme within 10 days of being directed to do so. Again, should the landlord fail to comply, the scheme administrator will make a claim against the insurance company underwriting the scheme.

The tenancy agreement

An AST agreement must now contain a clause to indicate that the deposit will be protected under the TDS.

Joint tenancies

Where there is more than one person on a tenancy agreement, the situation regarding deposit protection is more complicated. Usually each tenant will have made an individual contribution to the deposit. How is that protected? It is not uncommon for a tenant to leave and be replaced in the course of the tenancy. What happens to his deposit? Does the scheme administrator communicate with each tenant individually?

The total deposit, in the case of a joint tenancy, is seen by the scheme administrator as a single deposit, regardless of each tenant’s contribution to it. For ease of administration, the landlord or agent must ask the tenants to nominate a lead tenant who will be the point of contact for the scheme administrators (although the names of all the tenants will appear on the paperwork). If the lead tenant, or any other, leaves before the end of the tenancy, the scheme must be notified so that new paperwork can be issued. The custodial scheme will not release part of the deposit if a tenant leaves. The outgoing and incoming tenants will have to come to their own arrangement. This could involve the new tenant paying his portion of the deposit to the outgoing tenant. Where a departing tenant is not replaced at all there is no solution to the problem! In the case of the insurance-based schemes, the landlord still holds the deposit and there is scope for more flexibility.

Tenant’s address

A peculiarity of the schemes is the requirement to have a correspondence address, other than that of the property to be rented, for the tenant or the lead tenant. The reason is that, in the event of a dispute at the end of a tenancy, the tenant will no longer be in the rented property. Also, at the beginning of the tenancy, the deposit may have been paid some time before the tenant takes occupation. In both cases the scheme administrator needs an address for correspondence.

Third-party deposits

It doesn’t matter who actually pays the deposit (it could be a relative, for example, or a local authority), it must be protected if the tenancy is an AST.

Paperwork

When a deposit is registered and an application for protection received, the insurance-based scheme Tenancy Deposit Solutions Ltd issues a deposit protection certificate to the landlord. It will contain the following details:

• Name, address and telephone number of the landlord.
• Details of letting agent (if applicable).
• Property address to be rented.
• Name of lead tenant and alternative address (see above).
• Names of other tenants.
• Name and address of any interested party (if applicable).
• Start date of tenancy.
• Date deposit paid.
• Amount of deposit.
• Period of protection. This will be from the start date until the deposit is unprotected. An additional 90 days will be allowed, during which a complaint can be made, if the deposit has been unprotected by the landlord alone.
• Address and contact details of the alternative dispute resolution service for the scheme (see below).

The certificate will already have been signed by the scheme administrator. Both landlord and tenant will now be required to sign in order to confirm the accuracy of the information contained in it.

Along with the deposit protection certificate, the scheme (looking ahead to the end of the tenancy) also provides, for landlord and tenant, a ‘request to unprotect deposit’ form. If there is no dispute about the deposit, both landlord and tenant sign the appropriate section of the form and send it to the scheme administrator within 10 days of the end of the tenancy. If there is a dispute, however, the tenant will complete the ‘Notification of a deposit complaint’ section of the form and return it to the scheme administrator. This must be no earlier than 10 days after the tenancy ends.

Alternative dispute resolution (ADR)

All the schemes have a system of arbitration for resolving disputes when landlord and tenant cannot agree. The purpose here is to avoid costly and time-consuming legal action. However, if either landlord or tenant objects to the ADR process the dispute can still be taken to court. If the ADR is used, however, both parties must agree to abide by the outcome and cannot subsequently take court action.

An application to have the dispute settled by the ADR service must be made within 28 days of the end of the tenancy. If one of the parties cannot be located or refuses to co-operate, a single claim can be made.

With regards to the deposit itself, there are some differences between the custodial and the insurance-based schemes where a dispute is involved:

• In the case of the custodial scheme the deposit is already in the hands of the scheme administrators. Where an insurance-based scheme has been used, the landlord holds the deposit but must now hand it over (or the disputed part of it) to the scheme before the arbitration process begins.
• In the case of the custodial scheme the entire deposit will be retained until the matter is resolved, even though only part of it may be in dispute. In the case of the insurance-based schemes, only the disputed part is retained by the scheme as only this portion has been handed over. For example, where there is a deposit in place of £700 and the landlord claims he needs £200 to effect repairs to his property, he will return £500 to the tenant and, if the tenant disputes his claim, transfer the £200 to the scheme for arbitration.

There are no costs involved for landlord or tenant in using the ADR service.

Scheme providers

The Deposit Protection Service (the custodial scheme) is run by Computershare Investor Services PLC, a company that runs a similar scheme in Australia.

There are two insurance-based schemes to choose from: Tenancy Deposit Solutions Ltd (in association with the National Landlords’ Association) and The Dispute Service Ltd. The first is aimed mainly at landlords while The Dispute Service is largely used by letting agents with a large number of deposits to protect.

Costs

There are no costs for either party in using the custodial scheme. The insurance-based schemes, however, are funded by insurance premiums and these, along with other administrative costs, are paid by the landlord. The fees come in the form of a single joining fee, followed by a separate fee for each deposit protected. There is a slight reduction in costs for members of landlords’ associations. There are no cost implications for the tenant, and neither landlord nor agent can pass on their costs to the tenant.

Penalties

Failure to comply with the rules for deposit schemes can have severe consequences for the landlord:

• Failure to carry out the initial requirements of the scheme within 14 days and failure to provide the tenant with the appropriate information about the scheme within 14 days will mean that the landlord cannot use the section 21 notice procedure (under the Housing Act 1988) to recover possession of the property. This would mean, in effect, that the landlord would need a court order to evict the tenant – something the court would not grant.
• A tenant can apply to the court to have his deposit returned if the landlord has not complied with the rules of the scheme. If, by the time the case comes to court, the landlord has still not returned the deposit, the court must order him to pay three times the value of the deposit to the tenant, within 10 days.

TDSs: SUMMARY

Do you need to take a deposit at all? There is no legal requirement to do so. In practice, with your type of tenant, have you ever needed to retain part or all of a deposit at the end of a tenancy? Or have you found that the deposit is largely irrelevant, in any case, because many of your tenants simply don’t pay the last month’s rent? If you have difficulty letting your property, would you have an edge over other landlords by making a point of not requiring a deposit? If you routinely take a guarantee from a third party (e.g. for student letting), do you feel this is protection enough?

It is possible to insure (at a price) against damage caused by tenants (see ‘Useful addresses’ for companies offering this service). This avoids having to take a deposit. The drawback is that your prospective tenants will be fully checked out (credit checks included) by the insuring company and will be rejected unless squeaky clean. If they are good enough to be accepted, you might well ask if you need to bother with a deposit anyway, or go to the expense of an insurance scheme.

If your tenant has a tenancy agreement that predates 6 April 2007 (when the new scheme came into force), think carefully before you draw up a new agreement when the term of that tenancy expires. Allowing the tenancy to continue as a periodic tenancy instead avoids the need to protect the original deposit.

When deciding between the custodial and insurance-based schemes, consider the financial implications. The custodial scheme costs nothing but will deprive you of the deposit. If, in practice, your deposits help with your cash-flow, this may influence your decision. If you normally put the cash in a deposit account you will lose the interest. Is the cost of the scheme, over the average term of your tenancies, more or less than the interest you would earn over the same term?

If you use a letting agent check that they are complying with the law and using an appropriate deposit scheme. Get confirmation of this in writing.

As there is now an independent arbitration system to resolve disputes, it is vital that you are well prepared to defend your position. To that end a comprehensive and detailed inventory is essential (there may well be an inventory clerk on the panel of arbitrators). While an inventory is not a requirement, you are guaranteed to fail if you don’t have one. If you have not bothered with inventories up to now, it is time to start.

By far the best safeguard, in addition to the written inventory, is to take timed and dated photographs or video footage of everything in sight. Many disputes centre round wear and tear (not covered by damage deposits) versus serious damage (which certainly is). A photograph speaks volumes.

If you find yourself in dispute over the deposit, obtain estimates (two or three) for any repair work you claim needs to be carried out. These should be presented, along with the inventory, photos, etc., to the arbitration panel. Make it as easy as possible for the panel to reach a quick decision in your favour.

Make sure your tax affairs are in order! It would be foolhardy to believe that the taxman will not gain access to the wealth of information so readily available now in TDSs. The scheme rules and regulations of Tenancy Deposit Solutions Ltd state clearly that data may be handed over to ‘regulators, industry bodies and other organizations for the purpose of fraud prevention and money-laundering prevention, or if there are concerns over your activities’. You have been warned!