Q: We act for tenants taking commercial leases. From time to time, we receive rent deposits from our tenant clients and pay them over to the landlord’s solicitors as part of the lease transaction.
The money is not being used to buy an asset; it is being provided as security for the tenant’s obligations under the lease. But there still seems to be a risk, particularly if the transaction aborts and the rent deposit needs to be returned. What source of funds checks should we be doing? And if the deposit comes back from the landlord or the landlord’s solicitor, do we need to do source of funds checks on that money too?
A: Your instinct is broadly right: this is a risk-based source of funds issue, not a rule that requires a full forensic investigation into every rent deposit.
The starting point is your own client. You are acting for the tenant, so your AML focus should be on understanding the tenant, the purpose of the transaction, the commercial rationale for the lease, the amount of the deposit, and where the tenant’s funds are coming from.
That does not mean you need to “prove” that the funds are clean. That is not the test. You should, however, record the questions asked, the answers given and any supporting material obtained.
So, in a straightforward commercial lease, if the tenant is a known trading business, the rent deposit is proportionate to the lease terms, the money comes from the tenant’s own business account, and the transaction has an obvious commercial purpose, the source of funds work may be fairly light-touch. You would still want to record the position: what the deposit is for, how it is calculated, where the funds are expected to come from, and why that makes sense in the context of the client and the matter.
The position changes if there are red flags. Examples would include a rent deposit that is unusually large, funds coming from an unexplained third party, offshore payments with no obvious reason, cash, urgency that does not make commercial sense, inconsistent explanations, a tenant with no credible business activity, or a transaction that looks artificial. In those cases, you would need to ask more questions and may need supporting evidence.
The return of the deposit is slightly different.
In most normal cases, you would not be expected to carry out full source of funds checks on money coming back from the landlord or the landlord’s solicitor simply because a rent deposit is being returned. If there was a credible landlord and tenant transaction, the deposit was paid out as expected, the lease then aborts or the deposit becomes returnable, and the same or expected amount comes back from the landlord’s solicitor or another identifiable and expected source, the AML risk will usually be low.
The involvement of the landlord’s solicitor is a relevant risk-reducing factor, particularly where the funds are coming from a regulated legal practice. LSAG guidance says that, on a risk-based approach, funds remitted from a legal practice regulated for AML to equivalent standards may be treated as lower risk. But be careful how you frame that. This is not the same as formally “relying” on the landlord’s solicitor’s CDD. Reliance has a specific meaning under the Money Laundering Regulations, and the guidance is clear that you cannot rely on due diligence carried out by another party unless the regulatory conditions are met.
In practical terms, you are saying: “This payment is consistent with the transaction, the route of funds makes sense, the amount is expected, and there are no red flags requiring further enquiry.”
If the transaction aborts while you are still holding the rent deposit, you should be thinking about whether this was a sham transaction all along. Carefully consider the risk analysis and CDD carried out at the outset, the legitimacy of the matter and the parties, and the circumstances of the aborted matter. You should not return funds without considering whether a SAR is needed, and funds should normally be returned to the original sender rather than redirected elsewhere.
The key is not to treat rent deposits as automatically high risk just because client account is involved. But neither should firms ignore them. They are transaction funds, and client account can be attractive to criminals precisely because money passing through a solicitor’s account can appear more legitimate.
So the answer is: yes, do proportionate source of funds work on the tenant’s deposit at the outset. No, you would not usually need full source of funds checks on money coming back from the landlord or landlord’s solicitor in the ordinary course of a genuine landlord and tenant transaction. But you should still sense-check the payment, record the rationale, return funds by a sensible route, and pause if the transaction starts to look artificial.
This is not legal advice. If you have a question you would like us to answer in this section, feel free to send it to info@jblcompliance.com.
