Commercial leasing in the Philippines is governed primarily by the Civil Code provisions on lease (upa) and the principle of freedom of contract. Unlike residential leasing (which can be subject to rent-control statutes), commercial leases are generally left to negotiation, subject only to law, morals, good customs, public order, and public policy.

Two recurring “front-end” payments in commercial leases are:

Advance Rent (prepaid rent); and
Security Deposit (a refundable security).

Because many disputes arise from confusing one for the other, the most important “rule” in practice is that their legal treatment follows the parties’ contract and the actual purpose of the payment.

1) Core Legal Framework

1.1 Freedom of contract (commercial context)

Parties may stipulate the amount, timing, and conditions for advance rent and security deposits, so long as the stipulations are not illegal or unconscionable, and do not violate public policy.

1.2 Civil Code on lease (upa)

The Civil Code provisions on lease supply the baseline rules on:

the lessor’s duty to maintain peaceful enjoyment and make necessary repairs (e.g., Art. 1654);
the lessee’s duty to pay rent and use the property with diligence (e.g., Art. 1657);
responsibility for deterioration, damage, and loss (e.g., Arts. 1667–1668);
termination/ejectment grounds (e.g., Art. 1673);
implied renewal (tacita reconducción) when the lessee stays and rent is accepted after expiry (Art. 1670).

These general rules interact with deposit/advance provisions because they determine what obligations may be secured, what may be deducted, and when termination is lawful.

2) Advance Rent: What It Is (and What It Is Not)

2.1 Definition and typical structures

Advance rent is rent paid ahead of the period it covers. Common patterns:

“One (1) month advance” applied to the first month;
“Two (2) months advance” applied to the first two months;
Advance designated as “last month(s) rent” to be applied at the end of the term;
Advance plus monthly rent (e.g., upon signing: 1 month advance + 2 months deposit + first month rent depending on the lease wording).

Key point: If the contract says it is “rent,” it is normally treated as rent—not refundable unless the contract provides otherwise.

2.2 Application rules

Because commercial leases are contract-driven, the “rules” depend on drafting:

If designated for the first month(s): it is typically consumed immediately by occupancy.
If designated for the last month(s): it is typically held and applied near the end, but the lease should clarify whether it can be used even if the lessee is in default or if early termination occurs.
If the lease is silent: disputes often arise whether advance can be “used up” for unpaid rent in the middle of the term. Many lessors insist it cannot be touched until the end; many lessees assume it can. The safest legal posture is that the lease wording controls.

2.3 If the lease does not push through

If a lessee pays “advance rent” but the lease is never perfected or never commences (e.g., conditions precedent not met), the payment may be treated as:

returnable as unjust enrichment/solutio indebiti if there is no basis to keep it; or
forfeitable if the contract clearly states it is non-refundable (e.g., treated as option money or liquidated damages), subject to limits on unconscionability.

The label alone is not decisive; the real intention and written terms are.

3) Security Deposit: Function, Nature, and Default Legal Treatment

3.1 Purpose

A security deposit is money given to secure performance of the lessee’s obligations, commonly:

unpaid rent;
unpaid utilities/association dues billed to the lessee;
cost to repair damage beyond ordinary wear and tear;
cost to restore premises to agreed handover condition (including removal of fit-out if required);
penalties expressly chargeable to the lessee.

3.2 Legal nature of a money “deposit”

A money “security deposit” in leasing is typically treated in civil-law terms as creating an obligation to return an equivalent amount at the end of the lease, less lawful deductions. Practically, it behaves like a refundable security that the lessor holds, but it is not automatically the lessor’s income and not automatically forfeitable unless the contract provides a forfeiture mechanism.

3.3 Refundability is the default—deductions must be justified

The commercial norm is:

deposit is refundable upon expiration/termination after settling accounts; and
deductions require a contractual basis plus proof/justification (e.g., billing statements, repair invoices, inspection reports).

Without a clear basis, withholding can be challenged as unjust enrichment or breach of contract.

4) Common “Rules” in Practice (Because the Law Leaves It to Contract)

4.1 How many months’ advance/deposit are “allowed”?

There is no single statutory cap for commercial leases nationwide comparable to residential rent-control regimes. Malls and prime commercial lessors commonly require multiple months of deposit/advance, and Philippine contract law generally allows it.

That said, extreme terms can still be attacked under doctrines on:

unconscionable stipulations;
abuse of rights; and
equitable reduction of liquidated damages when penalties are iniquitous or unconscionable (courts may reduce).

4.2 Can the lessor automatically forfeit the security deposit?

Only if the contract clearly provides for forfeiture (e.g., “security deposit shall be forfeited as liquidated damages upon pre-termination”), and even then:

forfeiture is often treated like liquidated damages/penalty, which may be reduced by courts if unconscionable relative to actual harm; and
forfeiture should not duplicate other recoveries in a way that becomes punitive (e.g., forfeiture plus full remaining rent plus large penalties) unless carefully justified and still reasonable.

4.3 Can the lessor apply the security deposit to unpaid rent during the term?

Common commercial positions vary:

Lessors often treat the deposit as a “hold” not to be used until the end, requiring the lessee to “top up” if applied.
Lessees often want the right to apply it to arrears.

Legally, it depends on the lease. If the lease authorizes application upon default, it is generally enforceable, typically with a requirement to replenish the deposit to its original amount.

4.4 Is the lessor required to pay interest on the deposit?

Not by default. Interest is generally due only if:

the contract expressly provides interest; or
there is legal basis for interest due to delay, demand, or damages (depending on circumstances).

If the parties want interest, the lease should specify:

rate,
when it starts,
whether it is simple/compound,
and whether interest is offset against charges.

4.5 How soon must the deposit be returned?

There is no single statutory “X-day rule” for commercial deposits. Good practice is to specify a definite period (e.g., 30/60/90 days) to allow:

final utility billing cycles,
reinstatement/repair assessments,
reconciliation of association dues or mall charges.

Absent a contractual period, return is due within a reasonable time after final accounting; unreasonable delay can support claims for damages and/or interest.

5) End-of-Lease Accounting: What Deductions Are Typically Defensible

Deductions from a security deposit are usually defensible when they are:

Expressly chargeable under the lease (rent, utilities, repairs, reinstatement, penalties); and
Supported by evidence (inspection reports, quotations, invoices, billing statements).

5.1 Ordinary wear and tear vs chargeable damage

Civil Code principles generally distinguish:

deterioration from normal use or passage of time (usually not chargeable), versus
negligent/unauthorized damage or misuse (chargeable).

Commercial leases often tighten this by specifying:

“handover condition” photos,
repair standards,
and approved contractors.

5.2 Fit-out and reinstatement

Commercial leases commonly require the lessee to:

obtain written approvals for fit-out,
comply with building rules,
remove improvements and restore, unless the lessor elects to keep them.

The Civil Code also recognizes rules on improvements introduced by the lessee (notably, the lessor’s options and the lessee’s limited removal rights depending on the type of improvement), but in commercial settings the lease’s reinstatement clause usually controls the practical outcome.

6) Interaction with Termination, Default, and Ejectment

6.1 Nonpayment and lease rescission/ejectment

Nonpayment of rent is a classic ground for judicial ejectment/unlawful detainer actions and/or rescission when contractual and statutory requisites are met. Deposit provisions matter because:

applying a deposit may temporarily cure arrears if allowed,
but does not necessarily waive default if the lease treats it as security only.

6.2 Acceptance of rent and implied renewal

If a fixed-term commercial lease expires and the lessee stays with the lessor’s acquiescence and rent is accepted, implied renewal may arise (tacita reconducción) under Civil Code rules. Deposit/advance handling should anticipate:

whether the deposit carries over,
whether rent resets,
and whether a new term is created.

7) Taxes and Documentary Requirements (Practical Rules That Affect Drafting)

Note: The items below are frequent compliance drivers in commercial leasing; the exact application depends on the parties’ taxpayer status, registration, and current BIR rules.

7.1 Withholding tax on rent (lessee-side obligation)

In many commercial setups, especially when the lessee is a withholding agent (e.g., a corporation), the lessee may be required to withhold expanded withholding tax (EWT) on rental payments and issue the corresponding certificate.

Advance rent is typically treated as rental payment for withholding purposes when paid.
Refundable security deposits are typically not treated as rent unless and until applied to rent or forfeited.

Lease clauses often require the lessee to provide proof of withholding and to gross-up if withholding is not allowed.

7.2 VAT / percentage tax implications (lessor-side)

Lease payments may be subject to VAT or percentage tax depending on:

the lessor’s registration and tax classification,
thresholds, and
the nature of the transaction.

Lease drafting often allocates:

whether rent is “VAT exclusive” or “VAT inclusive,”
who bears any VAT,
and what happens if the lessor becomes VAT-registered mid-term.

7.3 Documentary Stamp Tax (DST) on leases

Leases of real property can trigger DST based on rental amounts and term under tax law. Commercial parties typically address:

who pays DST,
when stamping is done,
and whether advance payments are included in the base.

7.4 Official receipts/invoicing

Commercial lessees typically require compliant invoices/receipts for rent. This affects:

timing of advance rent payment,
proof needed before applying deposits,
and withholding support.

8) Common Commercial Variants Beyond “Security Deposit”

Commercial lessors may require additional up-front securities that should not be confused with security deposit:

Fit-out bond / construction bond – ensures compliance with fit-out rules; refundable after inspection.
Utility deposit – ensures payment of utilities billed through the lessor/administrator.
Surety bond – third-party surety guarantees obligations; avoids tying up cash.
Bank guarantee / standby letter of credit – common for large tenants.
“Key money” / goodwill payment – typically contractual consideration; enforceability depends on documentation and legality of purpose.

Each instrument has different enforcement mechanics and refund rules; the lease should treat them separately.

9) Drafting Essentials: Clauses That Prevent Disputes

A commercial lease should define, in plain terms:

9.1 Classification and application

What each payment is called (advance rent vs security deposit vs bonds);
Whether advance rent is for first months or last months;
Whether deposits may be applied during the term upon default;
Whether replenishment is required after application.

9.2 Refund mechanics and timeline

Time period for return after termination and surrender;
Requirement of joint inspection and written turnover report;
Itemized statement of deductions with supporting documents;
Treatment of pending utility bills (e.g., holdback portion).

9.3 Forfeiture and liquidated damages

Clear triggers (pre-termination, abandonment, prohibited use, nonpayment);
Whether forfeiture is exclusive or in addition to other remedies;
Express acknowledgment that amounts are reasonable (helps defensibility, though not absolute).

9.4 Condition of premises

Baseline condition at turnover (photos, punch list);
Restoration scope;
Treatment of improvements and whether the lessor may appropriate them.

9.5 Default, cure periods, and notices

Cure periods for nonpayment and other breaches;
Service of notices;
Consequences for failure to cure (application of deposit, termination, legal action).

10) Dispute Patterns and How Philippine Law Typically Frames Them

“Deposit vs advance” reclassification disputes Courts tend to look at contract language and intent. If it is labeled and treated as rent, it is usually not refundable; if treated as security, refundability with lawful deductions is expected.
Unjust withholding of deposit Where deductions are unsupported or outside the lease, the lessor may be compelled to return amounts and may be liable for interest/damages depending on delay and proof.
Excessive forfeiture/penalty Forfeiture clauses can be enforced, but courts retain equitable power to reduce penalties/liquidated damages when unconscionable in relation to actual loss.
Double recovery Clauses that effectively allow the lessor to recover the same harm multiple times (e.g., forfeiture plus full accelerated rent plus large penalties) are vulnerable to judicial scrutiny.

11) Bottom-Line Principles

Commercial lease front-end payments are primarily contractual.
Advance rent is rent (generally non-refundable) unless the contract says otherwise.
Security deposits are presumptively refundable after accounting, subject to contractually authorized and provable deductions.
Forfeiture is not automatic unless stipulated, and even stipulated forfeiture can be moderated if unconscionable.
Tax and compliance treatment often differs between advance rent and refundable deposits; leases should allocate documentary duties clearly.