I have always found the holding deposit (an initial retainer paid to the landlord or agent to reserve a tenancy) is a very useful device to commit the tenant to your letting. But is it legal to withhold the advance deposit you take from a prospective tenant if they back out?In my experience a prospective tenant makes his or her mind up pretty quickly if they are genuinely interested, then to close the sale, so to speak, you need commitment. Asking for an initial cash payment focuses minds and prevents time wasters making excuses like, I'll go away think about it, or I'll be back (after I've looked at several other properties).When demand for properties is high, tenants know that good properties let quickly, so it's usually in their own interest to retain it if they like it, whilst the usual checks are carried and a tenancy agreement is prepared.However, there is often confusion about the difference between a holding deposit and a 'damage'� or security deposit, and whether it comes under the rules regarding deposit protection. Also, it often leads to disputes when one or other party backs out for one reason or another and the whole or part of the holding deposit is being retained.In effect the taking of a holding deposit is a contractual arrangement which has legal implications. It is very common, and has become custom and practice in the letting industry, that a deposit is taken without any written agreement, and the landlord / agent expects to retain the deposit if the tenant backs out.This may well work in practice but legally this leaves the landlord on shaky ground as a court would be unlikely to enforce the arrangement if it came to a dispute. Like any other contract, the arrangement should be in writing and each party should be aware of the consequences in advance of not fulfilling their promises.The holding deposit, if genuinely for that purpose, is not subject to the Deposit Protection (DP) rules, though there is some doubt as to whether it would be if taken a long time in advance of the tenancy, for example a student paying 6 months in advance for a letting for the following year. Most holding deposits are taken for one week or so, and I would suggest one week's rent is the appropriate amount, so as there's 30 days to protect a security deposit, the DP rules issue does not arise.A holding deposit agreement (example here - www.landlordzone.co.uk/documents) should be drawn up and signed by both parties, clearly setting out the details of the parties, the property to be let, the date of the start of the tenancy, any admin fees to be charged, and under what circumstances the deposit or part of it will be retained. This will also act as a receipt for cash changing hands and it will state that the holding deposit is to be applied to the security deposit and be protected in a DP scheme once the agreement is signed.Courts will enforce contracts when the terms are considered reasonable. For guidance on this landlords and agents should refer to the 'Guidance on unfair terms in tenancy agreements'� published by the Office of Fair Trading Sept 2005 (now replaced by the Competition and Markets Authority (CMA) and the Financial Conduct Authority) - http://goo.gl/G9YyQ6The relevant sections state: Sections 3:37 to 3:42:A 'no refund' term where the tenant is required to make a substantial prepayment before a tenancy agreement is signed, is likely to be unfair'� Where cancellation is the fault of the tenant, the landlord or agent is entitled to hold back from any refund of prepayments a reasonable sum to cover either the net costs or the net loss of profit resulting directly from the default'� Tenants would be at fault if, for instance, they gave false or misleading information, but not merely because the landlord thought their references were not sufficiently good.'�Put simply, (1) you cannot impose on the consumer (tenant) a penalty which is greater than that on the business (landlord), and (2) any penalty must represent the financial loss to the injured party.So, if a tenant backs out the landlord / agent should deduct its costs / losses from any holding deposit taken and refund the difference, if any.A landlord would incur costs if it removes the property from the market and advertising, and carries out checks and paperwork etc, so is entitled to recover these reasonable losses if the prospective tenant backs out.On the other hand, should the landlord decide not to let for any unjustifiable reason, the tenant would be entitled to a full refund and possibly some compensation for any reasonable costs / losses sustained. The arrangement must always be even handed for the contract to be enforceable.Article by Tom Entwistle