Securing the Security Deposit

Most leases provide that the tenant is required to give the landlord a security deposit. But the recent Appellate Division decision, in 23 East 39^th Street Mgt. Corp. v 23 E. 39^th St. Dev., LLC, shows that some owners are not aware of their legal obligations when holding a security deposit. By not following the law, an owner can be required to return the security deposit to the tenant before the lease expires. In case the tenant does not pay the rent or damages the premises, owners want a security deposit as protection.

It is important to remember that, until it is repaid or applied, the security deposit continues to be the money of the tenant. The owner only holds the money in trust for the tenant. So, the owner cannot commingle the tenant’s security deposit with the owner’s personal money, and the owner cannot use the security deposit as its own.  The rule against commingling applies to commercial and residential tenancies and fair market and regulated tenancies. 

So, the tenant’s security deposit should be placed in a separate bank account. The bank must have a place of business in New York State. The owner needs to notify the tenant in writing of the name and address of the bank and the amount of the deposit. Usually, that is done in the lease, but often that information is left out of the lease. If the security deposit is deposited into an interest-bearing account, the owner is entitled to a 1 percent administrative fee.  Any other interest belongs to the tenant.  Whenever the security deposit is for a rental of property containing six or more family dwelling units, the security deposit must be deposited in an interest-bearing account.  

In the 23 E.39^th Street case, the owner never placed the security deposit into a separate bank account. The security deposit was $400,000. Since the owner commingled the tenant’s security deposit with its own funds, the Appellate Division ruled that the tenant was entitled to an immediate return of the security deposit. The court found that the owner could not use the security deposit as an offset against unpaid rents. 

Sometimes leases will provide that commingling of the security is agreed to and that the security deposit does not need to be in an interest-bearing account.  Even in commercial and fair market leases, such clauses will not help the owner. The law expressly provides that any lease clause that waives the obligation of the law is absolutely void.  

The lesson to be learned is that an owner should never commingle security deposits with its own funds. It is important to pay attention to the details and open separate accounts for each security deposit, as required by the law. While there might not be much at stake with one residential tenant’s security deposit, if a whole building or a commercial tenant demands the return of its security deposit, the owner will expose itself to substantial risk.  So, owners should secure the security deposit.