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Security Deposit

ContractStandards Analysis
 Article Type
  Purchase, License or Performance  Negotiated
Most leases (especially residential leases) require the payment of a security deposit to protect the landlord from non-payment and damage to the property.
  • What is the amount of the deposit?
    • What is the form of the deposit (cash, letter of credit)?
    • How is the deposit held?
      • interest bearing or non-interest bearing account
      • Comingled or separate account?
  • In what circumstances can the deposit can be used and applied?
    • Non-payment of rent
    • Damage to property
    • Expenses incurred
    • Default under the lease
  • When must the balance of the deposit be returned?

Standard Clause

(a) Deposit. Upon execution of the Lease, Tenant agrees to pay to Landlord a security deposit equal in amount to [AMOUNT] on the Effective Date (the “Security Deposit “).

(b) Use of Deposit. Upon a default by Tenant, Landlord shall have the right to apply so much of the Security Deposit as is necessary to cure such default or pay an expenses incurred as a result of such default.

(b) Return of Deposit. Any remaining balance of the Security Deposit shall be returned by Landlord to Tenant within [NUMBER OF DAYS] [a reasonable period of time] after the termination or expiration of this Lease [and vacation of the premises by the Tenant]. 

Alternative Clause Elements

Form of Deposit—Letter of Credit
Tenant shall deposit with Landlord upon the execution of this Lease by Landlord and Tenant, an irrevocable standby letter of credit (the "Letter of Credit") in the amount of [AMOUNT] as the "Security Deposit" under this Lease. The Security Deposit shall be held by Landlord as security for the performance by Tenant of all its obligations under this Lease.

Interest Bearing (Tenant Favored Clause)
Tenant shall deposit the Security Deposit with a financial institution in an account of Landlord to be designated by Landlord upon signing this Lease (the “Security Account”). Landlord shall be required to segregate the Security Deposit from the other funds of Landlord and maintain the Security Deposit in the account together with all interest accrued thereon until the Security Deposit is applied or returned in accordance with the terms hereof. The Security Account shall be an interest bearing account offering the highest yield generally available for deposits similar in amount to the Security Deposit.

Non-Interest Bearing (Landlord Favored Clause)
Tenant shall not be entitled to receive and shall not receive any interest on the Security Deposit, and Landlord may commingle the same with other monies of Landlord

Optional Additional Clause Elements

Restoration of Applied Funds.  Tenant shall, upon demand, restore any portion of the Security Deposit which may be applied by Landlord to the cure of any default by Tenant.

Transfer of the Property. In the event of a sale or transfer of Landlord s interest in the Premises or the Building, Landlord shall have the right to transfer the Security Deposit to the purchaser or lessor, as the case may be, and upon any such transfer Landlord shall be relieved of all liability to Tenant for the return of the Security Deposit, and Tenant shall look solely to the new owner or lessor for the return of the Security Deposit.

Nature of the Deposit. The Security Deposit shall not be considered an advance payment of rental or a measure of Landlord’s damages in case of default by Tenant.

Discussion

The typical landlord lease form will require the tenant to deliver a cash security deposit upon lease execution and permit the landlord to hold such deposit interest free throughout the lease term. A tenant with a great deal of leverage may be able to successfully eliminate this requirement. However, a tenant with somewhat less leverage still may be able to change the form of security (e.g., substituting a letter of credit for a cash deposit) or make the obligation less burdensome in terms of duration or amount (e.g., providing for the release or reduction of the deposit at some point during the lease term). A letter of credit represents an interesting alternative to a cash deposit, especially if a tenant has a good relationship with its bank, it which case it may be able to provide the letter of credit without depositing any supporting collateral. If the letter of credit comes from a reputable bank and the draw down procedures are relatively simple and failsafe, many landlords will accept such security.
The Keys to Negotiating Lease Security

1. General Information on Security Deposits. See, Security Deposit Information (under California Law); Security Deposit Law in Residential and Commercial Leases

2. Interest on Security Deposit. "Tenants should be aware that unless otherwise provided in their lease, commercial landlords will not typically return interest earned on security deposits to tenants following the termination of a lease and there is no such requirement under Pennsylvania law." Pennsylvania Commercial Leases 101.

3. Effect of Bankruptcy of Tenant. "Letters of credit provide a distinct advantage to a landlord in this regard. The "independence principle" holds that letters of credit and the proceeds of letters of credit are not property of a bankruptcy estate." Letters of Credit Offer Landlords Protection against Tenent Bankruptcies.

4. Effect of Bankruptcy of Landlord. In the event of bankruptcy of the landlord, a tenant's "security deposit might be lost. In many cases, commercial leases provide for the security deposit to be given to the building owner and the building owner has the ability to commingle the money with other money used for the operation of the building. When money is commingled and the owner files for bankruptcy, you, as a tenant in the building, may become an unsecured creditor of the landlord and if there are no funds to pay off unsecured creditors, you may lose that security deposit." Commercial Lease Security Deposit At Risk In Bankruptcy


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