How Landlords Use Security Deposits in Commercial Real Estate

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Your landlord may ask for a security deposit to assure that cash will be available if you fail to pay the rent or don’t make other payments required under the lease. Unlike residential landlords, who in many states may not ask for more than two or three months’ rent as a deposit, commercial landlords may set whatever deposit amount they want. You may be able to negotiate the dollar amount and more favorable terms if you are a desirable tenant with impeccable credit and business history (especially if you are renting space that has been vacant a long time).

Unless the lease provides otherwise, the landlord may not increase the deposit during the term of the lease, and you may not use the deposit to cover the last month’s rent. Your landlord will typically return the deposit at the end of the lease, minus any deductions, such as for damage repair.

Where the Landlord Will Keep the Deposit

No law requires the landlord to put it into the bank or pay you any interest the deposit earns. Ideally, the landlord will put the deposit in a separate account (not commingled with the landlord’s other funds) in a federally-insured bank and give you the interest, but that’s up to the landlord (and your bargaining power).

How the Landlord Will Use the Deposit

Landlords often deduct from the deposit at the end of the tenancy—to cover damage that you haven’t fixed or outstanding rent. However, landlords may also use this money during the tenancy. A typical deposit clause will state that the landlord may use the deposit if you fail to pay money you owe under the lease. When the landlord dips into the deposit to cover unpaid rent or another default, you will typically have a set amount of time to replenish the deposit (try to get as much time as possible to do this).

Breaking an important term or condition of your lease—a default—also constitutes grounds for termination of the lease. Can the landlord use the deposit and terminate? Unless the deposit clause clearly states that the landlord can’t do both, that’s what might happen. In fact, you’ll want to go further and require the landlord to first look to the deposit to make up for any monetary default on your part—in other words, you don’t want the landlord to have a choice of curing the default or terminating the lease. If the deposit can cover the money you owe, you’ll want a provision in the lease that there will be no termination. A landlord who agrees to this provision will probably insist that this cure right will be extinguished if your defaults are large and/or frequent.

When the Landlord May Use the Deposit

You won’t want the landlord to be able to dip into the deposit, perhaps without even telling you, every time you owe a payment or are late with rent. At the very least, bargain for a notice and cure right—a promise that the landlord will alert you before using the deposit and give you a few days to come up with the money. For example, if you’re going to be slightly late with the rent because a large account will be late paying you, you’d want the landlord to notify you before taking the rent out of the deposit—so that you can redouble your efforts to collect on that overdue account.

Landlords sometimes take money from a security deposit not only when the debt is clear and undisputed, but even when the very existence of the debt is in question. For example, suppose the two of you are engaged in a dispute regarding the proper calculation of common area maintenance (CAM) costs. If the rent clause doesn’t require that these disputes be mediated or arbitrated, the landlord might simply satisfy the claimed debt from the deposit. To guard against this end run, negotiate for a clause that allows the landlord to use the deposit only when you’ve failed to pay an undisputed debt (one you don’t contest) or an adjudicated debt (one that was the subject of court proceedings and was reduced to a judgment against you).

This article was excerpted from Negotiate the Best Lease for Your Business by Janet Portman.

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