Wednesday, April 6, 2016

Security Deposit - Held In Trust Or Not?

It is an understandable to assume that, when you entrust someone with your money, to hold and use only under certain conditions, and to return the money back to you when/if those conditions don't apply, the money are held by someone in trust for you (Dillon v. Cross (1907) 5 Cal.App. 766; Spencer v. Duncan (1895) 107 Cal. 423), or as a bailee (Niiya v. Goto (1960, Cal App 2d Dist) 181 Cal. App. 2d 682; CC § 1814).

Not so with the security deposits. The court in Korens v. R. W. Zukin Corp. (1989) 212 Cal.App.3d 1054, ruled that the money held by the landlords as security deposits create a debtor-creditor relationship, but are not held in trust, citing in support CC § 1950.5(d). (Id. at 1058-1059). Is the Korens Rule absolute? As it is with many legal concepts,  the answer is "it depends."

Prior to Korens's universal statement, it was not an obvious conclusion that the money held by the landlord are not in trust or on the bail. There were even more extreme decisions, deciding that, under certain circumstances, the entire title to the advanced payment or money given from a tenant to a landlord had passed to the landlord and need not to be returned. [See, Curtis v. Arnold (1919) 43 Cal.App. 97, and the cases following it.]

Restatement Second of Property, Landlord & Tenant, § 12.1, comment l states: “The security deposit arrangement may take other forms than the establishment of a debtor-creditor relationship. The parties could establish a trust of the deposit, with the landlord as trustee and accountable to the tenant at the end of the trust for the remaining trust assets, including the actual amount earned by the trust during its existence.”

In Connecticut, under the terms of a lease agreement, a landlord holds a tenant's security deposit "in trust" for the tenant. "[A] security deposit, whether commercial or residential, is the tenant's property and . . . the landlord holds it for the tenant's benefit subject to the tenant's fulfilling all its obligations under the lease.” Johnson v. Mazza, 80 Conn. App. 155, 162 (Conn. App. Ct. 2003).

Many learned treatises also entertained the possibility of the trust relationship created over the security deposit's hold:  “[T]he dispute [btw. landlord a tenant regarding security deposit] may be resolved based on the characterization of the relationship between landlord and tenant with respect to the deposit. Courts usually characterize the relationship as involving a debt, a pledge, or a trust.” 5-40 Thompson on Real Property, Thomas Editions § 40.05, fn. 190, citing James R. Wilson, Lease Security Deposits, 34 Colum. L. Rev. 426, 458, 464 (1934), and Security Deposits and Guaranties Under Leases, 1 Real Property, Prob & Tr. J. 405, 415 416 (1966). It is notable that Thompson essay assigns most trust decisions to the jurisdiction of New York.

Back in California, the security deposit, unlike rent, is the property of the tenant. Action Apartment Assn v. Santa Monica Rent Control Bd. (2001) 94 Cal.App.4th 587, 599. The landlord holds it in priority to landlord’s own funds. “An advance payment received by the landlord as security for the performance of a lease is held by the landlord for the benefit of the tenant, and the tenant’s right to refund is senior to any claim by a creditor of the landlord except a trustee in bankruptcy.” Miller & Starr, Real Estate 3d, §19:144, citing Civ. § Code 1950.7(b), a non-residential security deposit statute. The landlord has a duty to make only specified kinds of deductions, which are “reasonably necessary to remedy tenants defaults.” Civ. Code § 1950.7(c). The remainder “shall [not may] be returned” Id

A case Granberry v. Islay Investments (Cal. 1995) 9 Cal.4th 738, 745, also confirms landlord's mandatory obligation to return unused portion of the deposit, but its underlying appellate decision [modified in part and superseded in part] uses a more colorful language, to quote: “If any meaning is to be given to the statutory provision in question, it must be that it obligates the landlord to account for and refund the unused portion of the deposit within the two-week period specified. Otherwise, the requirement that the landlord "shall return any remaining portion of such security" is meaningless. ... It might as well be written in "invisible ink."” Granberry v. Islay Investments (1993) 28 Cal. App. 4th 1640, 1649, citing for the “invisible ink” quote a case Huijers v. Demarrais (1992) 11 Cal.App.4th 676, 678-679, which held that “[a] statute without a remedy might as well be written in invisible ink,” applying a common law remedy to such a statute.

And at least in one concept, the security deposit may still be held in trust by the landlord, even after the Korens decision--that is in the concept of tenant's bankruptcy. Upon filing the bankruptcy, all tenant's property becomes the property of the estate, and (under Action Apartment Assn v. Santa Monica Rent Control Bd.), the security deposit is also tenant's property and thus part of the bankruptcy estate. See Federal decisions to that effect: Hechinger Liquidation Trust v Parmod Monga (In re Hechinger Inv. Co. of Del., Inc.) (2003, BC DC Del) 299 BR 340; Redback Networks, Inc. v. Mayan Networks Corp. (In re Mayan Networks Corp.) (Bankr.9th Cir. 2004) 306 B.R. 295, 305.

If you are concerned about your rights and obligations in a landlord-tenant relationship, make your first step toward taking control over the circumstances, and call my office at (415) 987-7000. I will be glad to assist in guiding you through the jungle. The only thing you can't afford is to stay put and uninformed. My office provides a confidential assessment of your particular scenario, free of charge, and I will share with you the results of the analysis along with my thoughts on available solutions.

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