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Is Your Security Secure?

secA knock on the door interrupts the banter of the cooperative’s board of directors, who are sitting around the living room of the president’s apartment.  It’s the fourth member at the door, who will make up the quorum necessary for this month’s matters to be resolved.  Before voting on the approval of an applicant or discussing the proposed capital improvements, the members want to finalize the lease of the commercial storefront owned by the cooperative.  While none of the members are lawyers or landlords by trade, they nonetheless have managed to negotiate a simple 10 year lease of a gluten-free vegan smoothie health bar.  The new lessee recently mailed a check for the security deposit which now sits in front of the board members.  After some discussion, one of the unwitting members suggests depositing the security deposit check into an interest bearing account which he uses for his own personal motorcycle repair business.  Although the board’s actions may appear legitimate on the surface, they are about to make a fatuous mistake which carries with it serious legal consequences.

Our unassuming board is going to want to be made aware of certain regulations governing the security deposit before finalizing their commercial lease.  While the internet is a never-ending source of articles and guides relating to the legal requirements on landlords in the residential paradigm, the internet is noticeably less fulfilling in the commercial setting.  This is likely to leave our amateur landlord who is trying to navigate the commercial leasing waters perplexed.  Of particular concern to is (a) whether to deposit the security into an interest bearing account and (b) whether the security should be deposited into a separate account designated strictly for such deposits.

If our benevolent board decides to do their due diligence, they are going to run into some serious confusion the minute they begin reading the relevant statute, New York’s General Obligations Law (the “NYGOL”)  § 7-103(2-a), which reads, “Whenever the money so deposited or advanced is for the rental of property containing six or more family dwelling units, the person receiving such money shall . . . deposit it in an interest bearing account . . .”  Clearly enough, the statute requires the security to be deposited into an interest-bearing account if the rental unit is situated in a building with six or more apartments, and does not require the same for a non-residential building being leased strictly for commercial purposes.  But what if the building, like the one being operated by our unwary board, is being utilized primarily as a residential cooperative or condominium, but contains a commercial storefront?  Does the board have to put the security deposit for rental of the storefront into an interest bearing account because the property also contains six-plus dwelling units?  This type of scenario is hardly an anomaly, yet the ambiguous language of the NYGOL leaves those who have a reason to care with unanswered questions and a slew of potential legal ramifications.

So what is the Board to do?

There is a simple solution with little to lose as the NYGOL also allows the cooperative owner to retain a sum equivalent to “one percent annum” of the earned interest as an administrative expense.   It is pretty clear that the coherent plan of action for the board to take is to deposit their commercial tenant’s security into an interest bearing account and pay the tenant all interest earned, less one percent, regardless of the argument that the plain language of the NYGOL may not apply to commercial leases.

Now that the board is aware of the type of account to use and who is entitled to the interest, what should we make of the member’s suggestion to deposit the security into his personal business account?  The answer is much simpler than the previous conundrum.  A landlord may not comingle a tenant’s security deposit with other funds in a landlord’s general account.   Case law has held that the consequence of doing so is conversion which entitles the tenant to recover the deposit in its entirety even if the tenant may be in breach of the lease, a very bad result for our cooperative and the board of directors.   Paterno v Carroll, 75 A.D.3d 625, (N.Y. App. Div. 2d Dep’t 2010).  Moreover, the board has a compelling justification to act within the bounds of these laws as § 7-109 grants the Attorney General authority to bring suit in the name of the People of the State of New York for violations of the sections relating to security deposits.

Our recently learned board is also going to want to take into consideration a few other requirements before adjourning their monthly meeting.  § 7-103(1) also requires the landlord who places his tenant’s security into an interest bearing account to give notice to the tenant specifying the name and the address of the bank where the deposit is held, by which the depository bank must have a place of business in New York State.

Now that we have managed to keep our board of directors out of trouble with regard to security deposits, they can concentrate on more interesting matters, such as arbitrarily denying the most recent purchase application…

– Ryan V. Stearns and Jerome J. Strelov


Category: Commercial Corner, For The Board, News, Security Deposits Comment »

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