Security Deposits and Letters of Credit

January 16, 2018 | By Charles Botensten

Q. I am a commercial real estate broker and I have a tenant who is negotiating a lease with a landlord and the tenant believes the landlord may have some financial issues.  The tenant is concerned that his security deposit could be at risk if the landlord declares bankruptcy?  Is this a valid concern and what can the tenant do to protect his security deposit?

A. Yes, the tenant’s concern is most definitely valid, and the tenant should strongly considering providing a letter of credit to the landlord in lieu of a cash security deposit to protect itself. Although there is an annual financial cost associated with maintaining a letter of credit, given the risk associated with the potential loss of a tenant’s cash security deposit if the landlord has used the tenant’s cash security deposit for its own purposes and the landlord is subject to a foreclosure, such cost is well worth it.  Likewise, given that when a tenant files for bankruptcy, a landlord must transfer the tenant’s cash security deposit to the trustee in bankruptcy, many landlords prefer a letter of credit in lieu of a cash security deposit (as generally stated, the letter of credit will withstand any request for a drawdown thereof).

The Legal Line Question by:
Neil B. Garfinkel
REBNY Broker Counsel

Partner-in-charge of real estate and banking practices at Abrams Garfinkel Margolis Bergson, LLP