Security Deposits 101

 

If you are in the rental industry, you must have a solid understanding of security deposit law.  Security deposit law in Colorado comes from two primary sources.   The Colorado Security Deposit Statute (the “statute”) that applies to every security deposit and the Colorado Real Estate Commission Rules (the “rules”) which apply to all security deposits being held by real estate brokers.  If the Real Estate Commission rules apply to you, you must comply with both the statute and the rules.

The statute establishes key legal requirements for security deposits in Colorado.  A security deposit is defined as any sum of money (no matter what you call it) whose purpose is to secure performance of a lease.  When a tenant moves out, you must account for the tenant’s security deposit.  If you don’t return the full deposit, accounting means providing the exact reasons why you kept all or any portion of the security deposit.  You have to provide the accounting within thirty days of when the tenant moves out or when the lease terminates, whichever is later.   You can extend the accounting period up to sixty days by agreement in your lease. 

If you fail provide the accounting by the deadline, you forfeit all rights to withhold any portion of the security deposit.  If a tenant disagrees with your security deposit accounting, the tenant has the right to sue you.  If the court finds you shouldn’t have withheld the security deposit or any portion of it, the court can award the tenant three times the amount of the security deposit wrongfully withheld, plus the tenant’s attorneys’ fees and costs.  The statute specifically provides that any lease provision or other agreement which attempts to alter or waive a tenant’s security deposit rights is void.  The prime directive of the security deposit statute is to make it impossible for a landlord to alter a tenant’s security deposit rights.

Now that you know the statute’s key points, lets discuss some of the most common statutory security deposit mistakes.  At or near the top of the list is the “old it’s not a security deposit ploy”.  Just because somebody calls it something other than a security deposit doesn’t mean it is not a security deposit.  Remember, it doesn’t matter what you call it.  If its purpose is to guarantee that the tenant will meet their lease obligations, then it is a security deposit. 

For the ill informed, this ploy can result in significant liability.  Because they call it something else, some landlords wrongly conclude that they are immune from all of the statute’s requirements.  When a landlord wrongfully believes that they are immune to all security deposit laws, the landlord usually violates every security deposit law.  A close second to the “it’s not a security deposit” is lease language that makes the security deposit “non-refundable” or language that results in the tenant automatically forfeiting the security deposit upon the occurrence or non-occurrence of some event.  Lease language creating non-refundable security deposits or resulting in automatic forfeiture of a security deposit are not enforceable in court.  See prime directive.  Non-refundable language, in addition to being unenforceable, can also kill you in court.  Judges will immediately conclude that you are an unreasonable and overreaching landlord when you use this type of lease language.

If you have been around the security deposit block a time or two, you know that attorneys’ fees are a critical component of security deposit litigation analysis.  Under the statute, you pay the tenant’s attorneys’ fees if you lose.  You shouldn’t risk incurring $6000 in attorneys’ fees trying to withhold a $300 deposit.  Why $6000? Because a tenant’s attorney can easily ask for $3000 to $4000 in attorneys’ fees in a security deposit case, and you also have to pay us to defend you.  Some Landlords have designed the perfect solution to get a shot at the $300 deposit without risking the $6000 in attorneys’ fees. These landlords have drafted lease language that provides that no one gets attorneys’ fees in security deposit litigation.  The only problem is that any lease language that alters a tenant’s security deposit rights is void because it violates the prime directive.  Landlords’ efforts to alter a tenant’s security deposit rights are not limited to an attorneys’ fee provision.  Again, all such efforts will fail in the end.  Don’t violate the prime directive by using lease language that attempts to alter a tenant’s security deposit rights.

In the business, the required security deposit accounting is known as a SODA (statement of deposit account).  New landlords and managers sometimes fail to send the required SODA when a tenant owes them money.  These landlords erroneously conclude that a SODA is not required if a tenant’s entire security deposit is withheld for substantial damage to the property.  “Why should I have to send an accounting, the tenant destroyed my property”?  You always have to send a SODA because the law requires it, no exceptions. 

We have also seen landlords attempt to ignore the clear consequences of not timely sending a SODA.  ” I’m not going to refund a deposit to a tenant that owes me money, just because I forgot to send the tenant his SODA within thirty days”.  We can’t make this any clearer.  If you blow the SODA deadline, you may not withhold any portion of a tenant’s security deposit for any reason.  You can still pursue the tenant if he owes you money.  You just can’t collect the money from the tenant’s security deposit.  Also remember that blowing the deadline includes failure to timely sending the SODA, and not including any security deposit refund owed.  Under the statute, the refund must accompany the SODA, or you haven’t complied.

While we see countless SODA charges that tenants may dispute, a tenant can always successfully dispute a SODA charge for a security deposit that the tenant never paid.  The SODA charge results because the tenant couldn’t pay the entire security deposit at move-in.  As a result, the landlord agrees to allow the tenant to move in based on the tenant’s promise to pay the security deposit in installments. Frequently the tenant never pays the security deposit.  If a tenant fails to pay an agreed upon security deposit, the landlord cannot charge on the SODA the amount of the unpaid deposit.  Upon move-out, a tenant is required to pay what the tenant owes, not what the tenant agreed to deposit as security to cover what the tenant owes.

Real Estate Commission rules also establish key security deposit requirements for brokers that are in addition to the statutory security deposit requirements.   The Real Estate Commission rules apply to you if you fee manage rental units.  Fee management landlords (property management companies) must deposit all security deposits into trust accounts separate from other money.  If you accepted or receipted for a tenant security deposit, you may not deliver the security deposit to the owner without the tenant’s written authorization in a lease, or unless you have given the tenant written notice via first class mail.  Landlord’s notice of transfer to the owner must include the owner’s true name and address, be sent by first class mail, and inform the tenant of the procedure for requesting a return of the security deposit.  The management agreement with the owner must also place financial responsibility on the owner for the return of any security deposit delivered to the owner.  Based on our review of countless management agreements, security deposits are often inadequately addressed in management agreements.

Fee property management companies make several common mistakes that violate Real Estate Commission rules when handling security deposits.  When a property management contract is over, the management company performs a final accounting for the owner, and transfers all money being held in trust for the owner, including security deposits, to the owner.  The transfer of all funds, including security deposits, at the completion of a management contract triggers the requirement to provide notice to the tenants that the security deposits are being transferred to the owner.  However, some management companies fail to provide the required notice.  Other management companies make the mistake of hand delivering the required notice.  Again, the notice must be sent by first class mail.

Management companies also wrongly conclude that based on the management arrangement, the security deposit rules do not apply to them.   For example, management contracts often require that all money received by a management company, including security deposits, to be deposited into an owner controlled bank account.  Based on this language, management companies erroneously conclude that the have “not received money (security deposits) belonging to others”, but have only collected the money for the owner.  The owner received the security deposit because the security deposit was deposited into the owner’s bank account.  However, under commission rules, receiving money belonging to others doesn’t mean to deposit and control the money.  Receiving means to take possession, not deposit.  This interpretation is also supported by another Commission rule that provides a broker receipting for a deposit can’t transfer the deposit to an owner without authority in a lease or without providing written notice to the tenant.

Given the rules, owner demands in management contracts, and modern banking capabilities, management companies need to pay particular attention to the sweep account.  Many owners now require all money be deposited into a sweep account.  A sweep account, as its name implies, is swept usually on a daily basis.  If the management company is depositing all money, including security deposits, into the sweep account, all security deposits are being transferred to the owner.  Accordingly, the management company should recognize this fact, bring this legal requirement up during management contract negotiations, and make sure that the management agreement complies. 

Methods of compliance include having the tenant’s lease providing authority for such transfer, giving the tenant written notice in the tenant lease, or having the tenant write separate checks (one for security deposit and another for all other fees due when leasing).  However, based in our involvement in management contract negotiations, none of these solutions are ideal, and some are strongly resisted by owners.  For these reasons, we have worked with clients to develop alternative solutions.  Regardless of the solution, the issue must be identified and addressed, or the rules will likely be violated.

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