Background

Section 1950.7 of the California Civil Code provides that if a security deposit in a commercial lease exceeds the first and last month’s rent and is used to cover only defaults in the payment of rent, the portion of the deposit in excess of the amount equal to one month’s rent shall be returned to the tenant within two weeks after the landlord receives possession of the premises with the remainder to be returned or accounted for within thirty days after the landlord receives possession of the premises.

Holding of 250 L.L.C. Case

In 250 L.L.C. v. Photopoint Corp., (2005) 131 Cal. App. 4th 703, the commercial tenant abandoned the premises. A California landlord with abandoned commercial premises has two mutually exclusive remedies: deem the lease terminated and seek damages pursuant to California Civil Code Section 1951.2, or, under California Civil Code Section 1951.4 if the lease so provides, continue to perform under the lease and seek rent as it becomes due. The landlord declared the lease terminated and opted for damages under California Civil Code Section 1951.2, and then offset the tenant’s security deposit against its anticipated rent damages.

The California appellate court held that because the commercial lease did not explicitly waive California Civil Code Section 1950.7 to provide that a security deposit might be held and applied against future rent damages, the landlord was not entitled to offset the amount of the security deposit it withheld against the even greater future damages the landlord anticipated it would sustain.

Significance of Decision

In view of the 250 L.L.C. v. Photopoint Corp. decision, it is prudent for a commercial landlord holding a large security deposit to, at a minimum, include a provision which makes clear that the security deposit can be held and applied against future damages and to explicitly waive the provisions of California Civil Code Section 1950.7 with respect to the time periods by which a security deposit must be returned. Absent such explicit waiver, a landlord who elects to terminate a lease pursuant to California Civil Code Section 1951.2 is prohibited from using the security deposit as an offset against the amount of anticipated future damages.

When the commercial lease does not provide for a waiver of Section 1950.7, a landlord with abandoned premises who is holding a large security deposit must next consider whether the lease provides for the Section 1951.4 remedy. If the Section 1951.4 remedy is available under the lease, the landlord may elect not to terminate the lease and continue to seek rent as it becomes due. In electing not to terminate the lease, the duty to return the security deposit to the tenant under Section 1950.7 does not arise, and the landlord can continue to apply the deposit against the rent as it accrues.