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California Commercial Leases, Security Deposits, and Civil Code Section 1950.7; Can the Landlord Offset Future Rent Damages?

California Civil Code section 1950.7 controls the commercial Lessor / Landlord’s use of the deposit. A commercial landlord got a surprise in decision involving a San Francisco commercial lease. The tenant had already leased the premises for five years when PERS (Public Employee’s Retirement System, California’s state employee retirement program) bought the building. PERS terminated, or reduced, many of the services the prior lessor had provided the lessee. The lessee was infuriated, and stopped paying rent. Two months later he made a partial payment of back rent, and vacated the building. PERS v. Winston

The trial court found that the elimination of some and reduction of other services followed by the tenant vacating the premises was a “constructive eviction” (where the conditions are so reduced that the tenant is forced to vacate the premises). The court concluded that the tenant owed rent for the time up until he vacated the property, reduced by an amount to account for the reduced services. The court made no finding as to the deposit. On appeal, the tenant said that the landlord was entitled to offset the deposit by the rent due, but was then required to refund the balance of the deposit. As a result, the landlord owed him money.

The Appellate Court agreed. It reasoned that under subdivision c) of 1950.7, where the only default is failure to pay rent, the lessor is required to return the balance of the deposit to the tenant “no later than two weeks after the landlord receives possession of the premises…” Thus, the landlord owed the tenant a refund before the lawsuit was filed. The landlord cannot offset the deposit for future rent damages, interest, or attorney fees it may recover in a lawsuit. Important in this case is the timing of the offset. It was critical in determining who was entitled to a money judgment.

tenant_parking.jpgThis is important for the potential award of attorney fees under Civil Code section 1717, which allows an award of fees to the party who “…recovered a greater relief in the action on the contract.”

The trial court had found that PERS was to recover a judgment, but the appellate court says no, since the offset of the deposit was to be done immediately on vacating the premises, the tenant here would recover a money judgment for the balance of the deposit. The attorney fees in this case surely exceed the damages awarded by a factor of more then 10.

What is a commercial landlord / lessor to do? First of all, ensure a knowing waiver of California Civil Code section 1950.7. Alternatively, make sure the deposit is accounted for immediately, and, if any balance is remaining, return it to the tenant. Surprising here was that the default in rent was the ONLY claim on the deposit of the landlord. Experienced Sacramento leasing attorneys routinely see claims for damages and cleaning expenses, which seems to eat up the security deposit.