Unlike residential security deposits, commercial deposits held to secure a rental agreement can be negotiated freely between the parties. The laws governing residential security deposits are long and detailed; commercial tenancies are far more flexible, since the parties can mutually agree on any amount to designate as security.
What a Commercial Security Deposit Can Cover
California Civil Code §1950.7 establishes that a commercial landlord may use security deposits to remedy monetary defaults, to repair damage to the premises caused by the tenant, and to clean the premises following termination of the lease.
The deposit must be held by the landlord for the tenant, but doesn’t need to accrue interest. The landlord can only claim amounts reasonably necessary for those specific purposes — remedying a rent default, repairing tenant-caused damage, or cleaning after the tenancy ends — provided the deposit was made for those purposes in the first place.
If the landlord’s interest in the property is terminated — whether by sale, assignment, death, appointment of a receiver, or otherwise — the deposit must, within a reasonable time, either be transferred to the landlord’s successor in interest, or have the remaining portion returned to the tenant after any lawful deductions.
Accounting for Security Deposits
As a good business practice, the deposit should be held in a federally insured bank account, either kept separate or reconciled monthly if commingled. A landlord can draw on the deposit during the lease term, with any unused portion returned to the tenant no later than 30 days after the landlord regains possession of the property.
Unlike residential tenancies, commercial tenancies don’t require an itemized accounting when the deposit is returned, unless the rental agreement says otherwise. The deposit can be claimed by the landlord during or after the tenancy for uncured damage or outstanding rent. If a landlord draws from the deposit mid-lease, the agreement typically includes a clause requiring the tenant to replenish it within a set time.
Nonpayment of Rent: A Different Refund Deadline
If the landlord’s only claim against a security deposit at the end of a commercial tenancy is a rent default, the standard 30-day refund deadline can shrink — depending on whether the deposit covers more or less than one month’s rent.
Under the Civil Code, if a commercial security deposit exceeds the first and last month’s rent and is used only to cover rent defaults, the portion exceeding one month’s rent must be returned within two weeks of the landlord regaining possession, with the remainder accounted for within 30 days.
Because of this, when a commercial security deposit exceeds one month’s rent (beyond any amount designated as last month’s rent), the lease should state that the tenant waives the Civil Code §1950.7 time limits, and clearly allow the deposit to be held and applied against future damages. Without that waiver, if the tenant vacates early and the landlord doesn’t terminate the agreement, the landlord must return the amount exceeding one month’s rent.
Restrictions on Security Deposits and Key Money
California separately prohibits commercial landlords, under Civil Code §1950.8, from requiring or demanding “key money” — a payment used to induce the landlord into renting the property, including the landlord’s attorney’s fees for preparing the agreement — unless the amount is stated in the written lease. Violating this restriction can result in monetary damages, attorney’s fees, and a penalty of three times the actual damages proximately suffered by the person seeking the rental.
This restriction does not prohibit the advance payment of rent, provided the amount and character of the payment is clearly stated in the written lease. It also doesn’t prohibit a landlord from charging a reasonable amount for legitimate business activity connected to starting, continuing, or renewing the lease — including verifying a tenant’s creditworthiness or qualifications.
Conclusion
Security deposits in a commercial lease carry real consequences for bad-faith handling: a landlord who retains a tenant’s deposit in bad faith is subject to statutory damages, on top of the tenant’s recoverable actual damages, in court.
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Disclaimer: Every situation is different and particular facts may vary thereby changing or altering a possible course of action or conclusion. The information contained herein is intended to be general in nature as laws vary between federal, state, counties, and municipalities and therefore may not apply to any given matter. This information is not intended to be legal advice or relied upon as a legal opinion, course of action, accounting, tax or other professional service. You should consult the proper legal or professional advisor knowledgeable in the area that pertains to your particular situation.
