Tenants Beware: When Your Deposit Lacks Security

Overview

Security deposits are a fundamental landlord protection under leases with the expectation of tenants that the deposits will be returned upon the expiration of the lease. While landlords frequently consider how to protect their rights in the security deposit should the tenant file for bankruptcy, a recent decision highlights the risk to tenants if the landlord is, instead, the debtor in a bankruptcy proceeding. The issue arises due to the broad scope of what is included in "property of a bankruptcy estate" and under what circumstances the non-debtor (here, the tenant) has a property right in the cash security deposit or is simply a creditor with a prepetition unsecured claim against the debtor-landlord. Notably, under Section 541(d) of the Bankruptcy Code, property held by a debtor in trust for a non-debtor does not become property of the debtor's bankruptcy estate to the extent of the non-debtor parties' beneficial interest in such funds. Trust rights can