BILL ANALYSIS �
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2013-2014 Regular Session
SB 603 (Leno)
As Amended April 29, 2013
Hearing Date: May 7, 2013
Fiscal: No
Urgency: No
NR
SUBJECT
Landlord and Tenant: Security Deposit
DESCRIPTION
Existing law authorizes a landlord to demand and hold a security
deposit for a rental agreement for real property, and
establishes the rights of a tenant with respect to the return of
that deposit. Existing law further authorizes actual damages
for improperly withheld security deposits, and statutory damages
of up to twice the amount of the deposit for bad faith
retentions. This bill would mandate a statutory damage equal to
the amount withheld from a deposit when a landlord improperly
withholds any portion of a deposit, regardless of a showing of
bad faith.
This bill would require that landlords keep deposits in a
separate account, which exists solely for that purpose, at a
bank or other institution protected by federal deposit
insurance, and notify tenants of the location of their deposit,
as specified. Failure to notify a tenant within 20 days of
receiving his or her funds as to the location of the deposit
would create a rebuttable presumption that the landlord acted in
bad faith in an action against the landlord for improperly
withholding a deposit. This bill would also require landlords
to pay the accrued interest from security deposits to tenants at
the end of tenancy, as specified, based on the Federal Reserve
six-month certificate of deposit rate. Failure to pay that
interest would subject a landlord to actual damages plus the
amount of interest improperly withheld regardless of a
plaintiff's ability to show a landlord's bad faith. Where bad
faith is shown, an improper withholding of interest would
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entitle a plaintiff to actual damages plus twice the amount of
the interest improperly withheld.
This bill would not apply to any city, county, or city and
county that requires the payment to tenants of security deposit
interest.
BACKGROUND
California law regulates various aspects of the relationship
between residential landlords and tenants, including the
collection and return of the security deposit. Those deposits
cannot be greater than two months' rent for unfurnished
properties, or three months' rent for furnished residential
properties. Landlords are only allowed to claim amounts from
the security that are reasonably necessary for specified
purposes (such as repairing damages exclusive of ordinary wear
and tear), and must return any remaining portion of the deposit
within 21 days after the tenant has vacated the premises.
In 2002, the Legislature enacted AB 2330 (Midgen, Ch. 1061
Stats. 2002) which further protected tenant's rights by
requiring a landlord to notify the tenant in writing of the
tenant's option to request an initial inspection upon notice of
the termination of a lease and the tenant's right to be present
at the inspection. That bill also provided that a tenant must
have the opportunity to remedy identified deficiencies, as
specified, during the period following the initial inspection
until the end of the tenancy. That bill changed the amount of
statutory damages for bad faith violations from $600 to twice
the amount of the security.
Despite laws outlining how security deposits should be managed,
the Department of Consumer Affairs notes that "[t]he most common
disagreement between landlords and tenants is over the refund of
the tenant's security deposit after the tenant has moved out of
the rental unit." This bill would further clarify how landlords
must manage security deposits, and define what damages a tenant
plaintiff is entitled to in the event that a security deposit
has been improperly withheld. Additionally, this bill would
require that a tenant is paid interest on a security deposit at
the end of tenancy.
CHANGES TO EXISTING LAW
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Existing law generally regulates the landlord-tenant
relationship, including the return of any security deposit
provided by the tenant. (Civ. Code Sec. 1940 et seq.)
Existing law permits the landlord to only claim amounts from
that deposit which are reasonably necessary for specified
purposes. Those purposes include compensating for a tenant's
default in payment of rent, repair of damages to the premises
(exclusive of ordinary wear and tear), and cleaning the
premises, as specified. (Civ. Code Sec. 1950.5.)
Existing law provides that no later than 21 calendar days after
the tenant has vacated the premises, as specified, the landlord
shall furnish the tenant with a copy of an itemized statement
indicating the basis for, and the amount of, any security
received and the disposition of the security and shall return
any remaining portion of the security to the tenant. (Civ. Code
Sec. 1950.5.)
Existing law provides that the bad faith withholding of a
security deposit subjects the landlord to statutory damages of
up to twice the amount of the security deposit, in addition to
actual damages. In any action for recovery of the security, the
landlord has the burden of proof as to the reasonableness of the
amounts claimed. (Civ. Code Sec. 1950.5(l).)
This bill would mandate that a court award statutory damages of
not less than the amount of the security deposit which was
withheld, if a tenant shows that a landlord improperly withheld
all or a portion of a security deposit.
This bill would require landlords to deposit security deposits
in an account established and maintained solely for the purpose
of holding security deposits. The account must be at an
institution that is insured by the federal government.
This bill would require landlords to notify tenants, in writing,
of the name and address of the financial institution where the
account is established within 20 days of receiving a security
deposit. This bill would further provide that failure to
deposit security deposits in a federally insured account or
notify the tenants of the location of that account within 20
days creates a rebuttable presumption of bad faith.
This bill would require landlords to pay tenants interest on the
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security deposit at the termination of tenancy, in a payment
separate from the underlying security deposit. Interest would
be calculated based on the Federal Reserve six month certificate
of deposit rate of the preceding calendar year. This bill would
additionally require that a tenant receives his or her interest
payment:
at the time when the notice of initial inspection is required
to be provided to the tenant, as specified; or
when the itemized statement indicating the disposition of the
security deposit is due, whichever is earlier.
This bill would provide that if a tenant has not received a
security deposit interest payment within the timeframe specified
above, the tenant shall be entitled to statutory damages in the
amount of actual damages plus the amount of interest withheld.
This bill further provides that if bad faith withholding is
shown, the tenant is entitled to actual interest plus twice the
amount of the interest withheld.
This bill would require landlords to notify tenants of each
tenant's right to annually receive interest on his or her
security deposit. This bill would authorize notice to tenants in
the following methods:
posting a notice at a conspicuous location within the
residential premises;
providing written notice at the time of entering into a lease
or rental agreement; or
sending a written notice to the tenant by first class mail.
This bill would exempt cities and/or counties that require
interest payments to tenants based on their security deposits
from the provisions of this bill. This bill would additionally
make technical and clarifying changes.
COMMENT
1.Stated need for the bill
According to the author:
Security deposits continue to be perhaps the single most
recurring source of conflict between landlords and tenants.
Many tenants are simply resigned to getting little or nothing
back on their deposits, which are only supposed to be used for
damage to the unit, rent left owing, or cleaning to bring the
unit up to the level of cleanliness when the unit was rented.
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The law allows deduction only for "damage" beyond ordinary
wear and tear.
Another problem has been exacerbated by the foreclosure
crisis. Landlords are not required to hold deposits in any
particular form. Tenants are unable to recover deposits from
bankrupt landlords. As a corollary, even though the deposits
are the tenants' property, no interest is required to be paid.
It is conservatively estimated that landlords hold $5 billion
in tenant deposits statewide. The income from the deposits is
kept by the landlords.
2.Statutory damages incentivize timely return of security
deposits
Under existing law, if a landlord fails to return any portion of
a security deposit, a tenant may sue in small claims court to
recover any amount improperly withheld. Where it is shown that
all or part of the deposit was improperly withheld, the
defendant landlord must return that part of the deposit to the
tenant (the tenant's "actual damages"). If the tenant is able
to show that the landlord withheld the deposit in "bad faith,"
the court may award up to twice the amount of the entire
deposit. This bill would instead require statutory damages to be
awarded in an amount equal to the amount of the deposit which
was improperly withheld. Tenants who are able to show bad faith
would still be eligible for damages of up to twice the amount of
the security deposit.
The California Apartment Association, in opposition to this
bill, argues that "by requiring judges to award mandatory
penalties for any de minimis error, SB 603 would create a very
strong incentive for every tenant to sue property owners." The
author contends that this would instead "remove the incentive
for landlords to simply retain deposits - [because] the stakes
will automatically become higher."
Tenants who seek to recover security deposits may do so in small
claims court. Generally, filing fees are the responsibility of
plaintiffs. The fee in small claims court depends on the amount
of the claim, and typically ranges from 30 to 75 dollars.
Plaintiffs also carry the burden of proof, thus tenant
plaintiffs who are required to show bad faith must demonstrate
to the court that the defendant landlord intentionally acted in
a way that he or she knew was improper with regards to the
tenant's security deposit. "Bad faith" could be shown in a
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number of ways, including witness testimony, records that have
been tampered with, or fraudulent bookkeeping. In practice,
many plaintiffs may have a difficult time proving bad faith. The
author argues that this difficulty experienced by plaintiff
tenants creates an incentive for some landlords to routinely
withhold deposits. The author writes:
It is difficult for pro se tenants in small claims court to
establish bad faith. As the plaintiff, the tenant has the
burden of proof in showing the landlord acted in bad faith.
Because of this, many landlords routinely keep deposits or
make questionable deductions, calculating that the worst that
could happen is that a tenant will take the time and energy to
go to small claims court, and at that point, the landlord will
have to return the deposit, but nothing further as bad faith
cannot be shown, or, even if it is, the court declines to
impose the penalty.
Under the provisions of this bill, landlords would be subject to
damages equal to the amount of the security deposit which was
improperly withheld, plus actual damages. Arguably, those
penalties could promote more accurate bookkeeping, and
dis-incentivize bad faith retentions of security deposits.
Further, awarding tenants twice the amount improperly withheld
may, as a practical matter, allow tenants to challenge landlords
who have improperly withheld deposits because the filing fees
associated with small claims court would more likely be covered
by any damages awarded.
3.Requiring landlords to hold security deposits in a specific
federally insured account, and notify tenant of the account
location
This bill would require landlords to deposit security deposits
in a federally insured account established and maintained solely
for the purpose of holding security deposits. Landlords would be
permitted to aggregate multiple security deposits in one
account, yet would be prohibited from comingling their own
funds.
Existing law establishes that security deposits are not intended
to cover the general operating expenses of the landlord's
business, but to cover specified expenses related to the tenant
and the unit that tenant has rented. Accordingly, by requiring a
separate account for all security deposits and prohibiting a
landlord from comingling funds, this bill seeks ensure that
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deposits are available for tenants at the termination of a
tenancy.
This bill would also require landlords to notify tenants, in
writing, of the name and address of the financial institution
where the account is established within 20 days of receiving a
security deposit. Failure to comply with those provisions would
create a rebuttable presumption of bad faith against the
landlord.
The California Apartment Association (CAA), in opposition,
argues that this is an unreasonable penalty. CAA writes:
Under SB 603, a property owner who simply forgets or does not
know that they need to ? deposit the tenant's security deposit
in a federally insured financial institution, or does not
disclose to the tenant timely or correctly the location of the
deposit is considered to have done so in "bad faith." As a
result, he or she is in violation of the law and may be
subject to TWICE the amount of the security deposit, plus
actual damages.
These concerns are mitigated by provisions of this bill which
provide a number of reasonable methods by which a landlord could
communicate the location of the deposits. Further, this bill
seemingly only requires landlords to notify prospective tenants
within 20 days of the location of their deposit, which is easily
accomplished by including the information on the lease or rental
agreement. With regards to existing tenants, this bill would
permit a landlord to notify tenants who signed agreements prior
to the enactment of this bill by "posting a notice at a
conspicuous location within the residential premises," or
responding to an inquiry from a tenant within 20 days by
certified first class mail. In addition, a presumption of bad
faith will only apply if the court first finds that a security
deposit was improperly withheld. Thus, CAA's concern that a
landlord's innocent mistake may subject him or her to high
statutory damages is contingent on at least two independent
events occurring: (1) the landlord withholds a portion or all of
a tenants' security deposit and the tenant sues to recover the
deposit; and (2) a court finds that the tenant was entitled to a
greater amount of the security deposit than he or she received.
4.Interest on security deposits to be paid to tenant
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This bill would require a landlord to pay tenants interest on
their security deposit at the termination of the tenancy. The
interest would be calculated based on the average annual
interest rate for the last year published by the Federal Reserve
Board for a six-month certificate of deposit (CD). This interest
payment would be required to be paid separately from the
underlying payment of the security, deposit and landlords would
be prohibited from withholding an interest payment. This bill
would additionally entitle a tenant who has not received his or
her interest payment within the specified time limit, to
statutory damages in the amount of the interest withheld, plus
actual damages. Plaintiffs who show bad faith (see Comment 2)
would be entitled to twice the interest of the interest
withheld, plus actual damages.
Proponents of this bill assert that it is a matter of basic
fairness that tenants should receive interest payments when
their money is held as a deposit during the tenancy. Opponents
argue that the administrative time and expense needed to comply
with these provisions would be laborious and expensive
considering that the average security deposit is low, and many
tenants who receive interest payments fail to even cash the
check. Further, opponents contend that the Federal Reserve
six-month CD rate is not applicable to the interest acquired by
the accounts that deposits should be held in.
A number of California cities have ordinances which require
landlords to pay interest to tenants, and have designated
interest rates that are arguably comparable to that of the
Federal Reserve six-month CD rate. The City of Berkeley uses
the actual Federal Reserve CD rate (currently at .28 percent) to
calculate interest payments to tenants, but landlords are free
to use or invest the security deposits in any manner they
choose. Los Angeles authorizes landlords to choose between two
methods of calculating interest: a rate established by the Rent
Adjustment Commission, currently at .22 percent, or, the actual
amount earned on the security deposit. The County of Santa Cruz
requires interest on security deposits to be due at the
termination of a lease or rental agreement, or when the interest
on the security deposit meets a $50 threshold, whichever occurs
earlier, and adjusts its rate every year. Between 2003 and
2001, that rate has fluctuated between .06 and .58 percent.
This bill would exempt any city and/or county, including the
above cities, that requires the payment of interest on a
security, thus giving cities and counties the option of creating
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a payment structure and amount which work for local
constituents.
5.1099-INT
This bill would require landlords to issue payments to tenants
based on interest accrued by a security deposit. This
requirement has raised questions regarding taxes and the
responsibilities of landlords.
A 1099-INT is the form issued by all payers of interest income
to investors at year's end. Form 1099-INT breaks down all types
of interest income and related expenses. Payers must issue Form
1099-INTs for any party to whom they paid at least $10 of
interest during the year. CAA argues that this bill would
require landlords to issue 1099-INT forms to tenants each year
with their interest payment.
The sponsor, Tenants Together, disagrees with this contention,
and offers the following explanation.
Landlords must file a 1099-INT on an account accruing interest
of $10 or more. FIS Reg. Advisory Serv. Compl. Manl. 5.107.
This requirement has apparently led landlord advocacy groups
in California to incorrectly conclude that a 1099-INT must be
issued and filed with the IRS with respect to interest
payments to tenants.
In Private Letter Ruling 8820063, the IRS concluded that the
interest paid from the bank to the landlord is separate from
the payment from the landlord to the tenant. Priv. Ltr. Rul.
8820063, p. 2 (1988). While the bank's payment to the
landlord is subject to reporting, the payment from the
landlord to the tenant is not. Id. This is because landlords
are not financial institutions like banks, as described in
sections of the Treasury Regulation 1.6049-(5)(a)(2) or (3).
The ruling explained that a tenant's security is most similar
to the security deposit required by a utility company, which
is exempt from reporting requirements.
This ruling is summarized as follows in 69 Journal of Taxation
185 (1988):
Traditionally, of course, the landlord deposits the
security deposit with a bank or other financial
institution in order to generate interest income. When the
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interest is paid (or credited) by the financial
institution to the landlord, it is subject to the
information reporting requirements of Section 6049 (and
Ltr. Rul. 8820063 so holds).
What, however, is the landlord's obligation with respect
to interest generated on behalf of the tenant? The ruling
negates the landlord's reporting obligation on two
grounds. First, the landlord is not collecting the
interest from the financial institution on behalf of the
tenant (in a "middleman" type of situation). It is the
landlord's obligation to pay interest to the tenant. Thus,
there are two separate transfers of interest, i.e., from
the financial institution to the landlord and, in turn,
from the landlord to the tenant.
While the former is subject to the Section 6049 interest
reporting requirement, the latter is not. Since a tenant's
security deposit is similar to the security deposit
required by a utility company (exempt from the interest
reporting requirements pursuant to Reg.
1.6049-5(b)(1)(v)), no interest reporting requirement
exists unless the landlord is a bank or a financial
institution.
A 1990 Private Letter Ruling reached the same conclusion in
the context of a landlord in a state where the law required a
landlord to maintain tenants' security deposits in an
interest-bearing escrow account. Priv. Ltr. Rul. 9022054 at
2. "Because P is not a person described in section
1.6049-5(a)(2) or 1.6049-5(a)(3) of the regulations, the
interest on the security deposits is not interest for purposes
of section 6049(a) of the Code. Accordingly, it is held that
P is not required to report the payment of interest to tenants
on their security deposits." Id. at 2-3.
Support : Asian Law Caucus; Bet Tzedek Legal Services; California
Alliance for Retired Americans; California Reinvestment
Coalition; Causa Justa :: Just Cause; Coalition for Economic
Survival; Courage Campaign; Eviction Defense Collaborative;
Housing and Economic Rights Advocates; Housing Rights Committee
of San Francisco; Isla Vista Tenants Union; Law Foundation of
Silicon Valley; National Housing Law Project; Santa Barbara
Rental Housing Roundtable; Santa Monicans for Renters' Rights;
Tenderloin Housing Clinic; Unite Here; two individuals
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Opposition : Apartment Association, California Southern Cities;
Apartment Association Greater Los Angeles; Apartment Association
Orange County; California Apartment Association; California
Association of Realtors; East Bay Rental Housing Association;
Leading Age California; NorCal Rental Property Association;
Ramirez Residential Properties, LLC; San Diego County Apartment
Association; Santa Barbara Rental Property Association
HISTORY
Source : California Rural Legal Assistance; Tenants Together
Western Center on Law and Poverty
Related Pending Legislation : None known
Prior Legislation : AB 2330 (Migden, Chapter 1061, Statutes of
2002) among other provisions, redefined security, required
specified landlords to notify tenants of their option to request
an initial inspection and the tenant's right to be present at
the inspection. The bill changed the amount of statutory damages
for certain violations from $600 to twice the amount of the
security.
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