No on Security Deposit Interest Bill

No on security-deposit interest bill; for landlords and tenants alike: Not worth the pain for pocket change The California Apartment Association is opposing legislation that would require property owners to pay interest on tenants' security deposits. Senate Bill 603 by Sen. Mark Leno also significantly changes the penalties under current security deposit law. "SB 603 has numerous problems," CAA says in a letter to Leno. "Ultimately, the potential costs far exceed any benefit for tenants and property owners." SB 603 would require owners to pay tenants interest on security deposits at the Federal Reserve Discount rate, now set at 0.75 percent. Most banks, such as Chase or Bank of America, now offer rates for savings accounts between 0.01 and 0.05 percent.  For a $1,000 security deposit, SB 603 would require the owner to pay the tenant $7.50 in interest, even though the account may only earn 10 cents of interest per year. "Tenants in California would get better interest rates under this legislation than almost any other Californian who invests their money in a financial institution," the letter says. Moreover, the costs that owners would incur administering payments would dwarf any interest earned. On average, a $1,000 security deposit would earn 10 cents per year. But once costs including postage, paper, envelopes, forms, checks, employee time and bank fees are factored in, the property owner's cost per tenant would range from $10 to $15. In many parts of the state, though, security deposits are as low as $250-$500. As such, the potential interest earned would be almost nothing. The bill also neglects to take into consideration that many tenancies are formed between April and September, especially in college communities. As a result, rental property owners would have to "pro-rate" the calculation for the first year in February, since the tenants will not yet have a full year's interest earned. Owners could be issuing checks for 5 cents or less. With most tenancies lasting about 12 to 24 months, rental property owners would have to repeat the calculation when the resident moves out. The city of Santa Cruz offers a strong example of why SB 603 doesn't make sense. In this city, landlords are required to pay interest on security deposits to tenants, yet a recent survey of rental property owners there revealed that tenants rarely cash their checks. Perhaps it wasn't worth their trouble. With the average deposits in Santa Cruz between $500 and $750, the interest yielded for tenants only reached about 30 cents for a full year. In one case, a property manager spent $500 in processing costs to issue a total of less than $30 in security deposit interest earnings to several hundred residents. Many of these checks were uncashed, creating additional issues for the landlord in tracking checks and balancing the records. If owners and management companies follow general accounting principles, they will file IRS forms, creating a paper trail for any later audits. A bank issues a Form 1099-INT to account holders each year when interest is earned. An owner who then redistributes that interest would provide a 1099-INT to the tenant, removing the portion of interest income from the owner's books and income tax return. Otherwise, the owner would be liable to pay the tax on the interest income. For example, if an owner has six occupied units and earns 8 cents in interest from the bank for the six tenants' security deposits held, the owner would have to mail out six Form 1099-INTs, showing that $45 was paid from the landlord's own pocket to cover the higher rate required by SB 603. SB 603 also creates the potential for a negative tax consequence for tenants. Under IRS regulations, tenants must report any interest earned on their tax returns, whether they are issued an IRS Form 1099-INT or not. Given that the amount of interest is so low, it is likely that tenants will simply forget to report the income and subject themselves to IRS audits and penalties. Under SB 603, a property owner who simply forgets or does not know that he or she needs  to provide 10 cents in interest to a tenant would be considered to have done so in "bad faith," resulting in violation of the law and possibly subjecting the owner to paying twice the amount of the security deposit, plus actual damages. In addition to requiring interest payments, SB 603 removes the bad-faith requirement for penalties on the security deposit law. SB 603 would entitle every tenant whose landlord makes a mistake -- even in good faith -- to return of any portion of the deposit wrongfully withheld and a mandatory penalty that is at least the amount of the entire deposit. There is no cap on the penalty amount other than the $10,000 small claims limit. By requiring judges to award mandatory minimum penalties for a minor error, SB 603 creates a very strong incentive for every tenant to sue property owners.Any degree of victory would mean the tenant gets at least the entire deposit back, plus actual damages. Instead of increasing penalties, California landlords and tenants would be best served with legislation that clarifies Civil Code Section 1950.5. "While the author implies that landlords keep tenant's security deposits as a money-making venture, the fact is this is just not true, CAA's letter says. "The subjective nature of Civil Code 1950.5 creates unrealistic expectations on the part of tenants and continual disputes between the parties. "By now adding penalties that could be as high as $10,000 in small claims court, with absolutely no focus or acknowledgement of the problems associated with the current statute, SB 603 is unrealistic and unfair."

WHEN TO CALL A LAWYER

WHEN TO CALL A LAWYER

QUESTION: The board is wasting our money calling a lawyer for anything and everything. Our dues are already too high--does a lawyer have to be called every time someone sneezes??

ANSWER: It depends on whether its an allergy or a cold. Knowing when to call legal counsel is no easy matter for boards. There is no need to call anattorney for routine decisions. However, eliminating legal counsel altogether can backfire and subject directors to potential liability.

Personal Liability. As volunteers, directors are protected against personal liability by the Business Judgment Rule, i.e., when they perform their duties (i) in good faith, (ii) in a manner the director believes to be in the best interests of the association, and (iii) with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.
Breach of Duties. As part of their reasonable inquiry or "due diligence," boards can seek the advice of legal counsel. (Corp. Code §7231(b).) Failure to seek advice on an important legal issue that results in damage to the association could serve as the basis for an action against the board for breach of their fiduciary duties.

Following are categories of matters and events where boards should seek legal advice:

1. Amending Documents. Whenever CC&Rs and bylaws are amended or restated, legal counsel legal should be involved in drafting and recording the changes.

2. Architectural. Failure to enforce as well as arbitrary and capricious enforcement can lead to costly litigation. Whenever an architectural dispute arises, legal counsel should be called to discuss how to achieve proper resolution or to position the association for litigation.

3. Assessment Collection. Setting up proper collection policies and consistently following those policies is important to maintaining the association's finances and minimizing legal challenges.

4. Contracts. Agreements not reviewed by an attorney can have significant hidden liabilities.

5. Ethics. Whenever a director or committee member has a conflict of interest and refuses to recuse themselves, it is time to call legal counsel.

6. Injuries. Whether it be slips and falls or other types of injuries in the common areas involving residents, guests, employees, vendors or otherwise, injuries should immediately be reported to insurance and to the association's attorney so conditions can be documented and steps taken to protect against further injury.

7. Lawsuit Threatened. In addition to putting the association's insurance carrier on notice of a potential claim, boards should talk to counsel about how best to respond to the threat so as to (i) reduce the risk that a claim is actually filed, (ii) better position the association to defend itself in the event one is filed, and (iii) take the matter into ADR if appropriate.

8. Lawsuit Served. Tendering a claim to the association's insurance carrier is the first order of business. Sending a copy of the complaint to the association's attorney is the second. General counsel needs to know of the litigation so he/she can protect the association's interest in the event insurance is slow to respond or declines coverage. In addition, the board may need guidance on how to respond to the plaintiff on issues outside of the litigated matter.

9. Personnel. The most common high-risk areas are when an employee is hired, disciplined or fired. Employment litigation tends to be expensive so it is best to avoid it.

10. Recall Petition. Emotions run high in recall elections and issues of defamation often arise. Failure to properly handle a recall can lead to significant problems.

11. Request for Reasonable Accommodation. Failure to properly evaluate and respond to a request for disability accommodation can result in costly litigation.

12. Rules & Regulations. At least once, the association's rules and regulations rules should be reviewed to make sure proper fine and hearing procedures have been established and to ensure they are enforceable (and not discriminatory, such as rules against children or restrictions on who may use pools, etc.). If enforcement issues are more than routine because of the particular individuals involved or because the issues may be more complex than normal such as with architectural issues, then legal counsel should be consulted before matters deteriorate into litigation.

13. Vendor Disputes. Disputes between the association and its vendors can erupt into litigation. Legal counsel needs to analyze appropriate contract provisions, evaluate the alleged breach, and advise the board on how best to resolve the dispute.