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What Happens to a (Refundable) Security Deposit in Bankruptcy?

In New York it’s common practice for people leasing property to require lessees to pay them security deposits before allowing them access to the property. Most commonly this occurs with rental apartments, but sometimes it can happen with storage space, rented vehicles, etc. For rented properties that the tenant-debtor has little intention of turning over or vacating any time soon, the question arises as to what happens to the security deposit in New York bankruptcy. It’s important because deposits can be worth quite a bit of money to the trustee; for instance, many apartments in New York City require tenants to put down a security deposit equal to one month’s rent just to move in.

Before answering the question, there are a few points to clarify. One, assuming the deposit is refundable, it does belong to the debtor and is therefore an asset the trustee can take. Essentially, so long as the security deposit existed at the time of the bankruptcy filing, it’s an asset to the debtor. Two, even so, the deposit is conditioned on the debtor’s care of the property. Consequently, if the lease between the tenant-debtor and the lessor ends, and the lessor refunds the security deposit, then the trustee can have it.

Problem number one for the trustee, though, is that the tenant-debtor might be able to shield the security deposit from the trustee via an exemption, especially if the tenant-debtor isn’t claiming a homestead exemption, which is almost certain for people renting apartments. As a cash sum, the debtor would have fairly substantial options for protecting it under either the federal or New York State exemptions. You can read about those options here.

In practice, the trustee is at a disadvantage for two reasons suggested above. For one, the security deposit is contingent on the lessor’s decision to fully refund the tenant when he or she vacates the premises. In many cases, tenants aren’t interested in leaving their homes during a bankruptcy. In order to obtain the security deposit, it’s possible that the trustee would need to wait for years to collect it once the debtor moves out. (And if the security deposit is for a rent-stabilized apartment in New York City, the trustee has little hope of obtaining it.) That would require keeping the bankruptcy case open for a prolonged period, which won’t interest most trustees.

Security deposits aren’t much money in bankruptcy terms, but for tenants they can be quite valuable. If you are a tenant facing financial difficulties, then you should talk to an experienced New York bankruptcy lawyer.

For answers to more questions about cash assets in bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced  bankruptcy lawyer Brooklyn NY Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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