Landlord Advocates: As a consequence of the bankruptcy laws, one can make an argument that all landlords should require their tenants to have their security deposits in the form of a LOC over cash. Generally stated, if you have a cash security deposit and the tenant files for bankruptcy, the landlords have to take that cash security deposit, deposit it into bankruptcy court, and they will stand side by side with the other creditors of the tenant as it relates to that tenant’s funds. Conversely, if you have a LOC, because the LOC is a contract between the bank and the landlord as to the funds that have been segregated of the tenant, if the tenant files for bankruptcy, simply put, the landlord does not lose the right to the security deposit.
Tenant Advocates: From the tenant’s perspective, when it comes to a cash security deposit, if you lock up a large amount of cash, you’re potentially restricting yourself by not having that cash at your disposal, and you’re receiving a de minimis rate of return on it. As a result, all tenants should explore the annual administrative cost that a bank will charge you for having a LOC.
Subleases: As it relates to subleases, as a subtenant, you are not in privity with the landlord (i.e., you have no contractual relationship with the landlord). In the event that your master lease gets terminated because the sublandlord is in default, your subtenancy is at risk and the landlord, in general terms, can cancel your sublease. The acid on the wound would be, if that situation arises, that your cash security deposit given to the sublandlord is at risk and very well might be lost. To prevent against this, you can either: (1) have the sublandlord’s attorney hold your security deposit in escrow, or (2) put up the security deposit in the form of a LOC.