Security Deposits in Texas Residential Leases

Topics Covered

Part One: Law Applicable to Security Deposits
Part Two: Reasonableness and Bad Faith in Accounting
Part Three: Sale of Leased Property to Another Investor

Residential Security Deposits

Investors who are new to the business of being residential landlords are best advised to acquaint themselves with the rules concerning security deposits, particularly since the Property Code declares that a landlord is presumed to be acting in bad faith if an accounting is not timely and properly given for these funds.

Bad faith in this context triggers a $100 statutory penalty and the recovery by the tenant of treble damages plus attorney’s fees—and, of course, whenever a law provides for the award of attorney’s fees, the door is opened to contingent-fee arrangements. This means that the usual cost-benefit analysis which potential plaintiffs must perform (Is this litigation going to be worth the expense?) does not apply. An aggrieved tenant may pursue an investor at no cost to himself. He is even granted the equivalent of preferred creditor status: “The tenant’s claim to the security deposit takes priority over the claim of any creditor of the landlord, including a trustee in bankruptcy.” Prop. Code Sec. 92.103(c).

PART ONE:
LAW APPLICABLE TO SECURITY DEPOSITS

Refunding the Security Deposit

“The landlord shall keep accurate records of all security deposits.” Prop. Code Sec. 92.106. “Except as provided by Section 92.107 [failure by tenant to give a written statement of forwarding address], the landlord shall refund a security deposit to the tenant on or before the 30th day after the date the tenant surrenders the premises.”Prop. Code Sec. 92.103(a).

“Before returning a security deposit, the landlord may deduct from the deposit damages and charges for which tenant is legally liable under the lease or as a result of breaching the lease . . . . The landlord may not retain any portion of a security deposit to cover normal wear and tear.”Prop. Code Sec. 92.104(a) and (b).

“If the landlord retains all or part of a security deposit under this section, the landlord shall give to the tenant the balance of the security deposit, if any, together with a written description and itemized list of all deductions. The landlord is not required to give the tenant a description and itemized list of deductions if: (1) the tenant owes rent when he surrenders possession of the premises; and (2) there is no controversy concerning the amount of rent owed.” Prop. Code Sec. 92.104(c).

Accounting for Security Deposits

The statutory requirement (Prop. Code Sec. 92.106) is that the landlord must keep an accurate record when it comes to security deposits. Does this require the ability to produce an Excel spreadsheet? Is a segregated bank account required? The answer is no to both questions, at least as to legally-required minimums, but both ideas are nonetheless good ones and are recommended for the professional investor.

Mailbox Rule for Notices

Although the usual mailbox rule applies (the letter is considered sent when deposited in the U.S. mail per Section 92.1041) it is imprudent for a landlord to wait until the last minute to send a security deposit accounting and risk being (even arguably) late and in presumptive bad faith. In most cases, unless there are extensive repairs to be made, there is no good reason for a competent landlord to delay sending out an accounting past ten days or so after surrender of the premises.

Email notices are permitted if the lease so states or “if the tenant and the landlord or landlord’s agent have previously communicated by email.” Prop. Code Sec. 92.113.

Requirement of a Tenant Forwarding Address

The tenant is obligated to provide a forwarding address in writing. Prop. Code Sec. 92.107(a). Note that even if the tenant fails to provide such an address, the right to an accounting and refund is not forfeited; it is merely delayed. This same section makes it clear that the landlord’s obligation to supply a written description of damages does not arise until a forwarding address is provided.

So should the landlord passively wait until a departed tenant gets in touch? We suggest not. Our recommendation to a landlord who has no forwarding address is to timely send the accounting (together with any refund check) to the tenant at the address of the rental property by certified mail with return receipt requested. The letter will come back if the tenant has left. An investor should always be prepared to demonstrate good-faith compliance with a statute even if that occasionally means walking the extra mile.

Tenant’s Notice of Surrender

Can a lease provide that a tenant must give advance notice of surrender as a condition for refunding the security deposit? Yes, so long as the lease provision is underlined or is printed in conspicuous bold print. Prop. Code Sec. 92.103(b). If utilizing such a clause, we recommend that it be both underlined and set in bold, 14-point type.

Substitution of Security Deposit for Final Month’s Rent

This is expressly prohibited by Property Code Section 92.108(a): “The tenant may not withhold payment of any portion of the last month’s rent on grounds that the security deposit is security for unpaid rent.” Doing so makes the tenant vulnerable to a finding of bad faith—and yes, that means treble damages plus attorney’s fees for the landlord. The reality, however, is that this is seldom granted. The vast majority of residential tenants are judgment-proof, and it is usually a waste of time and money to pursue them—which does not mean that the investor should not look at each circumstance, case by case, before writing it off.

Fee in Lieu of Security Deposit

A landlord may elect to charge a fee instead of a traditional security deposit. If the landlord and tenant agree to the fee then the agreement to collect the fee must be in writing and signed by the tenant and the landlord or the landlord’s representative. Prop. Code Sec. 92.111.

PART TWO:
BAD FAITH AND REASONABLENESS

Presumption of Bad Faith

Bad faith on the part of the landlord is presumed according to Section 92.109(d) if the required accounting is not sent within 30 days. “A landlord shall have 30 days from the tenant’s furnishing of a forwarding address to refund the deposit or provide an itemization of damages before the presumption of bad faith will arise.” Ackerman v. Little, 679 S.W.2d 799, 75 (Tex.App.—Dallas 1984, no writ).Property Code Sec. 92.109 addresses this topic:

Prop. Code Sec. 92.109. Liability of Landlord

(a) A landlord who in bad faith retains a security deposit in violation of this subchapter is liable for an amount equal to the sum of $100, three times the portion of the deposit wrongfully withheld, and the tenant’s reasonable attorney’s fees in a suit to recover the deposit.

(b) A landlord who in bad faith does not provide a written description and itemized list of damages and charges in violation of this subchapter: (1) forfeits the right to withhold any portion of the security deposit or to bring suit against the tenant for damages to the premises; and (2) is liable for the tenant’s reasonable attorney’s fees in a suit to recover the deposit.

(c) In an action brought by a tenant under this subchapter, the landlord has the burden of proving that the retention of any portion of the security deposit was reasonable.

(d) A landlord who fails either to return a security deposit or to provide a written description and itemization of deductions on or before the 30th day after the date the tenant surrenders possession is presumed to have acted in bad faith.

Rebutting the Presumption of Bad Faith

The burden is on the landlord to the establish reasonableness and necessity of any deductions. Unreasonable deductions or withholding return of the security deposit entirely raise the prospect of a finding of bad faith. “Absent rebutting evidence, the presumption that the landlord acted in bad faith compels a finding of bad faith.” Pulley v. Milberger, 198 A.Q.3d 418, 428-29 (Tex.App.—Dallas 2006, pet. denied).

“A landlord acts in bad faith if the landlord acts in dishonest disregard of the tenant’s rights or intends to deprive the tenant of a lawfully due refund. Good faith is established by showing honesty in fact in the conduct or transaction concerned. . . .Evidence that a landlord had reason to believe he was entitled to retain a security deposit to recover reasonable damages is sufficient to rebut the presumption of bad faith . . . . If the landlord is able to defeat the presumption of bad faith with regard to the retention of a security deposit, the landlord also is required to prove that his retention of any portion of the security deposit was reasonable.” Johnson v. Waters at Elm Creek L.L.C. 416 S.W.3d 42, 47-48 (Tex.App.—San Antonio 2013, pet. denied).

Rebutting evidence may thus include the fact that the landlord reasonably believed he had the right to retain a security deposit or that the landlord was inexperienced and not fully informed on the law. In this circumstance, it would appear that ignorance of the law can indeed be a defense.

PART THREE:
SALE OF LEASED PROPERTY TO
ANOTHER INVESTOR

Who is liable for the security deposit?

What if the investor sells the property to another investor? Who is liable for a deposit under the Property Code? Unless proper notice is given to the tenant, both seller and buyer may be liable. Section 92.105(a) states flatly that “the new owner is liable for the return of security deposits . . . from the date title to the premises is acquired. . . .”

Property Code Section 92.105(b) provides that the seller “remains liable for a security deposit received while the person was the owner until the new owner delivers to the tenant a signed statement acknowledging that the new owner has received and is responsible for the tenant’s security deposit and specifying the exact dollar amount of the deposit.”

Such a signed statement—with language precisely tracking the statute—should therefore be prepared along with the warranty deed and any other transfer paperwork, and the seller should ensure that it is delivered to the tenant. Otherwise, the seller may remain liable for both the accounting for and return of the security deposit, with all the attendant risks of a potential finding of bad faith.

Conclusion

Although Texas is a business-friendly state, parts of the Property Code are stacked against the real estate investor (the section on executory contracts comes to mind) and this includes provisions relating to security deposits. If an argument over a deposit can be settled reasonably by a landlord, it should be, and quickly. Write off the loss and live to fight another day. And, as in any situation where a monetary dispute is resolved, the landlord should get a release in exchange for the settlement check.