BILL NUMBER:S7965

TITLE OF BILL:
An act
to amend the general obligations law, in relation to tenant security
deposit accounts

PURPOSE OF BILL:
This bill ensures that tenants receive a fair share
of the interest earned by their security deposits.

SUMMARY OF PROVISIONS:
This bill amends General Obligations Law § 7-103(2)
to provide that the fee retained by landlords for their
expenses in administering tenant security deposit accounts shall be
twenty percent of the interest earned on such accounts, up to a
maximum of one percent of the amount on deposit.

EXISTING LAW:
General Obligations Law § 7-103 currently authorizes
landlords to retain the first 1% of any interest earned on a tenant's
security deposit.

JUSTIFICATION:
Prior to 1970, there was no requirement that tenants be
paid interest on the money held by landlords as security deposits for
              

their apartments. Instead, landlords were free to place those funds
in non-interest bearing accounts, and to simply return the security
deposit to the tenant at the end of the term of the lease.

The Legislature sought to cure this inequity through the passage of
Chapter 1009 of the Laws of 1970, which amended General Obligations
Law § 7-103 in two ways. First, the law provided that landlords in
buildings with six or more dwelling units must place security
deposits in accounts earning the prevailing rate of interest for
similar accounts in the area. Second, the law authorized the
landlords to retain a fee of 1% of the amount deposited to cover any
expenses that the landlord incurred in administering the accounts.
Thus, for the first time tenants were assured that they would receive
interest payments on the security deposits that they provided 16
their landlords, and the law also sought to compensate landlords for
the administrative costs that they were expected to incur,

Unfortunately, the effectiveness of this law has been greatly
diminished by the manner in which Chapter 1009 was drafted and has
been implemented, together with other events that have occurred
during the past 30 years.

First, when the amendments to General Obligations Law § 7-103 were
enacted in 1970, interest rates on basic savings accounts were
about 6%.

As a result, at the time it appeared reasonable to permit landlords to
retain a 1% administrative fee, because the tenant would still
receive most of the interest earned. For example, a $1000 security
deposit would earn $60 per year, with $50 (83% of the total interest)


being paid to the tenant and $10 (17% of the total interest) being
paid to the landlord.

Over the years, however, there has been a significant drop in interest
rates on savings accounts, and under the current statutory scheme
tenants have borne all the financial consequences of that decrease.
Indeed, some banks are now paying only 1.1% interest on tenant
security deposits, but the landlord is still getting a full 1% fee,
and the tenant is left with only one-tenth of 1%. For example, the
same $1000 security deposit that earned $60 per year in 1970 would
earn only $11 per year now, with the landlord still getting $10, and
the tenant only $1. Thus, now the landlord is receiving 91% of the
security deposit interest, and the tenant is receiving only 9%.
General Obligations Law §7-103 specifically provides that rental
security deposits "continue to be the money of the tenant.... and
shall be held in trust by the landlord" for the tenant, and thus it
is particularly unfair that the landlord should receive most of the
interest on such deposits.

A second significant flaw in General Obligations Law § 7-103 is that
it provides an administrative fee to landlords, even if no
administrative expenses are incurred, When Section 7-103 was amended
in 1970, it was anticipated that landlords could be faced with
significant costs in administering the accounts, and the Legislature
therefore granted landlords a 1% fee to cover those expected costs.
After that amendment was passed, however, banking institutions
developed special "tenant security deposit accounts" through which
the bank handles virtually all of the administrative functions for
the landlords. Banks provide these services as an inducement to
landlords, because tenant security deposits from the hundreds of
thousands of tenants in New York State provide tens of millions of
dollars in deposits to the banks. Section 7-103 continues to
authorize the payment of a 1% administrative fee to landlords,
however even though they perform no administrative duties.

Granting landlords a flat fee eliminates any financial incentive for
landlords to place tenant security deposits in higher-earning accounts.
For example, while some banks are paying only 1.1% on tenant security
deposit accounts, other banks pay up to 2.5% on the same types of
accounts. Section 7-103 specifically provides that the landlords hold
the security deposits "in trust" for the tenants, and as trustees
they are obligated to seek the highest interest rate available for
their tenants. Most landlords fail to do so, thereby subjecting
themselves to lawsuits for a breach of their fiduciary duties, but
the cost of litigation prevents tenants from asserting their rights.

The losses to tenants are significant. As noted above, a $1000
security deposit in an account earning 1.1% will result in the
landlord receiving $10 per year and the tenant receiving only $1 per
year. If the landlord placed the funds in an account earning 2.5%,
the landlord would still receive $10, but the tenant would receive
$15, which is 1500% more than the tenant would receive with the 1.1%
account. Although an increase of $14 per tenant per year may not
appear significant, and certainly does not provide a sufficient
incentive for a tenant to commence litigation, the cumulative loss to
all tenants in the State is in the millions of dollars per year.


The adverse impact on tenants is further exacerbated by the manner in
which security deposit earnings are calculated for tax purposes.
specifically, even though Section 7-103 provides that the
administrative fee is paid directly to the landlord, and only the
interest actually paid to the tenant "shall be the money of the
person making the deposit", most banks calculate the full interest
earned as income of the tenant. As a result, all of the interest is
reported to the Internal Revenue Service and set forth on the
tenant's Form 1099 each year, and the tenant must pay income taxes on
that full amount.

This results in a gross inequity for the tenant. Using the same
example once again, a $1000 security deposit earning 1.1% will pay
$11 in interest each year, with $10 being paid to the landlord and $1
being paid to the tenant. However, the bank reports the full $11 as
income of the tenant. If the tenant is in a 20% tax bracket and does
not itemize deductions, the tenant will have to pay $2.20 in income
tax. In other words, the tenant who has $1000 being held in trust in
a security deposit account will end up with a $1.20 loss per year ($1
in interest minus $2.20 in taxes), while the landlord will receive a
$10 gain per year from the "administrative fee", even though the bank
is performing all of the administrative duties. Ironically, the
tenant would be better off if the money were placed in an account
that earned no interest at all.

This bill addresses the inequities in the current law. specifically,
the bill amends General Obligations Law § 7-103(2) to provide that
landlords shall receive an administrative fee equal to 20% of the
interest earned on the tenant security accounts, up to a maximum of
1% of the amount on deposit. This conforms the law to the initial
intent of the Legislature in 1970, when at least 80% of the interest
earned on these accounts would have been paid to the landlords based
upon the interest rates prevailing at the time.

In addition, by switching from a flat fee to a percentage fee, this
bill will give landlords an incentive to seek out the
highest-interest accounts available. For example, a landlord holding
$750,000 in tenant security deposits will receive a fee of $1,650 per
year if the funds are placed in a tenant security deposit account
earning 1.1%, but the fee will increase to $3,750 per year if the
funds are placed in an account earning 2.5% per year. Encouraging the
use of accounts earning higher interest rates will provide benefits
to both the landlord and the tenant, with landlords earning higher
fees and tenants receiving larger interest payments.

Chapter 1009 of the Laws of 1970 was truly landmark legislation,
ensuring for the first time that the tens of millions of dollars in
security deposits paid by tenants would be placed in interest-bearing
accounts to benefit tenants. unfortunately, a combination of several
factors - the manner in which the legislation was drafted, the
transfer of administrative duties from landlords to banks, the
absence of financial incentives for landlords to seek higher-earning
accounts, and the subsequent, significant drop in interest rates- --
has resulted in some tenants experiencing financial losses under the
current statutory mechanism for allocating interest on tenant
security deposit accounts. This legislation addresses this problem
and ensures that tenants will once again be paid an appropriate


percentage of the interest earned by their security
deposits held by landlords.

FISCAL IMPLICATIONS FOR STATE AND LOCAL GOVERNMENTS:
None.

EFFECTIVE DATE:
The bill takes effect on the first of January following enactment.