BILL NUMBER:S3183

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 depos-
its  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 imple-
mented, 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  land-
lord.

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 axe 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 land-
lord" for the tenant, and thus it is particularly unfair that the  land-
lord 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 land-
lords 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  liti-
gation 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 depos-
it", 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 inter-
est 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 depos-
it 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 $1,550 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,  ensur-
ing  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 administra-
tive 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  legis-
lation  addresses  this problem and ensures that tenants will once again
be paid an appropriate percentage of the interest earned by their  secu-
rity deposits held by landlords.

FISCAL IMPLICATIONS FOR STATE AND LOCAL GOVERNMENTS:  None.

LEGISLATIVE HISTORY:  2010: S.7965/A.6824-A 2012: S.387/A.635

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