Question

I have three unrelated tenants in one of my rental homes, all having signed the lease when they moved in at the same time following a vacancy. One tenant has left and the other two remain. The tenant who left is seeking her security deposit back. Who is responsible for paying back the deposit; the landlord or the tenants who have remained behind?

Answer

The answer primarily depends on what it says in the lease agreement that the three co-tenants signed and perhaps secondarily how issues regarding these tenants have been handled in the past. I am not aware of any state having a specific law regarding the issue. Adding or subtracting co-tenants is not an unusual event, so a lease agreement should always contain adequately explicit information regarding the shared deposits and rent – specifically what happens in the beginning, when co-tenants are added or subtracted, and when all co-tenant depart at the same time.

Since I have no idea what’s in your lease agreement or what your policies have previously been regarding co-tenant issues, I’ll start with a short discussion of a number of issues regarding co-tenants.

All occupants of legal age should be required to sign the lease. Although many states make co-tenants jointly and severally liable by statute, the lease agreement should still contain such a clause because the tenants then cannot get away with claiming to be unaware of their liabilities.

Security deposits and rents should each always be considered a single total amount rather allocated among co-tenants. The landlord should only accept one full security deposit (in cash or bank check) and the FULL rent each month (by cash or bank check for the initial first month’s rent) from one person. The residents can fight it out among themselves for the “privilege,” but if anybody offers to pay their “his or her share” of the deposit or rent, the landlord should refuse to accept a partial rent amount, referring them to the lease agreement which should have so stated. Accepting multiple separate checks can result in additional problems if one or more, but not all, are returned as NSF. Furthermore, such acceptance may also indicate waiver of the “joint and several” words of the lease mentioned above.

Unless prohibited by law, the lease agreement should require written consent of the landlord to a tenant’s request to sublet or assign the rental unit or to replace one co-tenant with another without written consent of the landlord. New co-tenants should be qualified to the same standard as those being replaced were unless the landlord is changing qualifying requirements for business reasons – e.g., a slow rental market requires lowering standards.

The agreement should include clauses regarding the security deposit and rent payment issues discussed.

If a co-tenant leaves and the residents find a replacement resident who is accepted by the landlord, then the landlord can agree to the replacement subject to the applicant meeting the landlord’s qualifying criteria.

The proposed replacement or additional co-tenant should be required to submit a rental application, pay any usual application and screening fees, and consent to the landlord’s standard tenant screening process.

Upon acceptance of the new co-tenant by the landlord, a new lease agreement or an amendment to the existing agreement should be executed by all occupants of the rental unit. This is important in order to make it clear that all remaining co-tenants were willing to accept joint and several liability regarding the new co-tenant.

As a general rule the more individuals liable for the lease the better for the landlord. Accordingly, if a co-tenant departs during the term of a lease, there is seldom a reason why the landlord should release that person from responsibility during the remaining original lease term even when another person replaces him as co-tenant.

In the case where a departing occupant will not be replaced, landlords may also want to consider financially re-qualifying the remaining occupants regarding their joint ability to pay the rent. However, one must be careful to consider familial status issues under fair housing laws.

Allocation of security deposit shares among old, new, and remaining co-tenants should usually be left as a matter between those parties. Absent some lease clause stating otherwise, the landlord is not legally required to release any of the security deposit until all lease terms are met and all the tenants have vacated the rental property. A replacement co-tenant usually should not pay a security deposit to the landlord. The landlord should personally return the security deposit only to the last person on the rental agreement to leave the apartment.

For protection of new, departing, and remaining occupants, it is a good idea that a walk-through inspection be performed and a checklist be completed whenever any co-tenant is replaced. It is recommended that the landlord collect reimbursement for damages to that date so that the continuing occupants can properly settle up with the departing co-tenant and start out with a clean slate and minimize damage claims later, a benefit to all parties.

Since I don’t know how your lease agreement deals with the above mentioned issues or whether it deals with any of them, it is difficult to provide specific advice regarding your present dilemma. Assuming that the agreement is significantly deficient regarding the mentioned recommended clauses, I think that your best option is to act as if the agreement DOES adequately deal with the issues or that the issues are covered under statutes or case law.

In other words, you require that the remaining tenants provide the departing tenant with a refund, with you creating documentation that memorializes that fact – perhaps even a new lease agreement for the period remaining of the original term. The walk-through inspection mentioned above should be performed to determine damages that have occurred to date so that the remaining tenant can collect (or deduct from the departing tenant’s refund) the departing tenant’s share, with the remaining tenants becoming liable for all damages evident at the end of the remaining tenants’ occupancy. If the departure date of the departing tenant does not coincide with the date rent is next due or if there is past due rent, this must be dealt with in a similar way as the security deposit.

If and when a new co-tenant is found by the remaining tenant and is accepted by you, similar procedures must be followed.

Additional discussions regarding co-tenant issues are found in our “9 Roommate Issues” Mini Training Guide.

Question 1

The water heater in my rental property went out yesterday. How do we compensate the tenant until a plumber can replace it?

Answer 1

How you compensate the tenant depends entirely upon what the two of you can agree on. Factors that might be relevant to any compensation amount might be (1) the number of persons occupying the unit, (2) the ages of the occupants, or (3) whether any occupant is ill or disabled.

However, I will mention that failure to provide a tenant with hot water within a “reasonable” time after failure of the water heater could be a legal issue of habitability. If you can’t quickly come to an agreement with the tenant regarding compensation, you should consider getting a plumber on the problem ASAP, even if doing so is more costly than waiting until your usual maintenance vendor can get to it.

If the tenant decided to file a complaint with your local housing agency, “reasonable” would depend upon the agency’s definition of “reasonable.” The agency could consider that replacement within a few days is acceptable or the agency might consider your cost of the replacement irrelevant and that it should be replaced the day of failure even if the cost is double the usual. So, it’s best to either compensate the tenant for any delay or pay the extra cost of immediate replacement. You could find that the extra cost of emergency replacement service might be less than the tenant’s expectation of compensation.

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Question 2

I want to put my rental properties into an LLC. How do I do this?

Answer 2

Although I’ll briefly discuss the subject of your question here, I urge you to see my “Lesson 15 – Forming & Operating LLCs” in our eCourse titled “Buying and Selling Income Properties” for fairly detailed discussions concerning a variety of issues regarding LLCs. You may first want to see the preceding “Lesson 14 – Vesting” in the same eCourse, as Lesson 14 provides discussions regarding the variety of ways in which title to a property can be held, including some of the legal, tax, and management advantages and disadvantages of each.

As you are probably aware, an LLC is considered to be the best way to hold title to rental properties for most investors because of the legal protection, income tax ramifications, and the ease of formation and operation compared to other entity forms of vesting.

Laws, registration procedures, and costs vary among states, so you must become familiar with those of your state.

A LLC is legally formed by filing LLC Articles of Organization with the filing office of the state or states in which you intend to do business. The filing office in many states is that of the Secretary of State, but LLCs are covered under various other state offices in some states. Although most states have similar procedures and forms, one must be sure to follow the procedures and use the proper forms for each state. Fortunately, obtaining the relevant information and proper forms is easy these days since it’s available on each State’s Web site.

Before filing the Articles, one must choose a name that is not already used for a LLC in that state. All states provide a means of checking availability of a name either by phone or on its Web site. Most states provide for reserving an available name for a certain period of time upon payment of a nominal fee.

It is relatively simple to form an LLC. Although a registered LLC is not legally required to have written agreements and can operate on the basis of oral understandings, it would be a very big mistake to do so, particularly for a multi-member LLC but even for a single-member one. A LLC should always have a detailed written operating agreement that defines the rights and responsibilities of LLC members and managers. Many states provide a generic legally acceptable form for the Articles of Organization on the state Website, but it is not necessarily adequate for every situation.

One disadvantage to not having a written operating agreement is that your state’s LLC statute will control basic issues and this might not reflect what the members want. For example, by statute, profits would be allocated equally among the members rather than in the same percentages as capital contributions or according to some other way the members agreed was equitable.

If it is to be a multi-member LLC, the documents that define and control the group should be very carefully drawn up and include enough details to cover every possible issue. Always write the documents as if the group is going to break up sometime in the future. Better yet, although it may seem like a pessimistic approach, write the documents as if partners are going to become enemies in the future. Accordingly, a number of issues should be considered in the LLC documentation.

The agreement should cover all possible contingencies including the insolvency, bankruptcy, death, incapacity, serious illness, divorce, or resignation of any parties, sale of interests, and other events that might impact the operation and success of the venture. Each of the issues in the previous sentence can result in unimaginable problems for you and failure of the venture if not adequately covered by documentation. For example, members would usually want to require that a sale of a member’s interest be to another member, with value based on a formal appraisal, rather than allow sale to just anyone.

There are many books available that deal with the subjects of forming and operating LLCs in considerable detail and after reading my eCourse Lessons referenced above you might consider browsing some of those books in your local bookstores. However, if you are not adept at generating legal documentation I recommend that you use an attorney for help with the documentation, at least for your first LLC, as once you have a good set of documentation on your computer, it is easy to create sets for subsequently purchased rental properties – it is important to understand and remember that each separate rental property should be vested in a separate LLC.

The attorney should be one who is experienced in forming LLCs rather than just any general practice attorney. If possible, use an attorney who has experience with the specific type of project involved – e.g., rental property ownership vs. a coffee shop business. If not using an attorney to draft documents for you, you can consider at least having your documents reviewed by an attorney.

However, first become as knowledgeable as possible about LLCs. Your expertise is important for several reasons. First, the attorney will likely never understand your needs as well as you and your fellow members, if any. Second, the attorney’s bill should be significantly lower if he is used primarily to check the adequacy of what you have put together and add a little necessary legalese. Third, you’ll be involved with the LLC long after the attorney has spent his fee, so you want to be sure things are done right.

Some folks think that after they’ve vested their properties in LLCs they no longer need to worry about them. However, it is important that you don’t continue operating in the same way as when you were personally the titled owner. In spite of the low cost and simplicity of forming and operating your LLC can, you can’t ignore the fact that your LLC owns the property.

If there is a lawsuit related to a property owned by your LLC (legal protection being the main reason you formed it), you will almost certainly be personally named as a defendant in addition to the LLC. In the complaint, you may hear words such as “unity of interest” and “alter ego.” There are many issues that can reduce the protection potentially afforded by LLCs. If you didn’t properly form and operate your LLC, it might result in a judgment against you personally, just as if you’d never vested your property in the LLC. It is very important that one operate individual LLCs as separate independent entities, separate from one another and separate from the owner.

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Question 3

I am a landlord in the process of evicting tenants for non-payment of rent. When I rented the apt to them the tenants asked if they could pay the security deposit the following week after they moved in and I said yes, thinking they were honest. When I went to ask for the money after they were in, the male gentlemen said he didn’t have the money, that he wouldn’t be paying it, and that I couldn’t do anything about it because we didn’t have anything in writing. So, I gave them a 3-day notice to pay or quit. The unit is in Los Angeles and under rent control and they went to the housing department and said I was trying to raise their rent. I got a notice from housing that stated I needed to cancel the notice because ‘I didn’t have anything in writing about charging the deposit, so doing so would be considered a rent increase. I complied with housing and cancelled the notice. I waited for the beginning of this month when rent was due and went to ask for the rent. The female tenant said they were told by the housing department that they didn’t need to pay rent and if I evicted them they could live rent free during the process. The following day I served them with 3-day notice to pay or quit. When they didn’t answer I filed an unlawful detainer. I had someone serve them the summons and complaint and they answered they had even hired a lawyer. In that answer they are claiming false allegations about me retaliating because they went to housing and that I tried verbally increasing their rent which is not the case. I also called housing and was advised that I could remove the stove and refrigerator since I was the legal owner of the property. They then went to housing again and put a complaint against me. Housing called me and said I needed to either return the items or decrease their rent. I’m very confused with this renting system because it seems like tenants have all the rights and they can get away with not paying rent and having all the comforts as someone decent paying their rent. Is there anything you can suggest I can do?

Answer 3

You have broken a number of basic rules related to managing rental property.

First, never assume an applicant is “good people.” Adequate screening and proper selection are essential for minimizing problems with new tenants. Selection must be based on credit reports, eviction reports, criminal history checks, prior landlord checks, and verifiable income. Furthermore, to avoid claims of discrimination, all applicants must satisfy the same qualifying criteria.

Second, every material issue related to a rental should be in writing and written with sufficient detail to eliminate ambiguity. Any change to the original written lease agreement and/or to normal custom, such as not collecting both the deposit and first month’s rent prior to giving possession should always be in writing. Furthermore, all occupants who signed the original lease agreement should sign any amendment thereto. In your case, the lease or an amendment thereto should have clearly defined the agreement regarding payment of the funds.

Furthermore, when not requiring payment of all deposits and fees and the first month’s rent prior to giving possession, it is almost always best to apply the amount received first against the security deposit, with any surplus applied next to any other deposits and fees allowed by law, with any surplus applied next against the rent. This is because failure to pay rent is usually the easiest eviction to obtain, whereas, obtaining the unpaid security deposit may require a separate lawsuit and a judge may not grant eviction for an unpaid deposit, almost certainly when not adequately written into the lease agreement. It is important that all initial funds required for possession be in cash, money order, or bank check. Remember that once the tenant has possession, a bad personal check will require an eviction to remove the tenants, something that can take at least weeks, even a couple of months if the tenants or their attorney know how to play the system.

Third, whether under rent control or not, a landlord should never remove anything from a rental unit without permission of the tenant. The owner of a rental unit has absolutely no right to remove anything from the premises or reduce any services related to the unit without agreement by the tenants. While the landlord usually has a fee simple interest in the property, the tenant has a leasehold interest which gives the tenant a number of rights. When there is any chance of disagreement regarding what is being removed, as was your case since you were already having a problem collecting the deposit, such removal should have advance written agreement. Contrary to what you understood when you called “housing” you should not have entered the premises (except in case of emergency – e.g., fire or flood) without proper advance notice required by the state of CA or any greater period required by the rent control ordinance. Doing so puts you at risk for (1) violation of the specific law related to entry, (2) violation of the lease agreement, as the unit was rented to include the items you removed, (3) claims related to invasion of privacy and peaceful enjoyment, and (4) charges of theft of whatever personal property the tenants wish to claim is missing.

Fourth, one should not manage rental property without adequate knowledge of all laws including (1) state landlord-tenant law, (2) federal and state fair housing laws, (3) federal and state environmental laws (e.g., lead paint laws), (4) county or municipal ordinances related to the aforementioned issues, and (5) for those few jurisdictions under some type of rent control, a full understanding of the rent control ordinance.

Tenants do have a number of rights. However, so do landlords, but it is extremely important that landlords fully understand the rights of both parties and that they do all things in accordance with the laws and utilize good procedures in management of their rental properties.

With the number of potential dangerous issues involved, you are strongly advised to consult a competent landlord-tenant law attorney as soon as possible, preferably one with significant experience in the particular court of jurisdiction for your property. Whenever a tenant is being represented by an attorney, it is usually particularly important that the landlord also be represented by an attorney. If you do not know how to find such an attorney, I suggest you contact a local landlord association to see if they can recommend one.