The Playbook / Clause 15
Security Deposits & Letters of Credit
Cash Deposit; Letter of Credit; Application; Replenishment; Return
A Security Deposit is the tenant’s own collateral (cash, a letter of credit, or another substitute) held by the landlord as security for performance, giving the landlord immediate access to funds on a default. The size, the form, and the mechanics of application, replenishment, and return are all negotiable, and the letter-of-credit alternative carries a layer of drafting decisions of its own.
What the landlord’s form is doing
Landlord wants:
- A large Security Deposit (3–12 months of Rent)
- Cash preferred over a letter of credit
- Landlord’s broad discretion to apply the Deposit without notice
- Auto-replenishment after any application;
- The Deposit not held in trust or escrow
Additional landlord security-deposit positions : the Deposit is not a cap on Landlord’s damages and is not an advance payment of rent; replenishment is due within days of demand and is characterized as Additional Rent (carrying late fees and interest, with failure to replenish a default); return of the Deposit is conditioned on Tenant’s full compliance with the Lease rather than on the absence of actual documented defaults; and on a sale of the property Landlord transfers the Deposit to the purchaser and is released. Tenant counters: a thirty (30)-day replenishment window after notice; return conditioned only on actual, documented, itemized defaults; and a written assumption of the Deposit obligation by any purchaser as a condition of Landlord’s release.
What tenants should watch for
Security deposits
Size. Target one (1) to three (3) months of Rent. Resist larger deposits. For build-to-suit or anchor deals, six (6) months may be the negotiated norm.
Form. Prefer letter of credit (LC) over cash. An LC preserves Tenant’s working capital and ensures Tenant’s funds are not held by Landlord (where they may be subject to Landlord’s creditors). LC must be: (i) evergreen (auto-renewing); (ii) drawable on Landlord’s sight; (iii) transferable to a successor landlord; (iv) issued by a bank with rating of A- or better; (v) for a period of at least one (1) year beyond the Lease Term.
Application. Landlord may apply Deposit to a default only after (i) written notice to Tenant of the default and (ii) Tenant’s failure to cure within the applicable cure period. Tenant should have notice and opportunity to dispute. Application is not Landlord’s "sole and absolute discretion."
Replenishment. If Landlord applies any portion of the Deposit, Tenant shall replenish to the original amount within thirty (30) days. Failure to replenish is itself a default after notice and cure period.
Return. Within thirty (30) to sixty (60) days after Lease expiration, Landlord shall return the Deposit (or unused balance) to Tenant, less only deductions for actual, documented defaults that arose during the Lease Term. Landlord shall itemize any deductions.
Interest. Where state law requires interest on commercial security deposits, Tenant should ensure Landlord credits interest. Oregon does not require interest on commercial deposits (residential only). Negotiate interest where the deposit is large.
Substitution. Reserve right to substitute LC for cash mid-Term, or to release a Deposit on Tenant’s achievement of credit milestones (e.g., investment-grade rating, sustained profitability).
Resist Landlord’s right to increase. Landlord forms reserve a right to increase the Security Deposit on triggers determined in Landlord’s “sole and absolute discretion”: a perceived decline in Tenant’s or Guarantor’s creditworthiness, repeated defaults irrespective of cure, exercise of a renewal or expansion option, or performance of alterations, with lease termination as the remedy for noncompliance. Resist the clause entirely; if unavoidable, require objective triggers, a commercially reasonable determination standard, and a notice and cure period.
Concession conditions. Where Landlord waives or reduces the Deposit as a concession, Landlord forms condition the concession on: (i) Tenant remaining the original named tenant; (ii) Tenant itself occupying and operating the whole Premises; (iii) no more than one default in any twelve (12)-month period, irrespective of cure; and (iv) a minimum net worth evidenced by audited financial statements. Negotiate the default condition to count only uncured material defaults, and confirm the concession survives Permitted Transfers.
Letters of credit
Governing rules and draw mechanics. Landlord letter-of-credit forms typically subject the standby letter of credit to the International Standby Practices 1998 (ISP98), ICC Publication No. 590, rather than UCP 600; confirm which regime the issuing bank will apply. Anticipate two further landlord positions: transfer and amendment fees passed through to Tenant as Additional Rent, and Landlord’s right to draw the full Letter of Credit if the issuing bank gives notice of nonrenewal and Tenant fails to deliver a substitute by a stated deadline; negotiate an adequate substitution window. Landlord letter-of-credit forms also require that the draw conditions be satisfiable by Landlord unilaterally: presentation of the original letter of credit, a sight draft, and Landlord’s own default certification, without Tenant’s signature or cooperation and notwithstanding any Tenant bankruptcy.
How this typically gets negotiated
Deposit negotiations run on form and size (cash versus letter of credit, and how many months of rent) and on the mechanics: when the landlord may draw, how fast the tenant must replenish, and how quickly the deposit comes back after the lease ends. Letters of credit add their own layer: issuer quality, evergreen renewal, transfer on a sale of the building, and draw conditions all get negotiated.
The specific language that resolves each of these points depends on the deal. Talk to Paul about your lease →
How the states treat it
Letter of Credit: UCC Article 5
Letters of credit are governed by UCC Article 5 and, in practice, by ICC UCP 600 (Uniform Customs and Practice for Documentary Credits) and ISBP 745 (International Standard Banking Practice). LCs are independent of the underlying lease obligation; a landlord can draw against a properly presented LC even if there is an underlying dispute. Tenant counsel should confirm UCP 600 governs and that the LC contains a no-fraud carve-out only for outright forgery.
Game film: real clauses from real leases
Excerpts from commercial leases filed as exhibits with the Securities and Exchange Commission, trimmed for length. Follow the citation for the full document on EDGAR.
“On June 1, 2021, and upon the condition that (i) an Event of Default shall not then exist and be continuing, (ii) no Event of Default shall have occurred during the Term, (iii) Tenant shall never have been late in the payment of any Base Rent or Additional Rent beyond the applicable notice and grace period provided herein, if any, and (iv) Tenant shall then have a market capitalization, as reported by NASDAQ and as certified by Tenant’s chief financial officer, equal to or in excess of $250,000,000.00, then the Security Deposit shall be reduced to $1,121,422.32. In such event, Tenant shall provide a replacement Letter of Credit complying with this Section in the amount of $1,121,422.32 to Landlord …”
Why it matters. A letter of credit burn-down that requires the tenant to have never been late during the entire term is a one-strike test, so tenant counsel should push for objective financial triggers alone and a right to re-earn the reduction, which this tenant partially obtained through the market capitalization cure mechanism.
“At Lessee’s written request (which request shall be accompanied by Lessee’s Financial Statements for the three (3) calendar quarters occurring immediately prior to such request … )(collectively, "Lessee’s Request Package"), the Security Deposit shall be reduced according to the following provisions. Any such request can be made no more than one (1) time during any twelve (12) month period commencing on the first day of the twenty-fifth month of the Term. … If Cash Flow from Operations (as herein defined), is positive, then the amount of the Security Deposit shall be decreased based on the Cash Flow/Rent Ratio (as herein defined) as follows: If the Cash Flow/Rent Ratio is 1.76 — 2.00 then the Security Deposit shall be reduced to $379,191.12”
Why it matters. This pre-IPO tenant negotiated a sliding-scale burn-down keyed to audited cash flow metrics rather than landlord discretion, giving a growing company a defined, repeatable path to shrink an oversized letter of credit as its financials improve.