📖 Commercial lease glossary
Commercial Security Deposit
A commercial security deposit is money or a letter of credit a tenant provides to secure its performance under a lease, which the landlord can apply against unpaid rent, damage, or other defaults. Unlike residential deposits, commercial deposits are not capped by statute in most states, are not always required to be held in a segregated or interest-bearing account, and are frequently structured as a letter of credit rather than cash — a structural choice with its own set of terms and traps.
Cash deposit vs. letter of credit
A cash security deposit is the simplest structure: the tenant pays a lump sum at lease signing, the landlord holds it (commingled with operating funds or segregated, depending on the lease and state law), and applies or returns it per the lease terms. For larger tenants and higher-value leases, landlords frequently accept an irrevocable standby letter of credit (LOC) instead — a bank's payment guarantee that the landlord can draw on if the tenant defaults, without the tenant's cash sitting idle with the landlord for the lease term.
The LOC route shifts several mechanics that a cash deposit does not have: an issuing bank, an expiration date, draw conditions the landlord must satisfy to collect (typically a sight draft plus a certification of default), and — critically — an "evergreen" clause that auto-renews the LOC unless the bank gives advance notice of non-renewal. A lease-required LOC is not a one-time item to file away; it is a recurring obligation to track against its own expiration calendar, separate from the lease term itself.
Reduction (burn-down) schedules
- ✓Many commercial deposits — cash or LOC — step down over the lease term rather than staying fixed, often tied to the tenant meeting specific milestones: a set number of years of on-time payment, an anniversary date, or a financial covenant (e.g., minimum net worth or a public-market cap threshold)
- ✓A burn-down schedule is usually tenant-initiated: the tenant must request the reduction and often certify it is not in default before the landlord is obligated to reduce or reissue a smaller LOC
- ✓Missing a burn-down right in the abstract means either the tenant overpays for years past its contractual reduction date, or the landlord holds security it is no longer entitled to hold — both are avoidable with the trigger date on record
- ✓Some leases run the reduction the other way: an escalating deposit that increases if the tenant's credit profile weakens or if it exercises an expansion or renewal option
Application, return, and the bankruptcy difference
On a payment or performance default, the lease typically lets the landlord apply the deposit against the amount owed, with a further tenant obligation to replenish it back to the original amount within a stated number of days. At lease expiration with no outstanding default, the deposit (or its remaining balance) is returned — commercial leases commonly allow landlords 30–60 days, sometimes longer, and often reserve the right to hold back a portion pending final CAM or tax reconciliation.
The cash-vs-LOC choice matters most if the tenant files bankruptcy. A cash deposit is generally treated as property of the tenant's bankruptcy estate, subject to the automatic stay and the claims process alongside other creditors. A properly structured LOC is a separate obligation of the issuing bank, not the tenant's estate — the landlord can typically draw on it without seeking relief from the automatic stay, which is precisely why landlords favor LOCs from financially weaker or newer tenants even when a cash deposit would otherwise be acceptable.
Traps our specialists check for
- ✓Evergreen and non-renewal notice gaps: if the landlord misses the bank's non-renewal notice window, an LOC can lapse mid-term with no replacement in place — the abstract needs the notice deadline, not just the LOC expiration date
- ✓Burn-down conditions buried in a side letter or amendment rather than the base lease — easy to miss if only the original lease is abstracted
- ✓Interest and segregation requirements: a handful of states require commercial deposits to be held in a separate, interest-bearing account and returned with interest — a term that changes the return calculation and is easy to overlook when it is set by statute rather than the lease itself
- ✓Deposit amount silently reduced or replenished by an amendment without the base lease being updated — abstracts should reflect the current amount and its full amendment trail, not just the origination figure
Frequently asked questions
Is a commercial security deposit legally capped like a residential one?
No. Most states cap residential security deposits (often at one or two months' rent) but exempt commercial leases entirely, leaving the amount to negotiation. Some states do impose interest or segregated-account requirements on commercial deposits even without a dollar cap — those requirements vary by jurisdiction and should be checked separately from the lease language.
Why would a landlord accept a letter of credit instead of cash?
An LOC gives the landlord a bank's payment guarantee without tying up the tenant's cash for the lease term, and — because it is the issuing bank's obligation rather than the tenant's asset — it is typically easier for a landlord to draw on if the tenant later files bankruptcy. Landlords with lower-credit or newer tenants often prefer it for that bankruptcy-treatment difference alone.
What is an evergreen clause on a letter of credit?
A provision that automatically renews the LOC for another term unless the issuing bank gives the landlord advance written notice (commonly 30–60 days) that it will not renew. If that notice goes unanswered, the landlord's standard remedy is to draw the full LOC before it lapses — so the notice deadline, not just the stated expiration date, is the date that actually matters operationally.
Does a security deposit earn interest?
Only if the lease requires it or state law mandates it for commercial deposits, which is less common than for residential deposits. Absent such a requirement, a landlord can typically commingle and hold a cash deposit without paying interest — a term worth confirming per jurisdiction rather than assuming either way.
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