New York law requires that a landlord receiving a tenant’s security deposit must hold the funds in trust for the tenant, by placing them in a separate account, and must not commingle the security deposit with the landlord’s own funds. Courts have held that a landlord’s violation of this requirement constitutes conversion and entitles the tenant to the immediate return of the security deposit.  The amount that the landlord must return to the tenant in such circumstances may not be reduced or offset by any debts that the tenant may allegedly owe to the landlord.

In a recent case involving a converted security deposit, the tenant vacated the premises before it was authorized to vacate under the lease, and thereby incurred liability for several months’ rent.  The tenant sought to reduce its liability by the amount of the security deposit to whose return it was entitled.  A lower court refused to allow the offset, but the appellate court has held that the tenant is entitled to the offset.  The court explained that while “a landlord is considered to be a trustee with respect to those funds deposited as security” and therefore is not allowed to offset them against other obligations, “[t]he same logic does not pertain where a tenant seeks to apply the security deposit to reduce amounts found owing to the landlord.”  Thus, the lower court should have “reduce[d] [the] amounts owed the landlord by a setoff representing the amount of the security deposit to which the tenant was entitled.”  23 East 39th Street Management Corp., v. 23 E. 39th Street Development, LLC, 134 A.D. 629, 23 N.Y.S.3d 33 (1st Dep’t Dec. 29, 2015).