October 19, 2023

Look Before You Lend: Commercial Lessors Holding Security Deposits in Trust May Open the Door to Lessee Conversion Suits


A decision from the U.S. District Court for the Southern District of New York should spark the attention of secured lenders whose borrowers hold commercial lessee security deposits.1 The opinion issued by Judge Valerie Caproni, 10FN, Inc. v. Cerberus Business Finance, LLC,2 dismissed a commercial tenant’s (the “Tenant” or the “Sub-Lessee”) claims of conversion and negligence against the bankrupt sub-lessor’s (the “Debtor” or the “Sub-Lessor”) executives and unjust enrichment and conversion against the Debtor’s secured lenders (the “Secured Lenders”) after concluding the Tenant’s security deposit was an unsecured loan to the Debtor.

I. 10FN, Inc. v. Cerberus Business Finance, LLC

In 10FN, Inc., the Debtor’s predecessor was a lessee under a commercial lease in Chicago, Illinois. The predecessor entered into a sub-lease agreement (the “Sub-Lease”) with the Tenant in 2016, pursuant to which the Tenant provided a security deposit of $271,092.87. After the predecessor and Tenant entered into the Sub-Lease, the Debtor purchased the predecessor, and in connection with the acquisition, borrowed funds from the Secured Lenders.3 Under the lending arrangement, the Debtor granted the Secured Lenders “first-priority liens on ‘substantially all [of] the Debtor’s assets’”4 and executed account control agreements permitting the Secured Lenders to sweep the Debtor’s accounts.5 The Debtor subsequently filed a Chapter 11 bankruptcy petition on March 29, 2019. Prior to the Debtor’s bankruptcy petition, however, the Secured Lenders swept funds, including “some or all of” the Tenant’s security deposit, from the Debtor’s accounts pursuant to the cash sweep provisions of the account control agreements. After the Debtor’s bankruptcy petition, the Debtor rejected the Tenant’s Sub-Lease as permitted under the Bankruptcy Code.6

After the Debtor rejected the Sub-Lease, the Tenant unsuccessfully tried to recover its security deposit.7 On February 18, 2022, the Tenant filed an amended complaint against the Secured Lenders on theories of conversion and unjust enrichment and against the Debtor’s executives for conversion and negligence. The court quickly rejected the Tenant’s negligence claim against the Debtor’s executives after concluding the executives did not owe any duty to the Tenant, an essential component of a negligence claim.8 While the 10FN, Inc. court also analyzed subject matter jurisdiction and certain conflict of laws issues, the court’s analysis and discussion of the Tenant’s conversion and unjust enrichment claims provide the most impactful lessons for secured lenders.

A. The Court Dismissed the Tenant’s Conversion Claim Because Neither State Law Nor the Sub-Lease Required the Debtor to Hold the Security Deposit in Trust.

In its consideration of the Tenant’s conversion claim, the 10FN, Inc. court ruled that, although New York law governed the claim, Illinois law controlled the Tenant and Debtor’s Sub-Lease.9 Under New York law, the court described conversion as “any unauthorized exercise of dominion or control over property by one who is not the owner of the property which interferes with and is in defiance of a superior possessory right of another in the property.”10 The court described the two key elements of conversion as “(1) the plaintiff’s possessory right or interest in the property and (2) the defendant’s dominion over the property or interference with it, in derogation of the plaintiff’s rights.”11 To determine whether the deposit could form the basis for a conversion suit, the court looked to the nature of the Tenant’s interest in the security deposit, which required an analysis of the Sub-Lease’s terms.

The Sub-Lease permitted the Debtor to draw upon the deposit after the occurrence of a default by the Tenant under the Sub-Lease and did not, by its terms, require the Debtor to segregate the Tenant’s security deposit or hold it in trust, diminishing the Tenant’s arguments that the deposit was held in trust. For additional support, the court next looked to both Illinois state law and the Chicago Municipal Code. The court noted that courts applying local law have found that lessors must hold residential tenants’ security deposits in trust, but it did not find any authority stating that commercial tenants’ security deposits were subject to similar requirements.12 To the contrary, the court found persuasive authority holding that a lease or state law treating security deposits as loans from the lessee confers upon the lessee the status of unsecured creditor when the lessor declares bankruptcy.13 Here, as the Sub-Lease did not require the Debtor to hold the security deposit in trust and permitted the Debtor to draw on the Tenant’s security deposit upon the occurrence of a default by the Tenant under the Sub-Lease, the court held that the Tenant gave the Debtor an unsecured loan.14 As the Tenant was the Debtor’s unsecured creditor, the Tenant’s only avenue for recovery was to file a claim in the Debtor’s bankruptcy case. Accordingly, the court rejected the Tenant’s conversion suit against the Secured Lenders.15

B. The Court Dismissed the Tenant’s Unjust Enrichment Claim because the Sub-Lease Directly Addressed the Security Deposit.

Next, the 10FN, Inc. court analyzed the Tenant’s claim that the Secured Lenders unjustly enriched themselves by unfairly retaining the security deposit knowing it belonged to the Tenant.16 A claim for unjust enrichment in New York must include an allegation that “(1) [the] defendant was enriched; (2) the enrichment was at plaintiff’s expense; and (3) the circumstances were such that equity and good conscience require [the] defendant[] to make restitution.”17 An unjust enrichment claim is barred, however, if a valid contract governs the focus of the dispute.18 While the court noted that the Tenant had no contractual relationship with the Secured Lenders, the Sub-Lease between the Tenant and the Debtor expressly governs the disposition of the security deposit. Accordingly, the court rejected the Tenant’s unjust enrichment claim.

II. Key Takeaways for Secured Lenders

Secured lenders using cash sweep provisions in lending agreements with borrowers holding commercial security deposits can take several lessons from 10FN, Inc. to protect themselves in the event the borrower declares bankruptcy. As shown by the Debtor’s position as sub-lessor in 10FN, Inc., these lessons apply not only to traditional banks lending to commercial property owners, but also to any secured lender with a borrower holding commercial lessee security deposits, such as short-term office rentals or wedding venue reservations. While lenders cannot directly negotiate leases between their borrowers and the borrowers’ commercial lessees, lenders can, through their lending agreements, require borrowers to include certain provisions in leases. When secured lenders sweep cash—including commercial lessees’ security deposits—from a borrower’s accounts, 10FN, Inc. provides guidance to secured lenders in avoiding a lessees’ potential conversion and unjust enrichment claims.

A. Contract Provisions Governing the Treatment of a Security Deposit Can Protect Secured Lenders from Unjust Enrichment Claims.

To negate a lessee’s unjust enrichment claim, secured lenders should consider requiring that all of a borrower’s leases include provisions directly discussing the treatment of the lessee’s security deposit. In certain jurisdictions, unjust enrichment claims cannot survive if their subject matter is directly addressed by an enforceable contract.19 While state law may differ in the approach to unjust enrichment claims, a lease directly providing for the security deposit’s treatment can defeat unjust enrichment claims. Secured lenders, therefore, can protect themselves against unjust enrichment claims by requiring that their borrowers expressly provide for the treatment of commercial security deposits in commercial lease agreements.

B. Secured Lenders Can Require Borrowers to Treat Security Deposits as General Obligations to Safeguard Against Lessee Conversion Claims.

Secured lenders can protect themselves against conversion claims by requiring that their borrowers structure lease agreements such that a court is likely to consider a security deposit a general obligation of the lessor rather than a deposit held in trust. Conversion claims can require claimants to prove: (1) the claimant’s “ownership or right to possession of the property” and (2) the “defendant’s conversion by a wrongful act.”20 Further, conversion claims can fail when the dispute arises from a breach of contract or a failure to repay a general obligation.21 A conversion claim based on funds swept from a trust, however, may have more success because of the claimant’s stronger interest in the funds. The primary method by which secured lenders can avoid rulings that security deposit funds are held in trust is through their lending agreements.

(1) Lending Agreements Can Require that Leases Disclaim Any Intent to Form an Express Trust.

First, lending agreements can prohibit borrowers’ leases from expressly holding lessee security deposits in trust. While the law differs between states, express trusts are generally created through a variety of differing, but overlapping, elements, including: (1) an express intent to create a trust; (2) an ascertainable object; and (3) a sufficient designation of a beneficiary.22 Further, courts often consider the intent to create a trust the most important factor in the analysis.23 Accordingly, at least one court has ruled

[a] transfer of money to be applied for certain purposes is not by itself sufficient to create an express trust. Otherwise, conceivably all security deposits could be considered held in trust, as every security deposit is meant to be applied for certain purposes, specifically to protect the recipient of the deposit in the event that the depositor fails to carry out its obligations.24

While lease agreements lacking an intent to create an express trust may be sufficient, agreements explicitly disclaiming any intent to form a trust will likely better safeguard secured lender interests. Even if a court finds that a lease agreement does not create an express trust for the deposit, however, it could nonetheless impose a constructive trust depending on the nature of the parties’ relationship.

While state laws vary slightly, the elements of a constructive trust generally include: (1) a confidential or fiduciary relationship; (2) an express or implied promise; (3) a transfer of property made in reliance on the promise; and (4) unjust enrichment.25 A constructive trust is a “potent [remedy] in bankruptcy because it gives the successful claimant ‘priority over the defendant’s unsecured creditors’ to the extent of the property subject to the trust.”26 Accordingly, creditors are incentivized to seek a constructive trust in bankruptcy proceedings. Since imposing a constructive trust “can wreak such havoc with the priority system ordained by the Bankruptcy Code, bankruptcy courts are generally reluctant ‘to impose constructive trusts without a substantial reason to do so.’”27 Some bankruptcy courts even require a creditor seeking a constructive trust to make a showing of fraud or other egregious conduct,28 an unlikely prospect where a secured lender has merely invoked its rights under the cash sweep provisions of its lending agreement. Although bankruptcy courts disfavor constructive trusts, secured lenders can further protect themselves from lessee claims by requiring borrowers to structure lease agreements to ensure security deposits are more likely to be considered general obligations.

(2) Lending Agreements Can Require Lessors to Treat Security Deposits as General Funds.

Secured lenders can require that borrowers hold security deposits in their general expense or emergency maintenance accounts rather than holding deposits in separate, segregated accounts. While segregation does not, standing alone, establish a constructive trust, courts have found segregated funds to be a strong indicator of a trust.29 Ensuring all security deposits are held in general accounts that contain funds from other unsecured lending sources, therefore, would bolster the argument that the lessee’s security deposit was an unsecured loan to the borrower to be returned at the end of the lease. Other than expressly disavowing that funds are held in trust, requiring security deposits to be held in general expense accounts likely provides the greatest protection for secured lenders against lessee conversion claims. If, however, accounts are in place prior to the secured loan or market conditions do not permit secured lenders to hold security deposits in general expense accounts, lenders could alternatively require that borrowers hold all security deposits in a single, commingled account. While this may not provide the same level of protection as placing deposits in a general expense account, a single account holding all security deposits would reduce the likelihood that the deposits are considered to be held in trust as compared to individual accounts for each deposit.

Finally, secured lenders can support an argument that a security deposit is a general obligation by requiring that borrowers treat security deposits as unsecured loans in their lease agreements. When considering whether the parties’ lease agreement treats a security deposit as an unsecured loan, courts may analyze whether the lessor can draw upon the deposit during the lease term in the event of lessee default, such as failure to timely pay rent or damage to the property.30  Furthermore, a lease agreement that requires lessors to return the lessee’s deposit, less any default damages, is indicative of a general unsecured loan.31 Courts may find that if a lease “treats the deposit as a form of loan to the [lessor] in order to create the possibility of a setoff if the [lessee] later incurs a debt to the [lessor], then the [lessee] becomes an unsecured creditor in bankruptcy.”32 Secured lenders requiring that borrowers’ lease agreements treat security deposits as unsecured loans for purposes of setoff upon a lessee’s default, therefore, can improve their chances that a lessee’s claim will be considered a general obligation.

Lenders should be mindful that a minority of jurisdictions require that all security deposits, whether commercial or residential, must be held in trust.33 If the state or municipal law governing the lease agreement between borrower and lessee requires commercial security deposits to be held in trust, lenders must be wary before sweeping the lessee’s security deposit in the event of a borrower bankruptcy filing. While the 10FN, Inc. court did not hold that a conversion claim based on periodic or event-driven cash sweeps could succeed, lessees could argue the decision implies that result.

III. Conclusion

In light of the 10FN, Inc. decision, secured lenders invoking cash sweep provisions of lending agreements should consider structuring their lending agreements, if permitted under state and municipal law, to protect themselves from lessee conversion and unjust enrichment claims. By requiring borrowers to directly address lessees’ security deposits in lease agreements, secured lenders will likely frustrate lessees’ unjust enrichment claims. Furthermore, secured lenders can require that borrowers act to prevent deposits being considered trust property.

By expressing an intent that deposits are not held in trust, holding deposits in general expense accounts, and permitting lessors to draw upon the deposit in the event of lessee default, lease agreements can be crafted to classify deposits as general obligations of the borrower, thus limiting lessee conversion claims.


1 The information contained in this article is not, and is not intended to be, legal advice. Each situation is different, and an attorney should be contacted for any questions or consultation with respect to your individual matter.

2 No. 1:21-cv-05996-VEC, 2022 U.S. Dist. LEXIS 190766 (S.D.N.Y. Oct. 18, 2022).

3 Id. at *2.

4 Id. (internal citation omitted).

5 A cash sweep provision typically provides that funds in one or more accounts may be “swept” to another account upon the occurrence of a specified event or in accordance with a schedule set forth in the financing documentation. Such funds may then be held as additional cash collateral or applied to pay down the outstanding loan balance, if permitted by the terms of the financing documentation.

6 10FN, Inc., 2022 U.S. Dist. LEXIS 190766, at *2–3; see also 11 U.S.C. §§ 365(a); 1107.

7 10FN, Inc., 2022 U.S. Dist. LEXIS 190766, at *3.

8 Id. As this article focuses on claims against the Secured Lenders, the court’s analysis concerning the Tenant’s conversion claim against the Debtor’s executives will not be discussed here.

9 Id. at *10.

10 Id. (quoting Moses v. Martin, 360 F. Supp. 2d 533, 541 (S.D.N.Y. 2004)).

11 Id. (quoting Zamora v. FIT Int’l Grp. Corp., 834 F. App’x 622, 629 (2d Cir. 2020)).

12 Id. at *11–12 (citing 765 ILL. COMP. STAT. ANN. 715; 815 ILL. COMP. STAT. 165/3; CHIC. MUN. CODE § 5-12-080).

13 Id. at *12–13 (citing In re McGee, 353 F.3d 537, 539 (7th Cir. 2003)).

14 Id. at *13.

15 Id. at *14 (citing Karimi v. 401 N. Wabash Venture, LLC, 952 N.E.2d 1278, 1285 (Ill. App. Ct. 2011) (following the “general rule” that “an action for conversion may not be maintained for money representing a general debt or obligation”)).

16 Id. at *15–17.

17 Id. at *16 (citing Labajo v. Best Buy Stores, L.P., 478 F. Supp. 2d 523, 531 (S.D.N.Y. 2007)).

18 Id. at *16–17 (citing Vista Food Exch., Inc. v. Champion Foodservice, LLC, 124 F. Supp. 3d 301, 312 (S.D.N.Y. 2015) and Coty, Inc. v. L’Oreal S.A., 320 F. App’x 5, 6 (2d Cir. 2009) (“[I]t is black-letter law in New York that recovery on an equitable theory of unjust enrichment is not permitted where the matter at issue is covered by a valid, enforceable contract.”)).

19 See, e.g., Charter Commc’ns Operating, LLC v. SATMAP Inc., 569 S.W.3d 493, 512 (Mo. Ct. App. 2018) (“Because express contract terms govern the issue in dispute, the terms of the contracts apply and unjust enrichment is not applicable as a matter of law.”); City of Scottsbluff v. Waste Connections of Neb., Inc., 809 N.W.2d 725, 740 (Neb. 2011); Lehigh Gas-Ohio, LLC v. Cincy Oil Queen City, LLC, 66 N.E.3d 1226, 1233 (Ohio Ct. App. 2016).

20 Plummer v. Day/Eisenberg, LLP, 108 Cal. Rptr. 3d 455, 460 (Cal. Ct. App. 2010); see also Repin v. State, 392 P.3d 1174, 1187 (Wash. Ct. App. 2017); PNC Multifamily Cap. Institutional Fund XXVI Ltd. P’ship v. Bluff City Cmty. Dev. Corp., 387 S.W.3d 525, 553 (Tenn. Ct. App. 2012).

21 Pioneer Comm. Funding Corp. v. United Airlines, Inc., 122 B.R. 871, 884 (S.D.N.Y. 1991); Capital Factors v. Homeline Corp. (In re Gen. Plastics Corp.), 158 B.R. 258, 287 (Bankr. S.D. Fla. 1993); Larew v. Hope Law, P.L.C., 977 N.W.2d 47, 63 (Iowa 2022) (“In general, no conversion claim exists where the dispute arises solely out of contractual obligations.”); Karimi v. 401 N. Wabash Venture, LLC, 952 N.E.2d 1278, 1285 (Ill. App. Ct. 2011) (“[A]n action for conversion may not be maintained for money representing a general debt or obligation.”).

22 Blixseth v. Blixseth (In re Blixseth), 459 B.R. 444, 458–59 (Bankr. D. Mont. 2011); Braden Trust v. Chavez, 430 B.R. 890, 894 (Bankr. D. Ariz. 2010) (citation omitted); Int’l Fid. Ins. Co. v. Marques, 358 B.R. 188, 194 (Bankr. E.D. Penn. 2006).

23 Braden Trust, 430 B.R. at 894 (citation omitted).

24 Intelius Sales Co., LLC v. Idearc Inc., No. 3:11-CV-339-B, 2011 U.S. Dist. LEXIS 73057, at *15–16 (N.D. Tex. July 7, 2011).

25 See, e.g., Superintendent of Ins. v. Ochs (In re First Cent. Fin. Corp.), 377 F.3d 209, 212 (2d Cir. 2004); Bird v. McCauley (In re McCauley), 549 B.R. 400, 414–15 (Bankr. D. Utah 2016); Castetter v. Henderson, 113 So. 3d 153, 155 (Fla. Ct. App. 2013).

26 Haber Oil Co. v. Swineheart (In re Haber Oil Co.), 12 F.3d 426, 436 (5th Cir. 1994) (citing Emily L. Sherwin, Constructive Trusts in Bankruptcy, 1989 ILL. L. REV. 297, 305 (1989)).

27 Id. (citing Neochem Corp. v. Behring Int’l, Inc. (In re Behring Int’l, Inc.), 61 B.R. 896, 902 (Bankr. N.D. Tex. 1986)); see Amendola v. Bayer, 907 F.2d 760, 763 (7th Cir. 1990) (“[T]he grounds for imposing a constructive trust must be so clear, convincing, strong and unequivocal as to lead to but one conclusion.”).

28 Was, LLC v. Coll (In re DC Energy, LLC), 555 B.R. 786, 792 (Bankr. D.N.M. 2016); see also In re Coffman, 273 B.R. 137, 138 (Bankr. S.D. Ohio 2001) (requiring in some cases “egregious and/or fraudulent behavior” to impose a constructive trust).

29 EBS Pension L.L.C. v. Edison Bros. Stores, Inc. (In re Edison Bros., Inc.), 243 B.R. 231, 238 (Bankr. D. Del. 2000) (finding “segregation is merely one factor in determining whether the parties intended to create a trust; it is not dispositive”).

30 In re McGee, 353 F.3d 537, 539 (7th Cir. 2003); Chriswell v. Alomari (In re Alomari), No. 10 B 47008, 2011 Bankr. LEXIS 3187, at *9 (Bankr. N.D. Ill. Aug. 15, 2011).

31 In re Alomari, 2011 Bankr. LEXIS 3187, at *8 (citing In re McGee, 353 F.3d at 540).

32 In re McGee, 353 F.3d at 539.

33 See, e.g., N.Y. GEN. OBLIG. LAW § 7-103(1); see also JAMES ROGERS & CLARISSA MEDRANO, SECURITY DEPOSIT LAWS (COMMERCIAL LEASE): STATE COMPARISON CHART (2020), https://www.akerman.com/a/web/65420/Security-Deposit-Laws-Commercial-Lease-State-Comparison-Chart.pdf (noting that New York requires commercial deposits to be held in trust while most states do not prohibit commingling, a key consideration in trust formation).

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