Gloria Nelson and her mother, Linda Mitchell, rented a single-family house from Bertha McGee. The tenants paid a $2,500 cash security deposit to McGee.
Local city ordinance requires landlords to place tenant security deposits into a segregated interest-bearing account, which McGee failed to do.
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When a dispute arose about the condition of the premises, McGee began an eviction. But the tenants voluntarily moved out, filing a counterclaim for return of their $2,500 security deposit.
However, McGee then spent the security deposit. She said she anticipated the judge would decide she didn’t have to refund the $2,500 to her tenants.
But the judge ruled the tenants had complied with their obligations and McGee owed double damages, plus interest ($5,208) for failing to return the security deposit after the tenants vacated.
Unable to pay the $5,208 judgment, landlord McGee filed Chapter 7 bankruptcy. She sought a discharge from her $5,208 judgment to her former tenants.
In this case of first impression in all the U.S. circuit courts, the judge explained, the issue is whether landlord McGee breached her fiduciary duty to her former tenants by failing to promptly refund their security deposit judgment.
If you were the bankruptcy court judge would you order the debtor landlord to pay the $5,208 judgment to the tenants?
The judge said yes!
The local city ordinance required landlords to keep tenant security deposits in separate interest-bearing accounts, the judge began. Landlord McGee failed to do so, he noted.
Because McGee failed to keep her tenant’s security deposit in a separate account, she breached her fiduciary duty to them, the judge explained.
“Instead she made off with the money, an act of defalcation that disqualifies her from receiving a bankruptcy discharge,” the judge ruled. Therefore, McGee must pay the $5,208 judgment to her ex-tenants before she can receive a bankruptcy discharge, the judge concluded.
Based on the 2003 U.S. Court of Appeals decision in In Re McGee, 353 Fed.3d 537.
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