What Does Key Money Mean in a Commercial Lease?

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In a commercial lease, key money is a term used to describe a sum of money paid to a landlord, building owner or manager by a potential tenant. It acts as security for the tenancy and may be considered a type of deposit. While the issue of key money is a controversial one in relation to residential leases, but it is completely above-board in commercial leases.

Key Money and Residential Leases

It used to be common for residential tenants to be asked for key money in areas where rents are controlled by law, such as New York. To get more money from their tenants, landlords in these areas often asked for key money that amounted to several months’ rent, to offset a relatively cheap lease. The payment was generally made off-the-books, because only licensed real estate brokers are allowed to charge commission on a rental. As such, the request for payment would be difficult to prove in court because there were no records of it.

Nowadays, it's common for a landlord to ask for a security deposit (typically the equivalent of one or two months' rent), which is held in escrow and is used to cover property damage and non-payment of rent. All remaining funds are returned to the tenant at the end of the lease. It's illegal for landlords to refuse to refund these funds, and most states require a landlord to account for all deductions from a security deposit.

For example, under Idaho law the landlord must provide the tenant with a signed statement itemizing the amounts retained, the purpose for the amounts retained, and a detailed list of expenditures made from the deposit. This is intended to stop unscrupulous landlords from falsely claiming they used the money for necessary cleaning or repairs.

Key Money and Commercial Leases

A request for key money is common practice in commercial leases. However, the charge must be included in the terms of the lease, because undocumented payments are illegal, however they are made and whatever they are named – for example, some leases may refer to "key payment" instead of "key money." If the payment is not stated on the commercial lease, the tenant could sue her landlord for recovery of the key money, plus any related costs or damages to her business, at any time during her lease.

Before signing a commercial lease agreement, it's a good idea to get a lawyer to check all clauses, including any in relation to key money.

In the restaurant business, key money may change hands when a business owner wants to sell the remainder of her lease together with any on-site equipment to try to get her investment back.

Read More: How to Amend a Commercial Lease

Law Relating to Key Money

Most states have laws governing security deposits, but don't specifically reference key money. However, the California Civil Code is one exception. It states that it is unlawful for any person to "require, demand, or cause to make payable any payment of money, including, but not limited to, 'key money,' however denominated" as a condition of entering into, continuing or renewing a lease unless the amount of payment is stated in the written lease.

This means that the key money request and payment is legal as long as the amount of key money is specified in writing as part of the commercial lease agreement.

In the 2003 case _Edamerica, Inc. v. Superior Court_, the court found that liability under the statute prohibiting "key money" (defined as any amount of money a landlord demands or requires in order to initiate, continue or renew a lease, including money denominated as rent) attaches only when the landlord fails to state the amount of the key money payment in the written lease or rental agreement.