Prepaid Rent And Judgments

August 12, 2023

What if you have been trying to recover a judgment against a clever debtor that has prepaid their residential rent for three full years? They got no discount for prepaying their rent, because it was a lease with monthly payments. They probably prepaid their rent to put their money out of reach of creditors.

One of many judgment articles: I am a judgment broker, not a lawyer, and this article is my opinion based on my experience, please consult with a lawyer if you need legal advice.

Is prepayment of rent subject to a creditor’s levy? What about scheduling a debtor examination and bringing in the landlord as a third-party holding the debtor’s assets? What about using a turnover order?

Is this a fraudulent transfer because the debtor did this with the intent to hinder or delay judgment creditors? Or not, because they got value (rent) for the exchange?

Who owns the prepaid rent, the debtor or the landlord? If the debtor was to ask the landlord to return it because the landlord has not earned it yet, would the landlord be required to return it?

What if the landlord reports their taxes on a cash basis, and reported the prepaid rent as income, and already paid taxes on it; would the tenant still be entitled to the return of prepaid rent because the landlord has not earned it yet?

Everything depends on the terms of the lease. If the lease was for three years and the debtor prepays it, then the money belongs to the landlord. If the lease is month to month, then the prepayment is an unearned deposit.

If the money is an unearned deposit, and the judge will not let you have it; you may still want to put a lien on the property (the deposited money) because the debtor could move out at any time and demand their money back. The landlord is not required to report the payment as taxable income until it is due; if they do not, then they are acknowledging that it is a deposit.

Deposits are not taxable income as per the IRS. If the landlord does report it as income then it is, but in either case how would you know? I doubt that you can force the landlord to provide you with their tax returns and even if you could; any income from the current year would not be proven until the landlord prepares their tax returns next year.

What is better evidence, is the landlord’s treatment of the money, instead of their tax returns. In California, an often under-utilized evidence code is 412 which provides: “If weaker and less satisfactory evidence is offered when it was within the power of the party to produce stronger and more satisfactory evidence, the evidence offered should be viewed with distrust”.

Often, if you try to levy against a rental deposit, the judge will decide the money belongs to the landlord until the tenant moves out, so the net deposit can be determined.

Many judges will reason that a creditor’s assignment or turnover order would jeopardize the property owner, because if the debtor knew that their deposit would go to the creditor, they may trash the place when they leave; because they had no reason to do a good clean up.

Residential landlord/Tenant law is heavily regulated by local ordinances. In court, the landlord would argue that they agreed in good faith to accept rent in advance for their property, and if the tenant moves, they can still keep the money because it is their money.

While it may be obvious to you what the debtor was trying to do, how would their landlord know? This was an arm’s length agreement for the rental of the property, so I do not believe the landlord could be involved in the possible fraud. And, proving fraud requires a new (and often expensive) lawsuit.

For those in California, you might want to try to examine the lease agreement, because if the court decides it is a prepayment of rent; then you may want to use CCP 695.035, to go after the debtor’s assignable interest in the lease. (If the lease permits a sublease, even if it requires the lessor’s consent, you are ok.)

The big problem is that judges do not want to see anybody turned out of their home, and so will likely list some reason (however thin) for allowing the landlord to keep the deposit. Even if you find a technical reason why you think you are right, you still will probably lose.

Because levying prepaid rent is not simple or guaranteed, why not look for available assets that could be levied less controversially; such as a bank levy, wage garnishment, or an assignment order?

Most people do not have the money to pay their rent two months in advance, let alone three years. Your debtor probably had or has substantial income coming in from somewhere.

If you decide to try to reach the prepaid rent, then you would do a third-party examination on landlord. If the judge does not allow this, then explain the situation to the judge, and how the pre-payment may be subject to attachment; and name the prepayment/deposit as the property to be liened. Then, ask that if the landlord reimburses any of that money to anyone, they will be responsible for paying you.

When you examine the landlord, also consider a proposed noticed motion for a turnover order right after that. Word your motion so that the hearing is right after the examination.

A noticed motion offers due process, and will give the judge a better idea how ridiculous the situation is. The judge might feel better as you could serve the landlord, and they would be able to make a claim at the hearing if they have one.

In California, the examination should get you a one-year silent lien on the funds. Instead of relying on CCP 699.040, use CCP 704.205 to conduct the third-party exam, and spontaneously seek a turnover of the money at the conclusion of the examination, while the court is allowed to restrain the property.

You might argue that only the current rent payments that are due constitute a debt. And, that the landlord is another creditor and the balance of the money is a non-exempt deposit against future payments. Then, ask for a turnover order against the landlord to turnover the balance of the money, you might get lucky.

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