Security Deposits & Carpet Cleaning Fees
Here’s a recent question from a property manager-

QUESTION-    We followed the 45-Day Letter Rules and deducted a $200 carpet cleaning and repainting fee that the lease clearly describes.  Yet, the tenant claims we owe her the entire security deposit back and that Indiana law does not allow us to keep from the security deposit anything other than damages, unpaid utilities and unpaid rent.  Is this tenant right?

MATT’S ANSWER-    No, the tenant is wrong for several reasons.  Your lease specifically states that you can withhold that $200 fee from the security deposit.  Secondly, the $200 fee is a form of damages called “liquidated damages.”  In essence, you and the tenant agreed to “liquidate” certain repairs costs – carpet and paint – at the set amount of $200.  Clearly, damages amounts can be withheld from the security deposit.

Additionally, the Indiana Court of Appeals and Supreme Court have held in prior landlord-tenant cases that a tenant is not owed a 45-Day Letter Notice for unpaid rent, because the tenant already knows that the tenant owes rent.  The purpose of the 45 Day Letter Rule is to give the tenant notice of what amounts and why the tenant is not getting all her security deposit back.  There is no point in sending a tenant notice to apprise her of her obligation to pay rent, as the tenant already knew about that obligation – it’s in the lease she signed.  So, the Courts have ruled against tenants in security deposit lawsuits where the deposit refund has been reduced by the amount of unpaid rent.  Here, the $200 fee is no different than the unpaid rent – in both matters, the tenant knew in advance that the tenant owed that amount to the landlord.  Accordingly, no notice in the form of a 45 Day Letter would be required.

Read more about Indiana’s Security Deposit Laws.


Avoid Shareholder Disputes- ALWAYS!

Every small business needs to address the possibility of future shareholder or owner disputes. These concepts apply to every business structure, including partnerships, limited liability companies ans corporations.

Shareholder disputes are time-consuming, expensive and counter-productive. Shareholders disputes are easy to avoid, if you agree on basic principles before shareholders come together as business partners. The basic principles include-

1. Who does what jobs.
2. Who gets paid what and when. (I include a provision to cover taxes.)
3. What happens if someone stops working or completing their job duties.
4. What happens if there is a buy-sell “triggering event” such as death, divorce, dissolution of the entity, disability, etc.
5. How elections are held to select company leaders.

The key to solving shareholder disputes is to AVOID them in the first place through buy-sell agreements, operating agreement and similar documents. Do NOT form your business partnership without addressing these issues IN WRITING AT THE START.

One final thought. . . pick your partners well. I have myself had to endure difficult and unreasonable business partners. So, trust me when I urge you to be cautious in selecting your partners. Assume each partner will be unreasonable at some point.

And get it in writing at the start!

What is “Phantom Income” for a small business owner?

Before I can define

“phantom income,” I’ve first got to explain how “tax flow through entities” work. Basically, if you own at least part of a partnership, limited liability company or S-corporation, you get a a tax bill each year based on your share of the business’ profits. That bill comes in the form of a K-1 tax form, which shows your portion of the profits or losses.

So, if you own 40% of a company (for the entire tax year) that had $100,000 of profits in 2008, then you would get a K-1 for $40,000. If you only owned that 40% for half the year, your K-1 should report $20,000 of imputed income to you. You then have to report that income on your individual income tax return and pay taxes on that amount.

But wait! What if the company never paid you a distribution (a/k/a dividend) equal to your K-1 number? Or, what if the company only pays you $12,000, but your K-1 shows $40,000 of income? If that happens, you have have “phantom income.” So, even though you only received a distribution of $12,000, you have to pay income taxes on the full $40,000.

If you want to avoid paying taxes on “phantom income,” then you should consider an agreement among all the owners and the company requiring the company to distribute at least enough profits to cover the taxes on your “phantom income. When I draft these agreements for my clients, I like to include a provision requiring no less than 40% of the company’s profits to be distributed, which should normally be enough in distributions to cover the highest marginal tax rate on any one owner. I include an exception, in the event the company has anticipated cash flow issues, or is about to make a large expenditure and needs the cash.

If you fail to include such a provision in your agreements, then you run the risk that the majority owners might try to “freeze out” the minority owners by causing “phantom income” to be reported on the minority owner’s K-1, year after year after year. In that case, it actually costs money for the minority owners to own a share of a profitable company.


How Do I Resolve A Dispute?

hand shake


The best way to resolve a dispute is to AVOID disputes in the first place!  Seriously.  Think about it.


Lawyers spend as much or more time resolving disputes than they do preventing them.  The cynic in me thinks that lawyers prefer lawsuits, because lawsuits are time consuming and generate more fees for lawyers.  When a client gets sued, the client has few options- settle on unfavorable terms, bankruptcy or fight the lawsuit.  There are costs associated with each of these three options.


There is a better way. . . well drafted and implemented contracts and legal forms.


Sadly, many clients do not want to pay a lawyer for the time it actually takes to create a good contract.  Yet, a good contract is like insurance, in that sense that you can pass on liabilities and risks to another person through contracts.  Actually, insurance is a contract between you and the insurer.  A good B2B or B2C contract transfers risks from your business to another business or your customer, much like insurance.


Best of all, contracts set expectations.  Everyone signing a good contract knows what the result of a lawsuit will likely be, resulting in fewer reasons to file lawsuits.  Think about this- Why would you defend a lawsuit, if you knew you were going to lose in court?  If your contract tells you that you’re going to lose, then settle and write a better contract next time.


The difficult lawsuits are those where (1) there is a bad contract in place or (2) the facts are uncertain.  Those are the cases that should go to court.


However, before you run to the courthouse, consider four other ways to resolve a dispute:

1.  Try it again.     Reformulate the relationship by drafting a new contract to replace the one you signed.  Presumably, you and your “opponent” wanted to do business together when you signed the first contract.  If the contract form you signed was poorly written, consider efforts to save the relationship and sign the contract you wanted from the beginning.  If all trust is lost, then this option won’t work.

2.  Try talking.   Try settlement negotiations with or without your lawyers present.  It is amazing how easy it is to resolve disputes over a cup or coffee or a beer.  Try it.

3.  Mediation.  This is a process available before or after a lawsuit is filed.  A mediator is hired to assist you in negotiating a settlement.  The process depends on the willingness of the parties to settle.  Note that the rules governing mediation differ depending on whether mediation is done before or after a lawsuit is filed.

4.  Arbitration.  Essentially, you hire a private judge.  The advantage of arbitration is that it is faster and cheaper than going to court.


In a future blog, I’ll talk about these four options in more detail.  There is an article on arbitration clauses in contracts on my law firm’s website-

Buy-Sell Agreements- If you have a business partner, you should have a partnership agreement.


A buy-sell agreement (“BSA”) is a great document.  BSA’s can be used for corporations, limited liability companies and partnerships.  Often, a BSA is embedded in the Operating Agreement of an LLC or the Partnership Agreement of a general, limited or limited liability partnership.  The form of a BSA is far less important than are its contents.  So, don’t get confused by the name of the agreement.  Rather, consider the purpose and content of a BSA.  I’ll write about the substance of BSA’s in a future blog.  Here, I want you to consider WHY you should consider a BSA for your business partnership.


BSA’s serve several important purposes, such as these:

  • A BSA can prevent disputes over control of a company.

HOW?  A well-written BSA establishes when and how one owner may or must buy the ownership of another owner.  If disputing owners know the outcome of their power struggle, they are less like to fight.  The end result is already decided.  Generally, people fight, when they believe they can make gains through the process.  BSA’s reduce the opportunities to gain through struggle, and thus reduce disputes/lawsuits.

  • A BSA creates a market for your ownership interests.

HOW?   There is no market to sell partial ownership interests in most small companies.  There is no stock exchange for such “closely-held” companies.  A BSA can create a market by requiring one owner to  buy the other owner’s shares under certain circumstances, which we call “triggering events.” 

    “Triggering events” are bad things that can happen to any business owner.  The key triggering events are: 

  • The death of an owner.
  • Marital divorce.
  • The disability of an owner.
  • Unwillingness of an owner to continue the business.  I call this “disinterest.”
  • Retirement by an owner.
  • Dissolution of the company.
  • A BSA can further your Asset Protection Plan.

HOW?   Under certain circumstances, a BSA can make it extremely difficult for the creditors of an company to get at the ownership interests of an owner.

  • A BSA enables you to keep your company longer.

HOW?   If your partner “triggers” your buy-sell agreement, you can agree in the BSA to a payment plan.  So, in other words, if you have to pay $80,000 to buy your partner’s ownership interests, the BSA can provide for terms.  Typically, you agree to a down-payment, a modest interest rate on the balance and payments over time.  That enables the “buying” owner to keep the business going, rather than being forced to sell the company or key company assets.  Having to buy-out your partner is an extraordinary expense.  A BSA can make those payments manageable.

  • Much, much more.

There are other advantages to BSA’s.  There are also disadvantages.  Whether a BSA is right for you depends on a number of factors.  Your CPA and attorney can help you determine if and how a BSA should be used.