Standby Letters of Credit vs Cash Deposits for a Commercial Lease

Your bank issues the letter on your behalf, promising to pay the landlord up to a stated amount if you default under the lease and the landlord makes a proper draw request. You never send the bank cash directly the way you would with a deposit; instead, the letter counts against your credit facility or requires you to post collateral, depending on your banking relationship and creditworthiness. The landlord accepts the letter as security precisely because a bank, not you, is standing behind the payment promise.

Most landlords are indifferent between the two as long as the security is real and enforceable, but some prefer cash because drawing on a letter of credit involves following its specific terms exactly, including exact dollar amounts, correct beneficiary names, and draw request formatting, and a poorly drafted letter can create friction at the exact moment the landlord needs to draw on it. If a landlord pushes back on accepting a letter, ask specifically what about the draft language concerns them rather than assuming it's a blanket policy, since it's often a fixable drafting issue.

A cash deposit's cost is the opportunity cost of that money sitting idle, plus whatever interest the lease agreement does or doesn't require the landlord to pay you on it, which varies by jurisdiction and lease terms. A letter of credit's cost is an annual issuance fee charged by your bank, typically calculated as a percentage of the face amount, plus the fact that the letter reduces how much borrowing capacity you have available elsewhere on that same credit facility. For a company with a credit facility it isn't fully using, the letter is usually the cheaper path; for a company with no existing banking relationship or facility to draw against, standing one up just for lease security may not be worth the setup effort.

A cash deposit typically gets returned, net of any deductions for damage or unpaid rent, after the lease ends and any walkthrough is complete, though the timeline for that return varies by state law and lease language. A letter of credit usually needs to be renewed or amended alongside the lease if the term extends, and it's easy to let a letter quietly expire mid-term if nobody is tracking its expiration date separately from the lease's own renewal date. Missing that expiration can put you in technical default of the lease even if you've never missed a rent payment.

If you have unused capacity on an existing credit facility and a bank relationship that can issue letters of credit efficiently, a standby letter almost always beats tying up cash for the length of a multi-year lease. If you don't have that facility in place and the deposit amount is modest relative to your cash position, setting up a whole banking arrangement just to avoid a cash deposit usually isn't worth the fees and effort. Run the comparison against your actual facility terms rather than a generic rule of thumb before you decide.

Weigh these factors when choosing the form of security:

• Whether you have unused capacity on an existing credit facility that a letter of credit would draw against.
• Whether your bank can issue standby letters efficiently, or whether setting one up would be more effort than the deposit is worth.
• How large the deposit is relative to your cash position, since a modest deposit may not justify a new banking arrangement.
• How the annual issuance fee compares with the opportunity cost of leaving cash idle with the landlord for the full lease term.

Whichever form of security you post, push to negotiate the specific mechanics in the lease itself rather than accepting the landlord's standard template. Ask for a defined, narrow list of default events that actually permit a draw or a deduction, rather than open-ended language that lets the landlord reach the security for any dispute. Ask for a stepped reduction schedule tied to time elapsed without incident, so the amount posted shrinks as your track record under the lease grows, which matters whether that security sits as cash or as a letter of credit behind it.