Fraudulent Scheme: Taking Stock of the HSTPA Three Years Later
By Zachary J. Rothken
“Bad laws are the worst sort of tyranny.” – Edmund Burke
Much ink has been spilled describing the drastic effects and purportedly unintended consequences of the Housing Stability and Tenant Protection Act of 2019 (“HSTPA”). Signed into law on June 14, 2019, the HSTPA changed the world of New York real estate as we know it.
Three years have since passed, and it has felt more like a decade. In the three years since the HSTPA, we have experienced a global pandemic, an exceedingly long eviction moratorium and bruising inflation. New political leadership has emerged at the Federal, State and City levels. The prospect of “good cause eviction” occupies headlines, and the legislature blindly declined to extend the vesting deadline for 421-a(16) tax benefits.
In lieu of rehashing the doom and gloom of the HSTPA, I would like to take this opportunity to take stock of some of the developments which have occurred in the last three years and where we, as New York City property owners, are headed as we tread further into uncharted waters.
What better way to commemorate the HSTPA’s three-year anniversary than to discuss the definition of fraud?
On June 14, 2019, then-Governor Cuomo signed the HSTPA which became effective immediately (late on a Friday afternoon, of course). The HSPTA as written, inter alia, repealed luxury deregulation, statutory vacancy increases and longevity increases, radically capped individual apartment increases to 1/168th or 1/180th of up to $15,000 of the cost of renovations, and made preferential rents constant for the remainder of a tenant’s tenancy.
The HSTPA, on its face, also increased the lookback period for rent overcharge claims to the “last reliable registration” going back “six years or more,” as of right, even without any indicia of a fraud and irrespective of how far back the “last reliable registration” may have occurred. The legislation did not clarify what “reliable” meant, so potentially any bump in the rent, however ancient, could presumably be deemed “unreliable” and subject to lookback to the registration immediately preceding that large increase. This was a major problem for property owners who, prior to the HSTPA’s abrupt enactment, were not legally required to maintain rent records for more than four years. The HSTPA also provided that treble damages may be imposed for the entire 6-year collectability period if the owner cannot prove that the overcharge was not willful.
In March 2020, the COVID-19 pandemic swept into New York City. The City essentially shut down, DHCR and the courts hit pause, and tenants stopped paying rent. An onerous eviction moratorium was put in place. Owners found themselves in an unprecedently challenging situation.
Much of this changed just two weeks into the height of the COVID-19 pandemic. On April 2, 2020, the Court of Appeals offered property owners a relative reprieve.
In Regina Metropolitan Co. v. DHCR, 2020 NY Slip Op 02127 (N.Y. 2020), in which Rosenberg & Estis represented one of the owners, the Court of Appeals held that the legislature overreached and that Part F of the HSTPA shall not be applied retroactively. The Court held that the HSTPA’s provisions which govern legal rent calculations and overcharges may not be retroactively applied to overcharges alleged to have occurred prior to June 14, 2019. Any pre-HSTPA overcharges must be governed by the law in effect at the time of occurrence.
While there is still a great deal to be clarified by the courts, Regina can be broadly summarized as follows: For overcharges which are alleged to have occurred prior to June 14, 2019, in the absence of a “fraudulent scheme to deregulate,” DHCR or a Court may not consider rent history beyond four years from the filing of the overcharge claim. Even if a claim of a pre-HSTPA overcharge is filed on or after June 14, 2019, the Appellate Division, First Department held that the base date is still four years prior to the date the complaint is filed. See Austin v. 25 Grove St. LLC, 2022 NY Slip Op 00716 (1st Dep’t 2022). Other courts have held that the lookback under such circumstances is June 14, 2015, which is four years prior to the HSTPA’s enactment date.
Regina further clarified that, consistent with pre-HSTPA law, if a tenant puts forth sufficient indicia of a “fraudulent scheme to deregulate,” DHCR or a Court may review the rent history beyond four years from the filing of the overcharge claim, but solely to determine whether a “fraudulent scheme to deregulate” occurred. In order to establish a “fraudulent scheme,” all elements of common law fraud must be met: a willful misrepresentation of material fact, falsity, scienter, reliance and injury. See Regina, n.7.
If a court or DHCR finds a “fraudulent scheme,” the default formula, along with the imposition of treble damages, will be applied. It remains an open issue as to how far back DHCR would impose treble damages in the event an owner is unable to establish that a pre-HSTPA overcharge was not willful. All other applications of the HSTPA, such as the elimination of luxury deregulation and statutory vacancy and longevity increases, still apply, but prospectively only.
Critically, Regina clarified that the same rules apply to “Roberts-type” cases (improper J-51 deregulations) and “non-Roberts-type” cases. Unaffected by Regina is that there is no limitation on lookback concerning regulatory status of an apartment; consideration of events beyond four years is permissible as of right for the purpose of determining whether an apartment is regulated. 150 E. Third St. LLC v. Ryan, 201 AD3d 582 (1st Dep’t 2022); East West Renovating Co. v. DHCR, 16 AD3d 166 (1st Dep’t 2005).
What is Fraud?
While Regina afforded owners a much-needed reprieve during one of the most challenging times in New York real estate history, it left many questions unanswered. Regina held that review of rental history beyond four years applies “where the tenant produced evidence of a fraudulent scheme.” However, despite Regina’s clear reference to a fraudulent scheme to deregulate, the question of how to define “fraud” quickly arose in subsequent cases.
In 435 Cent. Park W. Tenant Assn. v. Park Front Apts., LLC, 183 AD3d 509 (1st Dep’t 2020), the Appellate Division, First Department expanded the definition of a “fraudulent scheme to deregulate” claim to, broadly speaking, any scheme involving fraud such as a “fraudulent rent overcharge scheme.” Park Front’s broad interpretation of “fraudulent scheme” was the first of its kind at the appellate level and appears, on its face, to be inconsistent with Regina.
Similarly, in Montera v. KMR Amsterdam LLC, 193 AD3d 102 (1st Dep’t 2021), the Appellate Division, First Department cited Park Front and echoed its prior holding that the “fraud” exception likewise applies to any type of fraudulent scheme, such as a fraudulent scheme to overcharge or a fraudulent scheme to keep previously deregulated units out of rent stabilization. Justice Gische issued a scathing dissent in Montera which, inter alia, underscored that the analysis concerns a “fraudulent scheme to deregulate.” Montera remains pending before the Court of Appeals as of the date of this writing.
In Gridley v. Turnbury, 196 AD3d 9 (2d Dep’t 2021), the Appellate Division, Second Department, held that the analysis must be whether the owner engaged in a “fraudulent scheme to deregulate.” In that case, the Appellate Division held that the Owner did not engage in such a scheme, and on December 14, 2021, the tenants’ motion for leave to appeal to the Court of Appeals was denied.
Likewise, in Ioannou v. 1BK St. Corp., 203 AD3d 627 (1st Dep’t 2022), the Appellate Division, First Department indicated that the analysis in determining whether “fraud can be shown” is whether the owner “engaged in a fraudulent scheme to deregulate.” See also, Hess v. EDR Assets LLC, 2021 NY Slip Op 06920 (1st Dep’t 2021); Vendaval Realty, LLC v. Felder, 67 Misc. 3d 145(A) (AT1 2020).
In Casey v. Whitehouse Estates, Inc., 197 AD3d 401 (1st Dep’t 2021), the Appellate Division, First Department seemingly contradicted its prior precedent in one fell swoop. In Casey, the court faulted the owner for performing its own calculations for refunds on alleged rent overcharges and held that the owner should have essentially sat and waited until the court performed its own calculations. Casey held that the owner’s good faith corrective measures constituted an “attempt to avoid the court’s adjudication of the issues and to impose their own rent calculations rather than face a determination of the legal regulated rent within the lookback period.” Casey also held that although the owner did not commit fraud prior to the four-year base date, the owner’s post-base date conduct constituted a fraudulent scheme.
The Appellate Division demonstrably erred in Casey because the whole institution of the “fraud” exception was because, as established in Grimm, pre-base date fraud renders the base date rent unreliable. Base date rents are presumed to be reliable, and subsequent events cannot, by definition, have an effect on a prior date’s rent’s reliability. Casey remains pending before the Court of Appeals as of the date of this writing.
Accordingly, the issue is one that is yet to be resolved. In the meantime, tenants will likely try to pin any perceived misconduct as a “fraudulent scheme.” We recommend that you reach out to us with any questions in this regard.