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2020 Newsletter Archive

Newsletter Exclusive Article:

The Long Term Impact of the New York State Court of Appeals Ruling

On Housing Stability and Tenant Protection Act of 2019

On April 2nd, the New York State Court of Appeals issued a landmark opinion In the Matter of Regina Metropolitan Co., LLC v. New York State Division of Housing and Community Renewal, and three related cases, including Reich v. Belnord Partners, in which Rosenberg & Estis, P.C. represented the owner. In a decision with far reaching implications for the industry, the Court of Appeals held that Part F of the Housing Stability and Tenant Protection Act of 2019 cannot be applied retroactively, because to do so would subject building owners to new or increased liability for past conduct. The ruling stated that the retroactive application of the overcharge amendments in Part F of the HSPTA would unconstitutionally infringe on owner’s substantive due process rights.

Each of the cases involved an apartment that was treated as deregulated during the owner’s receipt of J-51 tax benefits, prior to the Court of Appeals’ 2009 decision in Roberts, wherein it concluded that luxury deregulation was unavailable during the receipt of J-51 tax benefits. The Roberts decision rejected the long-standing interpretation of the law by the lower Courts and DHCR and had the effect of re-regulating thousands of apartments previously deregulated in good faith in reliance on the then interpretation of the law. It also opened the floodgates to rent overcharge claims by tenants arising out of the Roberts decision. The 2019 enactment of the HSTPA exacerbated these issues by eliminating the existing statute of limitations and extending both the lookback period for determination of rent overcharges and the recovery period in which tenants could recover damages, including the expansion of treble damages.

In Rosenberg & Estis‘ case, Reich v. Belnord Partners, LLC, the tenants took occupancy of the apartment in 2005 at a market rent following luxury deregulation. Following the Roberts decision in 2009, the owner registered the apartment as rent stabilized and notified the tenants of those rights, and the tenants waited more than six years, until 2016, to file a claim of rent overcharge. After Rosenberg & Estis was successful before both Supreme Court and the Appellate Division in obtaining a dismissal of the tenants’ rent overcharge claim, the tenants were granted leave to appeal to the Court of Appeals.

The tenants’ appeal to the Court of Appeals was heard after the state legislature enacted the HSTPA, which made sweeping changes to rent laws. Part F of the HSTPA drastically changed the method to determine the legal regulated rent in overcharge cases and expanded the scope of an owner’s potential liability by eliminating the statute of limitations, providing that an overcharge claim can be filed at any time, eliminating the four-year lookback rule and permitting the Court to consider an apartment’s entire rent history, expanding the recovery period from four to six years, expanding the record keeping requirement, expanding the treble damages penalty for willful rent overcharge from two years to six years, and making the award of attorney’s fees mandatory, rather than discretionary.

In what would ultimately be a substantial strategic error, the tenants argued that the amendments contained in Part F of the HSTPA should be applied to their pending appeals, so as to retroactively modify the standards for determining rent overcharges. As a consequence of the tenants’ claims, the Court of Appeals invited the parties to submit supplemental briefing with respect to the application of the HSTPA, and asked the parties to advise the Court what issues, if any, they believed that the Court should resolve. Rosenberg and Estis opposed the tenants’ arguments, as well as those raised by various amicus curae, and argued that the HSTPA could not survive constitutional scrutiny of its impact on owners’ substantive rights, nor could it revive those claims that were already time-barred because of the expiration of the statute of limitations.

The Court of Appeals adopted Rosenberg and Estis’ analysis and held that the amendments contained in Part F unconstitutionally infringed on the owner’s substantive due process rights if applied retroactively to past conduct and overcharges prior to HSTPA and do not revive the overcharge claims that were time-barred. The Court held that overcharge claims must be resolved pursuant to the law in effect when the purported overcharges occurred.

The Court of Appeals decision has many far-ranging favorable implications that are significant to owners, including:

· Statute of Limitations: The HSTPA does not apply retroactively to revive an overcharge claim that was time-barred at the time the HSTPA was enacted. Thus, a rent overcharge claim that was barred by the four-year statute of limitations on June 14, 2019 is forever barred.

· Four-Year Lookback Rule in Cases Concerning Overcharges Prior to June 14, 2019: In rent overcharge cases concerning overcharges or owner conduct alleged to have occurred prior to the enactment of the HSTPA (June 14, 2019), the overcharge claim must be resolved pursuant to the law in effect at the time the alleged overcharge or conduct occurred. Pursuant to the law in effect prior to the HSTPA, review of the rental history outside of the four-year lookback period is not permitted for calculation of the base date rent or to permit recovery for years of overcharges barred by the statute of limitations. Review of the renal history outside of the four-year look back period is only permitted in the limited category of cases where the tenant produces evidence of a fraudulent scheme to deregulate the apartment and, even then, solely to ascertain whether fraud occurred.

· Willfulness and Fraud in post-Roberts Cases: The Court clarified that willfulness means “consciously and knowingly charging improper rent,” such that a finding of fraud (or willfulness) is generally not applicable in post-Roberts cases, where owners relied on incorrect guidance from DHCR in luxury deregulating apartments, explaining that conduct cannot be fraudulent without being willful. Therefore, absent proof of fraud, the default formula is not applicable in post-Roberts cases, including “where the base date rent is the result of a mere mistaken overcharge (not fraud) and the rent charged on the base date is known.”

· Record-Keeping Requirement: Pre-HSTPA law will apply to overcharge claims concerning overcharges or conduct alleged to have occurred prior to June 14, 2019. Thus, absent fraud, an owner will not be required to produce records, including individual apartment improvement records, for a period more than four years prior to the assertion of the overcharge claim.

· Treble damages: For rent overcharge claims that arose prior to the enactment of the HSTPA, an owner will not be liable for the expanded six-year treble damage period, and, with respect to Roberts cases, reliance on DHCR’s rulings prior to Roberts will insulate an owner from a finding of willfulness.

· Apartments Not Necessarily Stabilized for the Duration of the Tenancy After the Expiration of J-51 Tax Benefits: Under pre-HSTPA law, the analysis automatically affording rent-stabilized status to apartments for the duration of the tenancy should not be followed. In buildings affected by Roberts, apartments revert to their original rent-stabilized status after expiration of J-51 benefits. The Court explained, however, “[t]his is not to say that tenants of those apartments necessarily are entitled to rent stabilization for the duration of their tenancy. Under [pre]-HSTPA [law]…Nothing precluded the owner from pursuing luxury deregulation after J-51 benefits expired [and] the fact that the owner had not provided notices advising the tenants of its participation in the J-51 program is irrelevant.” Thus, although not specifically referenced in Part F of the HSTPA, owners may be able to successfully pursue luxury deregulation petitions for years prior to 2020.

· Filing Belated Registrations Does Not Generally Result in a Rent-Freeze for Overcharge Calculation Purposes: The failure to timely file rent registrations will not deprive an owner of its right to otherwise lawful increases. The Court explained, “the fact that…registration statements were filed retroactively is addressed by a separate statutory surcharge for late registration” and in any event, “rent freezing is inapplicable in Roberts cases where the failure to timely register resulted directly from DHCR’s endorsement of a misunderstanding of the law.” Thus, whether or not registrations were timely filed, an owner should be entitled to adjust the base date rent by legally permitted increases.

Owners should be mindful of one aspect of the Regina decision that clarified the manner in which the default formula is to be applied. If a tenant establishes a fraudulent scheme to deregulate an apartment, the Court of Appeals sanctioned the use the default formula in such cases for calculating the legal rent and the amount of any overcharge.

Five months after the Regina decision, the Courts have largely applied the limitations imposed by the Court of Appeals. In Schrader v. Lichter Real Estate Number One, L.L.C., 2020 N.Y. Slip Op. 32501(U), another case handled by Rosenberg & Estis, the Supreme Court granted the owner summary judgment dismissing tenants’ complaint and holding that the conduct alleged – – failure to offer rent stabilized leases, renewals, and lease riders, and to register the apartments with DHCR – – is insufficient to establish fraud, and referable to owners’ belief that it was entitled to rely on the then existing DHCR guidance and regulations.

In Dugan v. London Terrace Gardens, L.P., 2020 WL 4212776, the Appellate Division, First Department vacated the lower court’s methodology for calculating the legal rents and determining rent overcharges and remanded the matter for the court to establish a methodology consistent with Regina. Similarly, relying on Regina, the First Department held in Corcoran v. Narrows Bayview Company, LLC, 183 AD3d 511, that a tenant’s claim for treble damages based on alleged willful deregulation of an apartment and failure to file rent registrations was properly dismissed where the owner followed DHCR’s pre-Roberts guidance.

While the post-Regina case law is largely good news for owners, Gold Rivka 2 LLC v. Rodriguez, 68 Misc.3d 1210(A) is cautionary. Ruling on motions by both the owner and the tenants to apply the holdings of Regina, the court found that because the tenants had established a fraudulent scheme to deregulate the premises, the rent must be set at the lowest rent registered for a comparable apartment in the building on the date that the tenant first took occupancy, and thereafter frozen until the owner registered the apartment with DHCR.

This landmark opinion has just begun to be examined by the lower courts, in part due to its issuance during the COVID pandemic. It does, however, provide stability and a framework for owners and lenders to evaluate tenant claims and potential liability in connection with acquisitions and lending.


Newsletter Exclusive Article:

The Distressed Tenant – What’s A Landlord To Do

Rumors are swirling that National Widget Co. is having financial troubles. Their stores average 30,000 square feet and are designed to highlight an assortment of widgets. Unfortunately, this multi-tier, custom lighted scheme does not serve other tenants well.

An email just arrived. National Widget would like to meet. In a follow up phone call, National Widget emphasizes how important your space is to them, how you as a landlord are the best landlord they could ever hope to work with and how they hope the meeting can help find a successful path forward.

The meeting begins with National Widget assuring you they are not going out of business. But, they may – well, probably, will be filing bankruptcy. The good news is that they would like to keep your space. But the bad news is that they cannot afford to keep it at the current rent. And, the escalations that you were counting on in the final 15 years of the lease will need to be sharply reduced if they are to remain in the premises. And, the really bad news is the current rent will need to drop by approximately 2/3. Or, if it’s better for you, they will give you the space back.

As the meeting ends, the National Widget Team reiterates how much they enjoy working with you, love your space and hope to continue the relationship. Take your time. They need your answer by the end of the week, or they will be forced to assume you want the space back.

National Widget also owes two months back rent. You mention this.

The answer?

Sorry.

The Bankruptcy

When you arrive in the office a week later, you learn that National Widget filed for bankruptcy. Senior management had decided not to respond to the offer. National Widget filed a number of “first day motions” including one that moved to reject your lease.

You immediately call your tenant. The tenant tells you — “We didn’t think you wanted to accept our offer. We are willing to talk. We really like you and your space.”

Did The Landlord Make A Mistake In Not Accepting The Earlier Offer?

Not necessarily. There is an ongoing conversation. Certain locations are non-core and will be closed. These locations will have their leases rejected. In this case, the location is marginal or good, but the rent appears to be high for the revenue that is generated. The tenant is willing to negotiate, so the landlord read the situation properly.

Isn’t It Better to Take An Offer And Avoid Risking Rejection in Bankruptcy?

This is a difficult decision and depends on the tenant, the property and the landlord. If the leasehold is below market, under the Bankruptcy Code, the Debtor could sell the leasehold and retain the sale proceeds. Thus, if a tenant can use the threat of its bankruptcy to negotiate concessions, a landlord could find itself having given away a valuable asset in the form of a leasehold which is ultimately transferred to a solvent tenant that could have paid market rent.

What’s The Answer?

All real estate is unique. Ultimately, the relationship of the tenant to the property, the neighborhood and the landlord may determine the outcome. Should you allow a tenant to reduce their footprint? Should temporary rent concessions or a renegotiation of the lease term occur? Each of these issues needs to be addressed on a case-by-case basis, looking at the financial condition of the tenant, their industry, the property, the lease and the landlord’s short and long-term goals.

Time to call a bankruptcy lawyer. Upon retaining bankruptcy counsel, you will probably learn that the courts tend to defer to the debtor’s business judgment in deciding whether or not to permit rejection of a lease of non-residential real property. You will also learn that most of your damages will be treated as general unsecured claims. Of course, depending on when the debtor vacates the premises and the Order authorizing rejection, a landlord may have an administrative claim in addition to its pre-petition claim as well as a claim for rejection damages. You will also learn that under the Bankruptcy Code, your rejection damages claims are going to be capped under the provisions of the Bankruptcy Code.

Tenant tells you how much they would like to stay in the space. They also tell you that they need rent concessions. Your lawyer says that the Debtor can simply assume the lease, but debtor’s counsel explains that given the cost, this does not fit in the current business model. You have a hard choice. Do you take the property back? Or, do you accept the concession? Ultimately, a landlord could elect to wait and see if the tenant elects to assume or reject the lease. If the tenant were to assume the lease, it must cure all prepetition defaults and assume the lease in its entirety. Of course, if the tenant rejects the lease, the landlord faces dark space.

This scenario is increasingly being faced by landlords as retailers continue to feel the pressure from rising labor costs and online competition. Landlords will need to evaluate how best to respond. Act too early or give too much and, in a subsequent bankruptcy, you may find your lease being sold to the highest bidder. Wait too long or ask for too much, and you may end up with dark space.

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