290 Div. (EAT), LLC v. City & Cnty. of S.F.

• Decision Date: 16 December 2022
• Docket Number: A162055
• Citation: 86 Cal.App.5th 439,302 Cal.Rptr.3d 493
• Parties: 290 DIVISION (EAT), LLC, Plaintiff and Appellant, v. CITY AND COUNTY OF SAN FRANCISCO, Defendant and Respondent.
• Court: California Court of Appeals Court of Appeals

86 Cal.App.5th 439

302 Cal.Rptr.3d 493

290 DIVISION (EAT), LLC, Plaintiff and Appellant,

v.CITY AND COUNTY OF SAN FRANCISCO, Defendant and Respondent.

A162055

Court of Appeal, First District, Division 2, California.

Filed December 16, 2022

Baker Botts, Jon D. Feldhammer, Benjamin C. Koodrich, for Plaintiff and Appellant.

David Chiu, City Attorney, Scott M. Reiber, Chief Tax Attorney, Carole F. Ruwart, Kevin Yeh, Ronald H. Lee, Deputy City Attorneys, for Defendant and Respondent.

STEWART, P.J.

This appeal presents an issue of interpretation of a tax statute. Plaintiff and appellant 290 Division (EAT), LLC (290 Division) contends that property it purchased from defendant and respondent the City and County of San Francisco (City) should have been reassessed for no more than the price it paid for the property. 290 Division paid $53 million, a price discounted to reflect a temporary below market leaseback it entered with the City..

The City relies on case law interpreting our Constitution's requirement that property be assessed based on its fair market value to mean that a buyer's agreement to limit the use of the property does not reduce its fair market value for tax purposes. The courts have long held that while the purchase price "may play a significant role in the reassessment of property upon its sale," that price "is only the beginning and not necessarily the end of the inquiry, and that one factor that may "skew the purchase price and make it an unreliable indicator of the fair market value" is a purchase agreement containing "restrictions on the buyer's use of the property, thus resulting in a reduced purchase price." ( Dennis v. County of Santa Clara (1989) 215 Cal.App.3d 1019, 1027, 1028-1029, 263 Cal.Rptr. 887.) The courts have held such restrictions in a purchase agreement do not bind the assessor. " ‘The present owner may have invested well or poorly, may have contracted to pay very high or very low rent, and may have built expensive improvements or none at all.... [S]ince ... the legislative standard of value is "full cash value," it is clear that whatever may be the rationale of the property tax, it is not the profitableness of property to its present owner.’ " ( Id. at p. 1030, 263 Cal.Rptr. 887.) The City argues this case law, which indisputably governs properties transferred between private parties, applies to assessment of properties sold by a public entity to a private party.

290 Division relies on a statute first enacted by the Legislature in the middle of the 20th century to provide that government-imposed land use restrictions on property must be taken into account when property is valued for assessment purposes. 290 Division argues the statute should be interpreted to include among the "enforceable restrictions" that reduce the value of property for tax purposes, a leaseback agreed to as part of an arm's-length transaction between a government seller and private buyer.

We hold that "enforceable restrictions" for purposes of section 402.1 of the Revenue and Taxation Code,¹ mean land use restrictions imposed by government acting under its police power, not restrictions agreed to by a public entity selling property to a private buyer in an ordinary arm's-length transaction.

BACKGROUND

I.Procedural Posture

290 Division appeals following the trial court's order sustaining the City's demurrer without leave to amend. 290 Division filed an action for refund of property taxes after it purchased two office buildings from the City that included a short-term leaseback at below-market rent. 290 Division alleged that the City's assessor failed to take the leaseback into account when valuing the buildings for property tax purposes and claims this violated section 402.1. After failing to persuade the City's Assessment Appeals Board (AAB), 290 Division sued the City in Superior Court and the City demurred to the complaint. In sustaining the City's demurrer, the trial court held that as a matter of law, the lease did not constitute an "enforceable restriction" within the meaning of section 402.1. The court further held that 290 Division failed to show a reasonable likelihood that the defect could be cured by amendment and sustained the demurrer without leave to amend.

II.Facts

The City owned two office buildings located at 1660 and 1680 Mission Street in San Francisco (Property). The City decided to offer the Property for sale to finance the construction of a new building. The City did not include an asking price in its offer for sale.² As a condition of the sale, the City required that the purchaser lease the Property back to the City for a period of up to five years after the sale; three years at specified below-market rates followed by two one-year options at market rates. 290 Division submitted an offer to purchase the Property for $52 million, which the City accepted. Prior to closing, 290 Division obtained a loan appraisal that valued the Property at $52 million. The appraisal took the leaseback into consideration. On May 1, 2017, the parties finalized the sale, entered into leases pursuant to the leaseback, and executed and recorded a Memorandum of Lease.

Once the change of ownership occurred on May 1, 2017, the City initially assessed the Property's new base year value at $68 million for property tax purposes. 290 Division appealed that assessment. At the hearing before the AAB, 290 Division argued that the assessor failed to consider the leaseback as an "enforceable restriction" in valuing the Property under section 402.1, subdivision (a)(2), which states that enforceable restrictions include "recorded contracts with government agencies." The City responded that the leaseback was not an enforceable restriction primarily "because the City negotiated the leaseback while acting in its proprietary capacity, rather than in its regulatory capacity."

The parties stipulated that the value of the Property was $52 million if section 402.1 did apply and $63.1 million if it did not apply. Thus, in purchasing the property for $52 million, 290 Division reaped the benefit of a discount of more than $10 million in the price in exchange for agreeing to the leaseback.

The AAB concluded that section 402.1 did not apply and found the fair market value of the Property to be $63.1 million for tax purposes. Following the AAB's decision, 290 Division filed a complaint for refund of property taxes in San Francisco Superior Court. The complaint alleged that the Property should have been valued at $52 million and that the AAB's decision was contrary to section 402.1 and not supported by precedent. The complaint sought a refund of property taxes for 2018-2019 as well as a prospective refund of any taxes computed using a base year value greater than $52 million. 290 Division filed a first amended complaint after the City filed a demurrer to the complaint.³ The first amended complaint added allegations that the City used the proceeds from the sale of the Property to fund a new office building and that the leaseback enabled City employees to continue working at the Property in the meanwhile. The first amended complaint further alleged that these benefits to the City from the leaseback "served the interest of public health, safety, morals and/or general public welfare."

The City demurred to the first amended complaint. As it had in the proceedings before the AAB, the City argued that the leaseback was not an enforceable restriction under section 402.1 because the City entered the lease in its proprietary capacity. The City argued that such a private contract was not the type of enforceable restriction contemplated under section 402.1. As support, the City referenced other examples of "enforceable restrictions" under section 402.1, such as zoning, permits, and development controls of local governments, which are " ‘designed to serve the interest of public health, safety, morals and/or general public welfare’—all exercises of ‘police power’ " rather than "private commercial arrangements entered into by private parties in the open market." It pointed to the general rule that if private parties enter into a lease and the rent is lower than what the market supports, "the property tax calculation will generally be based upon the market-supported rent, rather than the rent required under the lease." (Quoting CAT Partnership v. County of Santa Cruz (1998) 63 Cal.App.4th 1071, 1086, 74 Cal.Rptr.2d 652 ( CAT Partnership ).) In the transaction here, the City argued, it was engaged in a proprietary function, not an exercise of police power, and the below-market rent for the leaseback was not the kind of police power restriction addressed by section 402.1.

In its opposition, 290 Division argued that the language in section 402.1 was clear and unambiguous that all "recorded contracts with governmental agencies" constituted "enforceable restrictions." The Legislature did not create any exceptions for contracts with governmental agencies acting in a proprietary capacity, and 290 Division contended that the court should not rewrite section 402.1 to include one. 290 Division further argued that even if section 402.1 only applied if the City restricted use of the Property while acting in a governmental or regulatory capacity, the first amended complaint adequately alleged that the leaseback allowed City employees to continue working at the Property "and thus contribute[d] to the area's roles as a center of government activity," which served a public interest.

Following oral argument, Judge Ethan Schulman sustained the City's demurrer without leave to amend. The court rejected 290 Division's "overly literal reading of the statute" and held that the lease was not an enforceable restriction because it lacked a governmental or regulatory component. The court relied on the reasoning in CAT Partnership, supra, 63 Cal.App.4th 1071, 74 Cal.Rptr.2d 652. The court further supported its conclusion by examining the other enumerated examples of "enforceable restrictions"...