Action Apartment v. Santa Monica Rent Control

• Decision Date: 13 December 2001
• Docket Number: No. B146227.,B146227.
• Citation: 94 Cal.App.4th 587,114 Cal.Rptr.2d 412
• Court: California Court of Appeals Court of Appeals
• Parties: ACTION APARTMENT ASSOCIATION et al., Plaintiffs and Appellants, v. SANTA MONICA RENT CONTROL BOARD, Defendant and Respondent.

114 Cal.Rptr.2d 412

94 Cal.App.4th 587

ACTION APARTMENT ASSOCIATION et al., Plaintiffs and Appellants, v. SANTA MONICA RENT CONTROL BOARD, Defendant and Respondent.

No. B146227.

Court of Appeal, Second District, Division 1.

December 13, 2001.

Certified for Partial Publication.^*

As Modified Jan. 3, 2002.

Review Denied March 20, 2002. ^**

Law Offices of Rosario Perry, Rosario Perry, Santa Monica, and Marie E. Berglund, for Plaintiffs and Appellants.

Doris M. Ganga, General Counsel, and Joel Martin Levy, Staff Attorney, for Defendant and Respondent.

MALLANO, J.

The City of Santa Monica requires landlords of residential rental property to place tenants' security deposits in interest-bearing accounts at federally insured financial institutions. Since January 1, 1999, the city has required landlords to pay tenants 3 percent interest per year on security deposits.

A group of landlords filed this action, alleging that, due to market conditions, financial institutions are paying less than 3 percent on security deposits, and, as a result, landlords must make up the difference with their own funds. The landlords contend that this type of exaction constitutes a taking of private property without just compensation (Cal. Const., art. I, § 19; U.S. Const., 5th Amend.).

The trial court dismissed the action on demurrer. We conclude that the complaint sufficiently pleads a takings claim because the 3 percent interest requirement does not substantially advance a legitimate state interest and has an adverse impact on landlords. We therefore reverse.

I BACKGROUND

In 1979, the City of Santa Monica adopted a rent control charter amendment—the Rent Control Law (Santa Monica Charter, §§ 1800-1820)—and created a rent control board (Board) to prevent landlords of residential rental property from charging unreasonably high rents while, at the same time, allowing landlords to make a fair return on their property. Pursuant to the Rent Control Law, the Board adopted regulations that use a "net operating income" (NOI) formula to determine whether rents are providing landlords with a fair return on their property and, if not, the amount of a rent adjustment.

Under the NOI formula, a landlord's income in the base year (usually 1978) is presumptively a fair return. (Rent Bd. Regs., reg. Nos. 4101(e), 4102.) In subsequent years, a fair return is maintained by permitting rents to be raised based on increased operating expenses and inflation. "NOI" is defined as "gross income" less "operating expenses." (Id., reg. No. 4101(a).) "Gross income" includes gross rents (computed as gross rental income at 100 percent paid occupancy), cleaning fees, parking fees, and income from laundry facilities. (Id., reg. No. 4101(b).) "Operating expenses" include real property taxes, utility costs, insurance expenses [management fees, normal repair and maintenance expenses, and expenditures for capital improvements. (Id., reg. No. 4101(c)(1); see generally Kavanau v. Santa Monica Rent Control Bd. (1997) 16 Cal.4th 761, 768-770, 66 Cal.Rptr.2d 672, 941 P.2d 851 (Kavanau).)

As amended, the Rent Control Law states: "Any payment or deposit of money the primary function of which is to secure the performance of a rental agreement or any part of such agreement, including an advance payment of rent, shall be placed in an interest bearing account at a federally insured financial institution until such time as it is returned to the tenant or entitled to be used by the landlord. Unless and until the Board enacts regulations directing that the interest on such accounts be paid directly to the tenant, the landlord may either pay such interest directly to the tenant or use it to offset operating expenses .... The Board may regulate the amount and use of security deposits consistent with the purposes of this Article and State law." (Santa Monica Charter, § 1803(s), italics added.)

The Board amended its regulations in 1983 to state that "[a]ll security deposits shall be placed in an interest-bearing account at an institution whose accounts are insured by the Federal Deposit Insurance Corporation or the Federal Savings and Loan Insurance Corporation until such time as they are returned to tenants or entitled to be used by the landlord." (Rent Bd. Regs., reg. No. 14001(a).) The amended regulations did not require that tenants receive the interest on security deposits. Accordingly, landlords could either pay the interest to tenants or use it to benefit the property. (Santa Monica Charter, § 1803(s); see Rent Bd. Regs., former reg. No. 14001(b).) Until recently, that was the state of affairs in Santa Monica.

On January 28, 1999, the Board approved regulations stating: "A landlord shall pay 3% simple interest per annum on all security deposits held for [at] least one year. The Rent Control Board shall review the market interest rates at least every three years to determine the rate for the next three years. [¶] ... Interest shall begin accruing on January 1, 1999. A tenant shall be given unpaid accrued interest either by direct payment or by a credit against the tenant's rent." (Rent Bd. Regs., reg. No. 14001(b), (c).)

With the enactment of the 1999 regulations, the Board exercised its authority under the Rent Control Law to "direct[ ] that the interest on [security deposit] accounts be paid directly to the tenant...." (Santa Monica Charter, § 1803(s).) As a consequence, landlords could no longer use the interest to benefit the property. Instead, they became obligated to pay tenants a fixed rate of return—3 percent per year—on security deposits. (The Rent Control Law requires that security deposits be placed in a "federally insured financial institution." For simplicity, we will use the term "bank" to include all such institutions.)

On March 28, 2000, Action Apartment Association, an organization of residential landlords, and Herb Baiter, a landlord who owns 18 rental units, filed this class action, seeking declaratory and injunctive relief and damages for inverse condemnation. (We sometimes refer to the association and Mr. Baiter collectively as plaintiffs or the Association.)

The complaint alleged as follows: "[A]ll members of the Plaintiffs' class pay their tenants interest on security deposits at a rate more than the amount of interest paid by the banks on the deposited funds.... [¶] ... [¶]

"At the time [that] the first interest payment to tenants was due ..., landlords were receiving between .5% and 1.5% per year on their security deposited funds. This means that at least half of the payment of 3% by landlords was not and is not offset by [the] receipt of interest from the bank and ... amounts to confiscation by regulation of the landlords' own funds. [¶] ... [¶]

"[T]here are approximately 3,200 owners of residential rental property [in Santa Monica] and approximately 28,000 residential rental units. This means that [the regulations concerning interest on security deposits] have caused or will cause the residential rental landlords of Santa Monica to pay approximately $770,000.00 per year which they should not have had to pay. [¶] ... [¶]

"[The Board] will not review the 3% interest rate set by the regulations for 3 more years. Thus before the next scheduled review, landlords will lose in excess of $2,000,000.00 due to the wrongful regulations. [¶] The lost interest payments are not offset by any corresponding general rental increase or any other payment of monies to landlords. [¶] ... [¶]

"The difference between the interest received and the interest paid out has caused and will cause Plaintiffs ... to have out-of-pocket losses...."

The complaint alleged that the regulations concerning security deposit interest were: (1) invalid under the takings clauses of the state and federal Constitutions (Cal. Const., art. I, § 19; U.S. Const., 5th Amend.); (2) preempted by a state statute that governs the payment, use, and return of security deposits (Civ.Code, § 1950.5); and (3) unlawful as being in excess of the Board's authority under the Rent Control Law (Santa Monica Charter, § 1803(s)).

On July 17, 2000, the Association filed an amended complaint that, in most respects, was identical to the first one. The Association added an allegation that it "[did] not challenge the maintenance of security deposits or the payment of interest on security deposits; [the Association] challenged] only the mandated payment in excess of interest earned on the deposited funds with its effect of requiring landlords to reach into their own pockets to pay the additional interest." The Association also added a cause of action seeking a writ of prohibition.

On August 23, 2000, the Board filed a demurrer, arguing that the Association's legal theories were without merit. The Association filed opposition. On September 28, 2000, the matter was heard and taken under submission. On October 25, 2000, the trial court issued its ruling, sustaining the demurrer without leave to amend. An order and judgment were entered to that effect. The Association filed a timely appeal.

II DISCUSSION

In reviewing the ruling on a demurrer, "we are guided by long-settled rules. `We treat the demurrer as admitting all material facts properly pleaded, but not contentions, deductions or conclusions of fact or law.... We also consider matters which may be judicially noticed.' ... When a demurrer is sustained, we determine whether the complaint states facts sufficient to constitute a cause of action.... And when it is sustained without leave to amend, we decide whether there is a reasonable possibility that the defect can be cured by amendment: if it can be, the trial court has abused its discretion and we reverse; if not, there has been no abuse of discretion and we affirm." (Blank v. Kirwan (1985) 39 Cal.3d 311, 318, 216 Cal.Rptr. 718, 703 P.2d 58, citations omitted.) All material allegations of the complaint are accepted as true. (Hensler v. City of Glendale (1994) 8 Cal.4th 1, 8, fn. 3, 32 Cal.Rptr.2d 244, ...