How Stuyvesant Town Decision May Affect Your J-51 Buildings

On Oct. 22, 2009, New York State's highest court dealt a devastating blow to the owners of the Stuyvesant Town and Peter Cooper Village complexes in Manhattan when it ruled that they improperly began charging market rents on thousands of apartments. In a 4-to-2 decision, the court said that the owners improperly raised rents beyond certain set levels at the complexes while receiving tax breaks from the city for major renovations.

On Oct. 22, 2009, New York State's highest court dealt a devastating blow to the owners of the Stuyvesant Town and Peter Cooper Village complexes in Manhattan when it ruled that they improperly began charging market rents on thousands of apartments. In a 4-to-2 decision, the court said that the owners improperly raised rents beyond certain set levels at the complexes while receiving tax breaks from the city for major renovations.

Problems for the new owners began soon after the Tishman Speyer partnership bought the complexes. Shortly after the purchase, nine tenants of seven apartments in the complexes filed suit, claiming that the landlord had improperly raised rents for thousands of market-rate tenants while collecting more than $25 million in tax breaks since 1992 under the city's J-51 housing program. The program was intended to encourage landlords to rehabilitate their properties by providing tax breaks on the cost of various building improvements or renovations.

In their class action lawsuit, the tenants contended that Tishman Speyer and former owner MetLife owe tenants about $215 million in rent overcharges and other costs on apartments decontrolled after vacancies or improvements. They also estimated that one quarter or more of the 11,200 units in the complex have illegally been subjected to luxury decontrol.

Broadly, the Court of Appeals decided that owners cannot deregulate rents on units under the luxury decontrol provisions of the Rent Stabilization Law while accepting public tax incentive benefits. It is estimated that the ruling could affect owners of as many as 80,000 apartments across the city that may also have improperly raised rents and deregulated apartments while receiving special tax breaks. We will discuss the potential impact of this ruling and the important issues that still need to be resolved in assessing the ruling's impact on your properties that receive special tax breaks.

Real Estate Industry Reaction

The initial reaction seems to be surprise that the court had overturned 15 years of real estate industry practice. In making its decision, the Court ruled that it does not “owe deference” to a 1996 advisory opinion from the Division of Housing and Community Renewal (DHCR) that determined that J-51 units are eligible for luxury decontrol. Prior to this decision, for the past 15 years, the DHCR had interpreted the Rent Stabilization Code to mean that only apartments that are rent regulated solely due to receiving J-51 tax benefits could not obtain high-rent/high-income or high-rent vacancy deregulation.

According to attorney Martin Heistein whose firm represented the owners, “The court failed to understand the distinction between buildings already rent stabilized that take J-51 benefits and buildings that first enter the rent-stabilized system at market rents taking much larger J-51 benefits.”

He was also surprised to see the majority in its decision rely on floor debate in the state senate, a highly disfavored means of interpreting statutes. Senator Kemp Hannon, one of the main sponsors of the J-51 law, was quoted as saying “to the extent the building is receiving a (J-51) tax exemption, it is not subject” to deregulation. Heistein argues that Senator Hannon's quote was taken out of context to support the finding that an owner cannot use luxury deregulation if the owner takes J-51 benefits. The quote was made in the context of new construction or apartments that were first entering the rent-stabilized system.

‘Unnecessary Upheaval’

Attorney Peter Schwartz notes that there may be significant consequences to the real estate industry resulting from the decision, since thousands of apartments have been deregulated over the years in buildings receiving J-51 benefits. Owners that have deregulated apartments while receiving J-51 benefits and that relied on the DHCR interpretation of the statute may face potentially large overcharge claims and penalties, wrongful eviction claims, and have to deal with issues of lease terms and required services in cases where additional services are given to a tenant who was believed to have been deregulated but is now stabilized.

In fact, the dissenters highlighted the “unnecessary upheaval” this ruling would cause. In dissent, Judge Susan Phillips Read wrote that while she was not suggesting the Court “shirk from its responsibility” for fear of creating “untoward or uneven consequences” for the parties in a case, it should avoid creating unnecessary upheaval in its decision-making.

“The Court does not, in my view, fulfill its duty to safeguard the stability of the laws when it tosses out a reasonable and longstanding statutory interpretation made by a specialized agency, as it does today,” Judge Read wrote in a dissent joined by Judge Victoria A. Graffeo.

Judge Read said many of the landlords who may be affected by the ruling are what she called the “Mom and Pop” owners of single buildings, many of them located outside Manhattan, who cannot afford prolonged court hearings.

“It will take years of litigation over many novel questions to deal with the fallout from today's decision,” Judge Read wrote. “In the absence of meaningful legislative action, uncertainty will reign in an industry already rocked by the bursting of the great residential real estate bubble.”

Retroactivity Issue

The court did not decide whether the ruling would have a retroactive effect or whether it would apply only to situations that occur subsequent to the decision. These issues were left to be decided in the lower courts. And until the courts provide some clarity, it is difficult for owners that receive J-51 benefits to chart a course of action.

According to attorney Niles Welikson, the factors that a court considers to determine whether a ruling should apply prospectively only seems to apply to this ruling. However, he states that there is unfortunately no way to predict at this time how the courts will rule on this particular issue. In fact, many questions that owners may have regarding the ruling are rooted in the issue of retroactivity. With the help of Welikson, the following are answers to the most common questions owners may have as a result of this decision.

Does it matter whether deregulation was luxury or high-rent vacancy? Some owners may be wondering if there is a distinction between situations where an apartment was deregulated during the J-51 benefit period based upon a vacancy and the rent being lawfully raised to $2,000 per month and those where an Order was obtained from the DCHR deregulating the apartment based upon a rental of $2,000 a month or more and the tenant's income being in excess of $175,000.

According to Welikson, there is no way to predict how the courts will rule on this issue since this also involves the issue of retroactivity. However, since high-rent/high-income deregulation involves the issuance of a DHCR “Order,” it is his firm's position that the Order must somehow be vacated by the DHCR or a court in order for it to be invalidated. As a result, he believes that an owner may rely upon an Order of Deregulation in this instance regardless of whether it was issued during the J-51 benefit period.

Must I adjust rents immediately?If you own a J-51 building, you may ask if rents for all apartments that were vacancy deregulated during the J-51 period must immediately be adjusted to reflect a stabilized rental.

The answer again depends on how the retroactivity issue gets resolved. If the ruling is not given a retroactive effect, the the apartments would have been properly deregulated assuming the $2,000 threshold was properly reached.

What should I do if tenant withholds rent? If a tenant who was vacancy deregulated during the J-51 benefit period withholds rent, claiming he should not be charged a fair market rent but rather a rent-stabilized figure, Welikson offers a temporary solution that involves having the tenant put the disputed amount in escrow pending a determination on the retroactivity issue. You may assume that the decision will eventually be found to have a retroactive effect and voluntarily adjust the tenant's rent as if the apartment had not been deregulated. But this could be a costly mistake in the event the court rules otherwise.

Must I renew affected tenants' leases, and if so, at what rent increases? You may be wondering if affected tenants' leases have to be renewed and, if so, what rent increases are permissible. Again, the answer depends on how the retroactivity issue is resolved.

Because of the ambiguity, if you were to offer a renewal lease at an increased rent, the tenant may refuse to sign. Ordinarily, you would start a holdover proceeding to evict the tenant for failing to renew a lease. At this point, it is possible that the court will outline a policy in dealing with these matters. However, until this occurs, Welikson believes that the courts will seek to maintain the status quo and therefore will not grant evictions or require that the tenants pay an increased rent since, if this decision is given retroactive effect, there is a possibility that they are already paying a higher rent than they should be paying under rent stabilization.

Welikson recommends considering offering the tenant a one- or two-year renewal lease at no increase. However, if you believe you need to increase the rent, you should do it pursuant to Rent Stabilization guidelines. Welikson warns that regardless of what you do, you need to be aware that the tenant may challenge your actions on the assumption that the ruling is retroactive, and therefore, his rent is incorrect.

What happens if tenant claims overcharges? A current tenant may either sue, claiming overcharges, or file a complaint with the DHCR. If the tenant sues, Welikson believes the court will probably withhold a determination until the retroactivity issue is resolved. If a DHCR complaint is filed, the DHCR would have to consider this issue. The DHCR has yet to outline a policy as to how it will handle these matters.

What should I do if former tenant seeks refund? If a former tenant claims that his former apartment was improperly deregulated and seeks a refund of rent paid in excess of the rent-stabilized rent, you need to consider how long ago the tenant occupied the apartment.

If the claim is over four years old, it would be barred by the statute of limitations. In other words, the tenant claim would be too old, and he would be unable to pursue the claim in court.

If the claim is within the four-year period, the retroactivity issue needs to be resolved. If you take the position that the ruling will have retroactive effect, which is a possibility, you can consider using the issue of retroactivity as leverage in attempting to agree to a settlement with the former tenant, reducing the amount you pay and also avoiding legal fees if the tenant pursues litigation.

There will be several years of litigation to resolve the issues raised in the Roberts v. Tishman Speyer decision. The decision will no doubt affect many owners, but exactly how everything plays out remains to be seen. The Insider will continue to follow the situation, but specific issues that arise in the near future should be dealt on a case-by-case basis with your attorney.

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