By Adam Leitman Bailey and Dov Treiman
December 11, 2018
In their Real Estate Trends column, Adam Leitman Bailey and Dov Treiman discuss a pair of new decisions from the Appellate Term, First Department which have toughened the standards under which a landlord may claim a substantial rehabilitation exemption from rent stabilization, the effect of which may be to bring back into stabilization many buildings whose owners believed in good faith that their buildings were not regulated.
In the recent decisions, WFCC Realty Corp. v. Huang Hui Zhen, 59 Misc 3d 140 and WFCC Realty Corp. v. Lin, 2018 N.Y. Slip Op. 51402(U), the Appellate Term, First Department forced building owners to completely reconsider their methods for proving a rent-stabilization exempting substantial rehabilitation has taken place in a building. Since 1995, landlords seeking to establish such exempting construction took place in their buildings, relied on whatever forensic data was available to them—bills, receipts, contracts, proofs of payment, and, lacking these, Department of Buildings records and forensic engineers expert estimations of the ages of building systems. However, these WFCC cases expand on concepts of Matter of Pavia v. DHCR, 22 A.D.3d 393, 802 N.Y.S.2d 361  to deny the use of these non-owner-maintained records to establish the requisite proofs, effectively making it impossible to prove an exemption to which the owner would otherwise be entitled.
“Substantial Rehabilitation” Defined
The laws that establish rent stabilization, particularly the Emergency Tenant Protection Act of 1974 set forth that buildings “substantially rehabilitated as family units on or after January 1, 1974” are not subject to rent stabilization. (Emergency Tenant Protection Act of 1974 or ETPA §5(a)(5)) However, neither the statute, nor its implementing regulation at Rent Stabilization Code (RSC) §2520.11(e)(3) define “substantial” or “rehabilitated” or the phrase.
For actual definition, one might wish to look to a standard desktop dictionary, but, in fact, the phrase “substantially rehabilitated” defies the dictionary and is a term of art described by a series of events that must have taken place and under these decisions, memorialized by a particular set of documents.
Substandard or Deteriorated. The first of those events is that a building must, through no fault of the current owner, have came to be “in a substandard or seriously deteriorated condition.” RSC §2520.11(e)(3); see also DHCR Operational Bulletin 95-2 (“OB95-2”), specifically OB95-2(I)(B). A presumption of substandard or seriously deteriorated condition applies “[w]here the rehabilitation was commenced in a building that was at least 80% vacant of residential tenants.” [OB95-2(I)(B); see also RSC §2520.11(e)(3)]. However, that 80% only uses the presumption to satisfy the deterioration requirement. There is no amount of vacancy required as a threshold to substantial rehabilitation itself.
In order to qualify for DHCR approved substantial rehabilitation, it is imperative that “[a]ll building systems comply with all applicable building codes and requirements, and the owner has submitted copies of the building’s certificate of occupancy before and after the rehabilitation.” [OB95-2(I)(D); see also RSC §2520.11(e)(5)]. Proof regarding certificates of occupancy is unnecessary in buildings exempt from certificate of occupancy requirements.
Systems Replacement. The second historical event is that “on or after January 1, 1974” the building was made functional. RSC §2520.11(e), further elucidating this second event states, “At least 75 percent of the building wide and apartment (specified) systems … must each have been completely replaced with new systems. Additionally all ceilings, flooring and plasterboard or wall surfaces in common areas must have been replaced….”
The specified systems of which at least 75 percent must be replaced are: plumbing; heating; gas supply; electrical wiring; intercoms; windows; roof; elevators; incinerators or waste compactors; fire escapes; interior stairways; kitchens; bathrooms; floors; ceilings and wall surfaces; pointing or exterior surface repair as needed; and all doors and frames including the replacement of non-fire rated items with fire rated ones. OB95-2(I)(A).
DHCR Approval. While many believe in a third historical event, that is that the DHCR has approved the substantial rehabilitation, this is not true. Rather, the owner has the option of asking the DHCR whether a substantial rehabilitation program actually qualifies. RSC §2520.11(e)(8). If the owner is seeking DHCR imprimatur after the work has been done, the owner must submit to the DHCR, “an itemized description of replacements and installations, copies of approved building plans, architect’s or general contractor’s statements, contracts for work performed, appropriate government approvals and photographs of conditions before, during and after the work was performed. Proof of payment by the owner for the rehabilitation work may be required.” OB95-2(III).
Papering substantial rehabilitation through the DHCR (as per Matter of Pavia, supra) is not the only path. A landlord can do so without any agency intervention at all. In Cassorla v. Foster, 2 Misc. 3d 65, 774 N.Y.S.2d 901 (1st Dept. 2004) the Appellate Term upheld the use of the courts for determining whether there had been a qualifying substantial rehabilitation, while applying the criteria of Operational Bulletin 95-2 (OB95-2) as a rule of law.
Where, however, the substantial rehabilitation is earlier in the history of the building, such as in the late 1970’s for example, OB95-2 furnished only approximate guidance prior to the WFCC, supra decisions. In the WFCC cases, the court held that OB95-2 is more relaxed for rehabilitations that took place prior to its promulgation, but remains descriptive of the necessary documents even for these earlier rehabilitations. However, the WFCC decisions refused to excuse the absence of “invoices, receipts or photographs” and did not allow the introduction of public records in their stead.
Conversions from Commercial Space
The “conversion of a purely commercial space into an almost purely residential space…is a substantial rehabilitation so as to exempt the building from rent stabilization. 22 CPS Owner LLC v. Carter, 84 A.D.3d 456, 923 N.Y.S.2d 450 (1st Dept. 2011); see also 885 Park Ave. Brooklyn, LLC v. Goddard, 55 Misc.3d 74, 53 N.Y.S.3d 794, 795 (App. T. 2d, 11, & 13 Jud. Dist. 2017).
Where the building contains hazardous conditions such as fire damage, tenants of the building can be required to vacate the premises in order to resolve the conditions. This may happen at the instance of the owner compelling access for the repairs and replacements or by the city issuing a vacate order. Those tenants who vacate their units due to vacate orders may obtain “constructive occupancy” through petitioning the DHCR which will condition their continued rights of tenancy on their actual timely payment of one dollar per month in rent. This “will have the effect of excepting the housing accommodation from exemption from rent regulation based upon such rehabilitation.” OB95-2(IV).
A landlord may not destabilize a unit where the tenant of that unit remained in occupancy during the rehabilitation. In The 12th Co. LLC v. New York State Div. of Hous. and Community Renewal, 303 A.D.2d 328, 757 N.Y.S.2d 539, 540 (1st Dept. 2003), the court found that “[t]he tenant [wa]s entitled to a rent stabilized renewal lease notwithstanding that the remainder of the building in which his apartment [wa]s located may have been substantially rehabilitated, there being no dispute that the tenant was in full occupancy of the apartment during any such rehabilitation, and that his apartment was not substantially affected thereby.”
However, to the extent tenants abandon their tenancy during this period, the abandoned units can come under the substantial rehabilitation exemption, if the project meets all the other criteria. To the extent that tenants do not abandon their apartments during the reconstruction, their tenancies remain rent stabilized. RSC §2520.11(e)(6). Apartments that are vacant prior to the rehabilitation and remain such during the construction, are exempted from rent regulation. RSC §2520.11(e).
Assuming the criterion that the building is substandard or deteriorated has been met, this means that it has conditions that are in violation of law. In New York City, this creates an automatic right by the landlord to have access to the apartment for purposes of curing these violations, that is, to perform the rehabilitation. NYC Administrative Code § 27-2008. While that provision does not specify where, how or at whose expense the tenant should be housed during the renovations, owners are better advised to provide alternate accommodations such as another apartment or hotel space.
The tenants do not have any real choice about allowing this access. Failure to do so is grounds for eviction.
Paths to Substantial Rehabilitation
Those landlords who decide to substantially rehabilitate a building have two avenues they can take, getting DHCR’s opinion on a particular construction project [RSC §2520.11(e)(8)], or conducting the work and hoping that DHCR and the courts agree.
As to the judicial determinations, the rules of collateral estoppel hold that with the landlord being the only party who would be involved both in DHCR and judicial proceedings, the landlord would be bound by an adverse finding in either path so as to estop an assertion of the regulation-free status in the other path.
However, neither the DHCR, a court, or another tenant would be bound by an affirmative finding of exemption made through a path in which that tenant did not participate, except that future tenants are bound by earlier DHCR decreed exemptions. [OB95-2(VI)].
OB 95-2(II) encourages owners “to apply for an advisory prior opinion at or about the time that they seek appropriate governmental approval for the rehabilitation work.” In 885 Park Ave. Brooklyn, LLC v. Goddard, 55 Misc.3d 74, 53 N.Y.S.3d 794, 795 (App. Term 1st Dept. 2017), the court reconfirmed that seeking an advisory opinion is at the discretion of the landlord, and the prior opinion is not needed to prove substantial rehabilitation.
No Immediate Effect
Substantial rehabilitation will often, but not always immediately, move the building completely out of regulation. Sometimes, a substantial rehabilitation in the building’s history can take years or even decades eventually to cause the deregulation. For example, as a building through the normal passage of time, exits the tax-benefit-for-construction-and-voluntary-rent-stabilization J51 and 421-a programs, questions often arise whether the building upon exit from the program is nonetheless subject to rent stabilization.
Generally speaking, if there was a substantial rehabilitation after 1974 but before entry into one of these programs, the building will be exempt and indeed, the very construction that historically brought the building within the program could be the one that eventually takes it out of stabilization.
The Unsuccessful Landlord
Where the landlord is relying on a post-OB95-2 substantial rehabilitation, elements for qualification are to be strictly construed, and solid records are imperative for success in a claim for exemption from rent stabilization. Cassorla v. Foster, 2 Misc.3d 65, 774 N.Y.S.2d 901, 903 (App. Term 1st Dept. 2004); Pape v. Doar, 160 A.D.2d 213, 553 N.Y.S.2d 344, 346 (1st Dept. 1990).
The OB95-2 mandated records must show that “all ceilings, flooring and plasterboard or wall surfaces in common areas must have been replaced; and ceiling, wall, and floor surfaces in apartments, if not replaced, must have been made new as determined by DHCR.” OB95-2(I)(A). In Cassorla v. Foster, 2 Misc.3d 65, 774 N.Y.S.2d 901, 903 (App. Term 1st Dept. 2004), the First Department held that the landlord did not meet the requirements for substantial rehabilitation where although the “landlord replaced kitchens, bathrooms and intercoms, the plumbing, heating and electrical systems were not materially changed; the roof, fire escapes, interior stairways and most of the floors were not replaced; and only portions of the apartment ceilings and plastered surfaces were replaced.”
Major Capital Improvements
Where, however, the project does not meet the criteria for substantial rehabilitation, it could still qualify as a major capital improvement which enables the owner to apply to the DHCR to have portions of the costs the work the owner incorporated into the tenants’ permanent rent. Copeland v. New York State Div. of Hous. and Community Renewal, 164 Misc.2d 42, 623 N.Y.S.2d 505, 509 (N.Y. Sup. Ct. 1994) (“Section 8626(d)(3)’s provision for rental increases based on ‘major capital improvements’ also appears to allow landlords to pass “substantial rehabilitation” costs on to tenants.”) “RSC section 2522.4(a)(2) permit(s) owners to apply for an increase in legal regulated rents, based upon the proven costs of building-wide major capital improvements.” OB95-2(V). A landlord “may file an application to increase the legal regulated rents of the building or building complex on forms prescribed by the DHCR.” [RSC §2522.4(a)(2)].
A pair of new decisions from the Appellate Term, First Department have toughened the standards under which a landlord may claim a substantial rehabilitation exemption from rent stabilization. However, since these toughened standards apply exclusively to construction work that took place prior to the promulgation of OB95-2, the landlord either has these records or does not.
Nothing can be done to bring them into existence at this point in history. The effect of these decisions may be to bring back into stabilization many buildings whose owners believed in good faith that their buildings were not regulated. This can have substantial ripple effects both through litigation and due diligence studies of supposedly exempt buildings up for sale.
Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C. Dov Treiman is a partner at the firm. Allyson Weinberg, a summer associate joining the firm next year, assisted in the research for this article.