Two years ago, the California Court of Appeal held that Santa Monica’s requirement that property owners pay their tenants interest on security deposits at a higher rate than the owners could obtain in a savings account was an unconstitutional “taking,” and therefore the owners where entitled to just compensation ( Action Apartment Association v. Santa Monica Rent Control Board [2002] 94 CA4th 587). In 2002, Small Property Owners of San Francisco (SPOSF) and three of our members sued the City, challenging its requirement that owners pay their tenants 5% interest on security deposits at a time when yields in short-term money market accounts were little more than 1%. The case, Small Property Owners of San Francisco v. City and County of San Francisco, Civil No. 406692, is available on the court’s website, www.sftc.org. Last year, the Court certified a class of 50,000 owners of 1-6 residential units who paid the 5% interest due on tenant security deposits in 2001 and 2002. The Court also denied the City’s motion for summary judgment.

In taking cases, the judge decides the legal issue of whether there was a taking and a jury decides the amount of just compensation. This past month, Judge Kramer conducted a bench trial on the key legal issues in the case: 1) Whether the City’s requirement to pay 5% interest was a taking; 2) whether, if there was, the entire history of the 5% ordinance going back 19 years should be considered to determine if landlords suffered a net loss over that time; and 3) whether owner’s transaction costs should be considered in determining the amount of the owner’s losses. Transaction costs owners incurred in paying the interest due to tenants. Before the trial began, both sides presented extensive legal briefs, totaling almost 200 pages. After reviewing those briefs, Judge Kramer orally announced that his tentative ruling was that SPOSF should prevail on every point. The judge then heard arguments by Andrew Schwartz, a deputy City Attorney, and Paul Utrecht for SPOSF. Mr. Schwartz argued that Supreme Court decisions after the ACTION Apartment decision had undetermined it, that there was no taking because the City made a rational judgment when it set the rent at 5% in 1983, that landlords actually made more than they lost if you take into account the entire 19 year history of the 5% ordinance, and that transaction costs should not count. According to Mr. Schwartz, the City’s legitimate interest in making owners pay the 5% interest was to lower tenant’s overall rental costs.

Paul Utrecht argued that the Court was bound to follow the ACTION Apartment decision because it is binding precedent on all trial courts in this state, that later Supreme Court decisions did not call it into question, and that the correct test of a regulation of this nature is a heightened test of whether it substantially advances the legitimate aims of the law. Under that test, the City could not show that its law advanced any legitimate interest. Rather, it was just a redistribution of wealth from owners to tenants. Paul Utrecht also pointed out that while the 5% law did not result in taking in 1983 when bank savings rates were at the level, it did result in a taking in 2001 when interest rates were only 1.5%. The Constitution allows a City to “take” property, but the City must pay “just compensation.” After two full days of oral argument, Judge Kramer announced his post-trial tentative decision, which was surprisingly in the City’s favor. His tentative decision states that the ACTION Apartment case is different from this case because Santa Monica required owners to invest the tenant security deposits in federally-insured bank accounts and hence could not be used for any other purpose, while under our law the property owner may invest the money anywhere, including the rental business. The judge found there was no taking, implicitly because the owners could have earned more than 5% return on investments other than money market accounts.

Under the trial procedures, the judge’s tentative decision is still open to challenge by SPOSF and the judge may change it, just as he changed the oral tentative ruling that he announced at the start of the trial. The primary defect in the written tentative decision in that the only evidence before the Court was that given the size of the security deposits and the legal obligation to return promptly the deposit when the tenancy ends, small property owners have no real way to obtain any greater return than that offered by a money market account. Those accounts paid only about 1.5% during the years 2001and 2002. Therefore, our case is no different than the ACTION Apartment case. If so, the Court is bound to abide by that decision and find that San Francisco’s law is a taking. We intend to make every effort to persuade the judge that his written tentative decision is wrong, and that he should go back to the tentative ruling that he announced before the trial began. Further proceedings will be held in June of this year.

Reprinted from the Small Property Owners of San Francisco Journal. SPOSF Board member Paul F. Utrecht is an attorney specializing in property law.

Visit the SPOSF website at
www.smallprop.org