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When is a sale not a sale?
Tenants fight DCRA interpretation of law
(Published November 3, 2003)
MARY LEE MALCOLM
One morning last October Kevin Fitzgerald woke up not knowing that he had a new landlord. Nor did any of the other tenants living at the Capitol Park Plaza apartments in Southwest Washington.
Now, roughly a year later, the tenants are living through an involuntary renovation that has "turned their lives into a living hell," said Fitzgerald at a recent press conference. He described apartments infested with vermin, ceilings rotted with mold, safety and fire hazards posed by poor security measures, and many other problems allegedly caused by the way in which the new landlord has carried out the renovation work in their building.
And they never saw it coming, he said, because of that 95/5 sale.
In a "95/5" sale, a controlling ownership interest in real estate is transferred to a new owner, but the seller retains a small legal interest in the property for at least a year: typically, a 5 percent interest.
Attorney Richard Luchs of the D.C. law firm Greenstein, Delorme & Luchs takes credit for coming up with this complicated real estate transaction as a way to get around the tenants’ rights under the Rental Housing Conversion and Sale Act. Under the act, residents have the right to make an offer to purchase the building they live in when the property goes up for sale.
"Some of my clients have a specific reason why they choose not to have to deal with tenants’ rights — the huge delays [the act] entails, and the opportunity it creates for a bidding war," Luchs said in an interview. "For the vast majority of tenant organizations, they are not interested in becoming landlords when the property is sold. But they will try to exercise their right to purchase, so they can then assign their rights to purchase the property to some third party, typically for some kind of compensation."
In the fall of 2000, to help make his first 95/5 transfer a reality, Luchs asked the District’s Department of Consumer and Regulatory Affairs (DCRA) to issue a letter stating that such a sale would not trigger the tenants’ right to purchase. A representative of the condominium and sales branch of DCRA complied with Luchs’ request.
Data made available by DCRA indicates that, since September 2000, DCRA has issued nearly 100 such "exemption" letters for partial transfers of ownership interests in real estate. The underlying sales affected an estimated 3,000 rental units in 125 properties.
Of the 99 letters DCRA has issued, 86 were given to just three law firms: 39 were issued at the request of Luchs’ firm, including a letter regarding the Capitol Park Plaza and Twin Towers transaction.
"I ask for the DCRA to sign off on the transactions as exempt from the act because the title companies want some independent corroboration that the transaction is proper before issuing title insurance," Luchs explained. "Otherwise I wouldn’t bother, because I’m comfortable with the legality of the transfers."
While Luchs may be comfortable, other lawyers are not.
"The problem is that the DCRA has got it flat wrong," said attorney Steven Skalet in testimony last month before the D.C. City Council Committee on Consumer and Regulatory Affairs. The committee, chaired by Councilwoman Sharon Ambrose, heard testimony regarding a proposed amendment to the law. The amendment, submitted by Councilman Phillip Mendelson, would require that any transfer of a "controlling interest" trigger the tenants’ right of first refusal, in order to stop landlords from using partial transfers as a way around tenants’ rights under the act.
Skalet alleges that the amendment would not be necessary if DCRA had not begun issuing these letters.
"These 95/5 transactions have occurred not because of any problem with the Rental Housing Act as it currently reads," said Skalet, whose firm, Mehri & Skalet, represents the Capitol Park Plaza and Twin Towers tenant associations in their legal challenge to the sale of the property. "Rather, 95/5 transactions have occurred because DCRA — at the urging of building owners and the small number of attorneys that represent those owners — adopted an unwritten policy that defies logic, and that is directly contrary to the express and explicit purpose of the [Rental Housing] act."
In a telephone interview, attorney Jonathan Tycko expressed his agreement that DCRA officials are simply misinterpreting the current law. Tycko is Skalet’s co-counsel in the Capitol Park Plaza case.
"If the sole focus of this legislation is to stop these 95/5 transfers, they could do that without amending the statute," Tycko said. "If they could just get DCRA to stop issuing these letters, the 95/5 transfers would stop happening. I think what is making the developers so bold about circumventing the tenants’ right of first refusal is having one of these letters in hand, stating DCRA’s position that anything less than a 100 percent transfer is not a sale."
Tycko said he is "not trying to attribute any bad motives on the part of anyone at DCRA."
"It’s probably more a function of a work overload, or a lack of resources and institutional inertia. However, there is no real evaluation of the proposed transfer. There’s no opinion of corporate counsel," he said.
The act provides that a person seeking a definition of "sale" get a declaratory judgment, he said. Tycko and Skalet allege that DCRA does not, and has never had, the authority to define "sale" under the statute, much less write opinion letters exempting specific transactions.
The attorneys view the DCRA letters as an essential link in the chain. "A real estate transaction can close without title insurance," said Skalet when asked about Luchs’ explanation for getting the letters. "But any institutional lender is going to insist on having title insurance, and almost all large commercial real estate deals require institutional financing."
Marc Borreli, an independent businessman who specializes in helping large companies sell major assets, confirmed that title insurance is a prerequisite to a real estate sale. "No bank is going to loan money without title insurance," he said.
Asked whether he felt the DCRA willingness to issue exemption letters facilitated the development of the 95/5 transactions, Councilman Mendelson answered, "I think there is something to that."
A DCRA official said she disagrees that the agency is misinterpreting the statute, or that it does not have the authority to write opinion letters. Raenelle Zapata, rent administrator for the department, told The Common Denominator that the official position of the DCRA was, indeed, that any transfer of any kind involving anything less than a 100 percent interest in rental property would legally allow landlords to avoid giving their tenants right of first refusal.
"That’s what the statute says in plain English," Zapata said. "And there are court cases that say that the DCRA’s position on this should be allowed to stand."
At issue is the DCRA’s interpretation of a 1994 amendment to the rental housing act. Under the original act, whether a "sale" occurs that triggers the tenants’ right of first refusal is to be evaluated on the basis of six different factors. These include whether the seller gives up possession of the property; whether he assigns all the rights in all contracts relating to the property; whether the buyer is responsible for taxes and other liabilities, or has an option to purchase in the future, or is required to maintain liability insurance covering the property.
In 1994, the city council amended this section of the act, adding a provision focusing exclusively on when the sale of partnership interests would be defined as a "sale." The amendment states that when a partnership, "which owns the accommodation as its sole asset" transfers 100 percent of its "partnership interest" to "1 transferee" within one year, such a transfer is a "sale" for the purpose of triggering the tenants’ right to purchase. The amendment was added without debate.
This amendment has been used as the exception to swallow the rule, Skalet said. Just because the amendment lays out clearly when a partnership transfer is a "sale" for the purposes of triggering the tenants’ rights of first refusal, does not mean that the sale of a less than 100 percent interest is automatically not a "sale." A partial transfer must still be evaluated with reference to the other factors laid out by the statute, according to Skalet and other challengers of the 95/5 transactions, in order to determine if the landlord has actually "sold" the property within the meaning of the act.
Richard Eisen, an attorney who primarily represents tenant organizations, pointed to the act’s legislative history as proof that the council never intended for the 1994 amendment to change the definition of "sale" to "only a 100 percent transfer." In his testimony before the committee, Eisen cited a 1995 report of the Committee on Consumer and Regulatory Affairs, discussing other possible amendments to the rental housing act, but "reiterating its earlier position...[that] the original intent of the council was to continue to include all changes in fundamental control of ownership in the definition of sale."
Partial transfers have survived three legal challenges. None involved a 95/5 sale. One involved the sale of an apartment building by an elderly man to two limited liability corporations, both owned by himself. Another concerned sale of a 50 percent interest in an apartment building by a mother to her son, who already owned the other 50 percent interest. Another involved the granting of a master lease of a property. In all three cases, the court determined that the transfer did not trigger the tenants’ right of first refusal. In each case the judge considered the letter issued by DCRA, as well as many other factors, to determine if the transaction met the statutory requirements of a "sale."
The 95/5 sales are now being challenged in at least three court cases. Attorney Benny Kass represents the tenants of 1816 Kalorama Road NW in their legal challenge to a 95/5 sale that transferred ownership of their homes, without their knowledge, in December 2001. The seller was represented by Luchs.
At Luchs’ request, DCRA issued a letter exempting the sale of the Kalorama Road apartments from the requirements of the Rental Housing and Conversion Act. This was done, said Bass in an interview, "when it wasn’t even a partnership or a corporate transfer. The property was owned by an individual." Even under a generous interpretation of the 1994 amendment, Bass said, the 100 percent transfer language only applies to partnerships.
"And in any case, it’s ridiculous to say that selling all but a 1 percent interest in a property is not a sale," he said."And what also helps in our case is we have a smoking gun."
During discovery, Bass uncovered a letter from Luchs stating there would be a "gentleman’s agreement" to transfer the remaining 5 percent interest after a year, for no additional money, specifically to avoid triggering the tenants’ right to purchase. The defendants contend such a strategy was "no more unlawful than structuring a real estate transaction to avoid paying taxes," according to documents filed with the court. The parties to the case are currently awaiting the judge’s ruling on a motion for summary judgment.
The real problem, according to Zapata, is not the definition of "sale," but the generous amount of time tenants have to exercise their right of first refusal. In her testimony on the proposed amendment to the the act, she stated, "Presently, it can take up to 660 days to consummate a sale [with tenants] given the time frames and extensions available...."
"The average time to purchase an apartment building [in a private sale] is approximately 60-90 days....Time delays, rather than partial interest sales is the critical factor," Zapata said.
Councilman Mendelson challenged the DCRA’s position, asking, "Why, if the time involved is the problem, have you never offered proposed legislation to correct it?"
"It’s not our position to second-guess the legislature," Zapata replied, adding that landlords would always find a way to structure their deals to get around any restrictions.
"I don’t think they’ll find a way around this bill," Mendelson fired back. He later referred to Zapata’s testimony as "not constructive," adding, "Landlord will want to comply....Selling a 49 percent interest is not the same thing as selling a building."
However, many others who spoke at the recent hearings agreed that changing the definition of a sale would not solve what landlords see as the true problems with the act: time delays, and the tenants’ right to assign their purchase rights to a third party. Among them was Michael Huke, president of CIH Properties, which specializes in affordable housing.
"The current legislation has become a springboard for gaming the system...But I firmly believe that if such a law were to provide a level playing field for both tenants and owners and were to insure reasonably predictable outcomes, then many owners would prefer to sell to the residents than to a third-party purchaser," Huke said.
Copyright 2003, The Common Denominator