Real Property Law
The Constitutionality of Rent Relief in the Age of COVID: Did the City of San Francisco Go Too Far?
On December 1, 2020, the San Francisco Board of Supervisors enacted an updated eviction and rent relief moratorium (“Ordinance”). This moratorium created a four-tier system for tenants in San Francisco, based on the number of full-time employees they had as of November 1, 2020, and provided various repayment periods for COVID-19 deferred rent that has accrued from March 2020. San Francisco is not unique in taking steps to assist tenants who have been harmed by the business effects of the COVID-19 pandemic, with other major metropolitan areas such as Los Angeles, Sacramento, Berkeley and San Diego each enacting their own moratoriums and rent relief programs.
Unlike the other rent relief and eviction moratoriums passed throughout the state, San Francisco went a step further for the tier of tenants the Board of Supervisors considered most vulnerable to the business losses attributable to COVID-19: tenants with nine or fewer full-time employees. For these “Tier 1” tenants, if they are unable to enter into a satisfactory agreement for repayment of past due rents with their landlords, the Ordinance grants them a unilateral right to terminate their leases upon thirty (30) days’ written notice (“Termination Option”).[1] While granting the Termination Option for Tier 1 tenants was a bold gesture by the City of San Francisco to attempt to assist the most vulnerable tenants in the City from going under, the constitutionality of the Termination Option is in doubt.
Article I, Section 9 of the California Constitution, provides that “a bill of attainder, ex post facto law, or law impairing the obligations of contracts may not be passed.”[2] This language, although absolute on its face, has been interpreted by the courts much more broadly and courts have held that “proscription is not an absolute one and is not to be read with literal exactness like a mathematical formula.”[3] If the state has used its police power to abridge a contract “a finding of impairment merely moves the inquiry to the next and more difficult question – whether that impairment exceeds constitutional bounds.”[4] In general, the rule is such that “minimal alteration of contractual obligations may end the inquiry at its first stage. Severe impairment, on the other hand, will push the inquiry to a careful examination of the nature and purpose of the state legislation.”[5]
Here, there is no question as that the Termination Option granted by the City of San Francisco abridges existing contractual relationships between landlords and Tier 1 tenants. Further, the right granted therein does not have merely a “minimal alteration of contractual obligations,” or even a “severe impairment,” but grants Tier 1 tenants the ability to repudiate the entirety of their leases. The practical effect here is that the government stepped into every Tier 1 tenant lease and added a termination clause that was not previously there, with the only caveat being that the right cannot be exercised until the expiration of some undefined period of good faith negotiations with a landlord.
Courts, however, have held that if “the state regulation constitutes a substantial impairment, the State, in justification, must have a significant and legitimate public purpose behind the regulation…such as the remedying of a broad and general social or economic problem…”[6] Most importantly, “courts properly defer to legislative judgment as to the necessity and reasonableness of a particular measure.”[7]
The Termination Option is undoubtedly broad in its application in that it does not give any consideration to how long the remaining term of a lease may be, the total amount of rent that is to be paid, the actual ongoing success or failure of a tenancy, or any other factors, such as landlord contributions for improvements or the existence of a guaranty.[8] The sole metric provided by the City of San Francisco to justify the Termination Option is the number of full-time employees a tenant had on November 1. The City states, as its rationale for instituting both rent deferral for all covered commercial tenants in San Francisco and the Termination Option, that “it is reasonable to prioritize tenants based on the number of employees, as a tenant with more employees will, generally speaking, be likely to have greater ability to pay rent and a greater ability to absorb financial losses as compared to businesses with fewer employees.”
The existence of the COVID-19 pandemic and the economic effects both tenants and landlords have suffered are well documented and prevalent. There is no doubt that a city or municipality attempting to help mitigate those effects and assisting tenants by providing rent relief is a valid public purpose. Even if there is a legitimate public purpose, “the next inquiry is whether the adjustment of the rights and responsibilities of contracting parties is based upon reasonable conditions and is of a character appropriate to the public purpose justifying the legislation’s adoption.”[9] Notwithstanding that courts defer to legislative judgment in contract impairment matters between two private parties, courts have also held that “although not permitting a construction which permits contract repudiation or destruction, the impairment provision does not prevent laws which restrict a party to the gains reasonably expected from the contract.”[10]
As previously discussed, the Termination Option does not simply restrict a landlord’s gains expected from a lease or defer payment into the future – it permits a total repudiation and destruction of a lease. Accordingly, the Termination Option can be seen as the City of San Francisco taking a sledgehammer to resolve a public problem, rather than crafting a more narrowly tailored solution. Whether or not an unbargained-for lease termination right is a reasonable “adjustment of the rights and responsibilities of contracting parties” is ultimately a matter for the courts to decide, but it is hard to see how total contract repudiation is justified.
In addition to constitutional issues, it is also unclear on what basis San Francisco believes it has the authority to insert the Termination Option into Tier 1 tenant leases. San Francisco cites Governor Newsom’s March 16, 2020 Executive Order (“Executive Order”), as the grounds for the enactment of the Ordinance, and by extension the Termination Option.[11] The Executive Order, however, only grants power to local municipalities with respect to “any provision of state law that would preempt or otherwise restrict a local government’s exercise of its police power to impose substantive limitations on residential and commercial evictions…”[12] It is clear that this language is intended only to apply to the enforcement of evictions to prevent displacements and likely was specifically drafted to avoid the constitutionality issues that may arise under Article I, Section 9 of the California Constitution.
Cities and municipalities that have enacted such eviction moratoriums, while vitiating the ability of landlords to exercise a remedy otherwise provided for by law, are not actually modifying the terms of the underlying lease. Instead, these governments are instead simply preventing landlords from using the power of the state to remove tenants from their premises.[13] The Termination Option, however, goes beyond the bounds the Executive Order and affirmatively establishes a new tenant right within the affected leases.
Some have also argued that the enactment of rent deferral ordinances by local municipalities also violates the California Constitution. While this argument has some merit in the fact that the rent relief offered in these moratoriums is a material modification of the terms of a lease, fundamentally the obligations of the parties are not being abrogated: tenants are still required to pay their rent and landlords will continue to offer the spaces for rent. Further, the term of the underlying leases are not being extended as a result of the rent deferrals – it is just the timeframe that tenants have to repay those accrued past debts. Lastly, as has been described above, courts will permit the substantial impairment of contracts so long as the government has a “significant and legitimate public purpose” for the enactment of such regulation. Given the public benefit derived by assisting commercial tenants in keeping their businesses afloat and the lack of material changes to the terms of leases, it is unlikely a court would rule that such rent deferrals are unconstitutional.
The establishment of eviction moratoriums during the COVID-19 pandemic has been a central feature in assisting commercial tenants throughout California maintain their businesses and avoid being thrown out of their premises. Like many other cities in California, San Francisco established such a moratorium and further provided automatic rent deferral for certain classes of commercial tenants likely to be more affected by the economic consequences of the pandemic. San Francisco, however, took an additional step by providing a new termination right to the smallest subclass of tenants in the City, which action was outside the scope of the Governor’s Executive Order. Despite the significant and legitimate public purpose behind San Francisco’s enactment of the Termination Option, that one party may unilaterally repudiate a lease, regardless of the negotiated terms and anticipated economic returns relied upon by the parties, poses a significant risk that the Termination Option will be found to be an unconstitutional overreach by the City.
[1] San Francisco Administrative Code section 37C.3(c).
[2] Cal. Const., art. I, §9.
[3] City of Torrance v. Workers’ Comp. Appeals Bd. (1982) 32 Cal.3d 371, 377.
[4] Id.
[5] Allied Structural Steel Co. v. Spannaus (1978) 438 U.S. 234, 345.
[6] Energy Reserves Group v. Kansas Power & Light (1983) 459 U.S. 400, 411.
[7] Id. at 412-413.
[8] It should be noted that the San Francisco Ordinance does not discuss lease guaranties in any way and the Termination Option simply states that a Tier 1 tenant lease may be abrogated. While the language of a guaranty should be reviewed to determine if there are continuing obligations, without appropriate waivers of California Civil Code sections 2807 and 2809, it appears that the Termination Option similarly nullifies the guaranty of a Tier 1 tenant lease. The reason for this is simple: if there is no underlying basis for a guaranty, a guaranty cannot exist. Here, if a lease is terminated following the exercise of the Termination Option, the guaranty of that lease would similarly terminate since there is no underlying obligation to which the guaranty can attach. If, however, appropriate waiver language is contained in a lease guaranty, it is unclear if the Termination Option serves to terminate the guaranty as well. Notwithstanding the potential abrogation of the guaranty of a Tier 1 tenant lease, the guarantor will remain liable for, at minimum, the value of all COVID-19 deferred rent accrued up and through the termination date.
[9] Id.
[10] California Teachers Assn. v. Cory (1984) 155 Cal.App.3d 494, 510-511.
[11] Governor’s Exec. Order N-28-20 (March 16, 2020); see San Francisco Ordinance No. 254-20.
[12] Governor’s Exec. Order N-28-20 (March 16, 2020).
[13] It should be noted that a recent decision in the Superior Court of the District of Columbia held that Washington D.C.’s blanket ban on the ability of all landlords to file new eviction cases was unconstitutional (Borger Management, Inc. v. Abel Hernandez-Cruz, et al. (D.C. Sup. Ct., Dec. 16, 2020, Case No. 2020 LTB 006637). While the decision in Borger does not permit a landlord to enforce a validly obtained eviction order, it does once again give them access to the court system to begin the eviction process and file a complaint. The San Francisco Ordinance, like many other California eviction moratoriums, is carefully worded in that it does not explicitly prevent landlords from filing new eviction actions against tenants, but only that “the landlord may not recover possession.” Municipalities should be careful in how they draft their eviction moratoriums so as not to prevent a landlord from filing new eviction cases, else they may run into a similar constitutional challenge as in Borger.