September 2018 - Gupta Evans and Ayres

Prop 10: Does Rent Control Make Sense for California?

September 29, 2018/in All Blog Posts, Real Estate/by Ajay Gupta

In June, the California Secretary of State confirmed Proposition 10 as a ballot initiative that, if passed, will allow cities in California to implement rent control. With the housing shortage in California, San Diego in particular, renters have seen dramatic increases in rent that quite simply have not kept up with the cost of living. As a result, San Diego is seeing gentrification in areas not normally associated with the displacement of middle- class renters, like La Mesa and the surrounding suburbs of downtown. This displacement is what is most likely bringing Proposition 10 to the ballots this November.

Historically, middle–class workers in California were able to afford homes, which granted them stability in terms of their cost-of-living. However, with skyrocketing housing prices, even those with good jobs have found themselves struggling to get into their first home. This confluence of unaffordable housing and the gentrification of the middle- class has brought the issue of rent controls back into the public purview.

Currently, rent controls are largely prevented under the 1995 Costa Hawkins Rental Housing Act.

The Costa Hawkins Act contains three major provisions:

It protects a landlord’s right to raise the rent to market rate on a unit once a tenant moves out.
It prevents cities from establishing rent control—or capping rent—on units constructed after February 1995.
It exempts single-family homes and condos from rent control restrictions.

Rents in San Diego have increased substantially over the last 3 years and vacancy rates remain low. The average rent in March of 2018 in San Diego was $1,887, which represented a 20% increase since 2015. At the same time, vacancy rates remain low, approximately 3.2%, which is below the historical average.

San Diego, unlike Los Angeles and San Francisco, has not implemented any rent controls. Across California, there are only 15 municipalities that have implemented rent controls prior to the acceptance of Costa Hawkins. Most rent control ordinances limit the permissible rent increase the landlord can charge if the tenant chooses to stay in the unit year over year. Rent control ordinances typically also prevent a landlord from evicting a tenant unless the landlord is planning on removing the property from the market. Finally, in some areas, even if the landlord is courting a new tenant, the landlord would be limited in the amount that he could charge the new tenant.

The implementation of rent controls will dramatically shift rights from property owners in rent controlled areas to renters who are fortunate enough to obtain housing in those areas.

The Economics:

In San Diego, the primary cause of higher rental costs is the result of the shortage of available rental units. With vacancies approaching 3%, most economists agree that San Diego’s high rental prices are a direct product of a fundamental lack of supply. Under this line of reasoning, which is the prevailing wisdom, the implementation of rent controls would simply lower the value of housing and therefore discourage investment in new housing. As the argument goes, while a select few who are in rent controlled districts would benefit, the decrease in new housing investments would cause higher rents for the remainder of San Diego’s renters.

Another line of reasoning focuses on the demand side of the equation. California’s homeownership rate is currently around 10 percentage points below the national homeownership rate, 54.6% versus 64.2%. That differential has always been true in California. Not surprisingly and directly proportionate, the rate of renters in California is about 10% higher than the rate of renters for the rest of the country, 46% compared with 36% respectively. Theoretically, by increasing homeownership rates, you would automatically decrease the number of renters in the market. Proponents of a demand side argument theorize that implementation of rent controls may decrease the value of homes for investors, but the value of homes would remain constant for primary residence holders. By shifting the value away from investors, homeownership rates will increase naturally through the conversion of rental properties to primary residence holders.

The rationale surrounding the demand side analysis is tortured on a number of levels. Most obviously, increasing homeownership rates by converting rental properties into primary residences simply decreases the number of available rental units on the rental market. While it does address the issue of gentrification for those that are able to buy homes, it does little to actually address the fact that there are more renters than houses available for them.

The argument does, however, touch on a fundamental issue that is unique to California: With such a large percentage of California’s population being renters, 10% more than anywhere else in the country, does California have an obligation to provide some stability to middle- class workers who are lifelong renters?

The Politics

The real rationale for Proposition 10 and the repeal of Costa Hawkins is grounded in politics, not economics. First, Proposition 10 itself does not implement rent controls; it simply would allow municipalities to implement rent controls at the local level. Proponents of Proposition 10 argue that areas such as San Francisco, Silicon Valley and National City all have different housing needs that should be addressed at the local level. Proposition 10 simply gives local municipalities the flexibility they need in order to meet the needs of their community and develop flexibility in community planning.

Proponents of Proposition 10 argue secondarily that housing stability should be a right as opposed to a privilege. The median household income in San Diego County in 2017 was $66,500. According to BankRate.Com, assuming 20% down and only $1,000 a month in non-housing related expense, the maximum recommended housing price is about $240,000. Meanwhile, the median home prices in San Diego rose 8.6% in April, 2018 to reach its highest level ever at $570,000.

Based on these numbers, the average middle- class worker cannot reasonably expect to ever buy a home in San Diego or in most metropolitan areas in California. Since that is our current reality, then shouldn’t local municipalities be given the option of protecting middle- class families from being displaced from their communities? Shouldn’t local government be given the tools to promote a stable and diverse community? If we value economic and racial diversity, shouldn’t a community be given the flexibility to plan for low income families through rent controls?

I struggle with these issues personally. We moved seven times in 11 years before we bought our home in 2018. Most of that was by choice, but I do know that rents went up precipitously over the same period. The one time where our landlord was selling the home we were renting, it was frustrating. As our kids are getting older, we are definitely accumulating more stuff, making the prospect of moving more daunting. Having a home now, I value homeownership, the stability it brings, and the investment in the community it allows. It would be devastating to know that I could never buy a home and I think that under those circumstances, I would want some stability in terms of my rental situation.

On the other hand, I firmly believe that the housing shortage and gentrification are supply side problems. The only practical means of bringing more housing on the market is to streamline the process of development and to increase investment into the housing market. Ultimately, the California housing market must be relied on to do what the California housing market has always done: Correct itself and bring housing back in line with what people can afford.

On balance, I take the position that Costa Hawkins should not be repealed. There are a myriad of reasons that lead to unaffordable housing in California. While each of these reasons can be separately analyzed and are topics worthy of their own articles, we have to start by looking at Proposition 13 and the relatively low effective property tax rates in California. From there, we quickly move to the development life cycle and costs of litigation. Finally, we have to look at the wealth effect and role that real estate plays in California’s economy.

Ultimately, what I am confident that we will find is that investors are competing with the middle-class for homes and driving the middle-class out of the owner occupied market and pushing them into an already flooded rental market. Further, I’m confident that the driving force behind the low owner-occupied housing rates can be traced to tax incentives that favor the investment buyer over the owner-occupied buyer.

As a result, the path to addressing middle-class gentrification is through policies that encourage higher owner-occupancy rates. While rent control may cause a small and unintended increase in owner-occupied housing rates, it really does little to help renters. Trying to address gentrification through rent control measures as allowed under Proposition 10 is just the wrong tool for the job, even if done at the local level. Instead, we must look long and hard at policies that have caused California to have the second lowest owner-occupancy rate in the country.

Reverse Veil Piercing: A Welcome Addition to the Creditor’s Collection Arsenal

September 18, 2018/in All Blog Posts, Corporate Litigation/by Chris Evans

In 2017, the California Court of Appeals ruled that creditors can directly pursue the assets of an LLC owned by a judgment debtor to satisfy the judgment. This process, known as “Reverse Veil Piercing,” marks a significant change in California law as it relates to collections and the way that the assets of an LLC are viewed in the eyes of the Courts. The ruling may also be indicative of how the Courts plan to treat closely held entities in the future.

In late 2017, California’s Fourth Appellate District concluded that “reverse veil piercing” may be used by creditors to add an LLC to a judgment the creditor has against an individual owner of the LLC. The decision, albeit narrow, was set forth in detail in Curci Investments, LLC v. Baldwin (2017) 14 Cal.App.5^th 214 and departed from the well-settled California law against reverse veil piercing set forth in the 2008 appellate decision, Postal Instant Press, Inc. v. Kaswa Corp. (2008) 162 Cal.App.4th 1510. The Curci ruling grants creditors a significant new means of collecting a judgment that otherwise may be extraordinarily difficult, or impossible, to collect.

The Facts

The case of Curci Investments, LLC v. Baldwin involved Mr. James P. Baldwin. Mr. Baldwin was a real estate developer who over his lifetime was involved in hundreds of corporations and limited liability companies. One of the LLCs was named JPB Investments, LLC (JPB). Mr. Baldwin was the 99 percent owner of JPB, with his wife holding the remaining one percent. Mr. Baldwin was also the manager and CEO of JPB and controlled all of its decisions and actions, such as cash distributions to Mr. Baldwin and his wife. JPB’s exclusive purpose was to hold, invest and/or distribute the cash balances of Baldwin and his wife.

Mr. Baldwin defaulted under a $5.5 million promissory note. Curci, the owner of the note, filed suit and eventually obtained a judgment against Mr. Baldwin, personally, in the approximate amount of $7.2 million. When Curci obtained its judgment against Mr. Baldwin personally, Curci pursued several avenues to try and collect on the judgment. However, after exhausting most of its options, Curci was unable to receive any recovery on its judgment. With few options left, Curci filed a motion to expand the judgment to include one of Mr. Baldwin’s LLCs, JPB (above), based on the theory that JPB was the alter ego of Mr. Baldwin. In other words, Curci wanted to utilize “reverse veil piercing” to reach the assets of JPB and satisfy Curci’s judgment.

Hold That Thought…

A quick aside about alter ego and piercing the corporate veil. These concepts are not particularly new and have long been permissible in California[1]. As is well-recognized, a corporation or an LLC are considered a separate legal entity, distinct from its stockholders, officers and directors (or members and managers), with separate and distinct liabilities and obligations[2]. This affords the shareholders of a corporation, or the members of an LLC, protection from judgments against the corporation or LLC.

However, that legal separation (and protection) may be disregarded by the courts when the creditor shows the following exists:

Such a unity of interest and ownership between the corporation (or LLC) and its equitable owner that the separate personalities of the corporation and the shareholder do not in reality exist (based upon a variety of factors); and
Injustice will result if the acts in question are treated as those of the corporation (or LLC) alone[3].

If these prongs are demonstrated, the actions of the corporation or LLC will be deemed to be those of the persons or organizations actually controlling the corporation. This is known as “piercing the corporate veil”—the creditor is piercing the protective veil of the corporation or LLC to reach the assets of particular shareholders or members[4].

The concept Curci sought to utilize with respect to its judgment against Mr. Baldwin was the concept of reverse piercing of the corporate veil. The concept of reverse veil piercing is similar to traditional veil piercing in that when the ends of justice so require, and the foregoing two prongs are shown to exist, a court will disregard the separation between an individual and a business entity. However, rather than seeking to hold an individual responsible for the acts of an entity, reverse veil piercing seeks to satisfy the debt of an individual through the assets of an entity of which the individual is an insider.

Reverse Veil Piercing In California Before Curci

In Postal Instant Press, Inc. v. Kaswa Corp. (2008) 162 Cal.App.4th 1510, 1513 (Postal Instant Press), the Court held that a third-party creditor may not reverse pierce the corporate veil to reach corporate assets to satisfy a shareholder’s personal liability. In deciding against allowing reverse veil piercing, the Court cited three concerns:

The effect of allowing judgment creditors to bypass standard judgment collection procedures;
The potential of harming innocent shareholders and corporate creditors (i.e. the non-debtor insiders of a corporation or LLC); and
Using an equitable remedy in situations where legal theories or legal remedies are available outweigh the wrong to the judgment creditor.

With the ruling in Postal Instant Press, reverse veil piercing in California was effectively dead, and it remained that way until Curci obtained its judgment against Mr. Baldwin.

The Curci Decision

In Curci, the Court acknowledged the above concerns, but distinguished the facts from those in Postal Instant Press. In doing so, the Court concluded that the three concerns were not present in the case before the Court. The distinction was grounded largely in the fact that Postal Instant Press was dealing with a corporation, whereas Curci was dealing with an LLC owned entirely by Mr. Baldwin and his wife.

The Court identified that a creditor does not have the same options against a member of an LLC as it has against a shareholder of a corporation. If the debtor is a shareholder of a corporation, the creditor can step straight into the shoes of the debtor, acquire the shares and then have whatever rights the shareholder had in the corporation, including the right to dividends, to vote, and to sell the shares. On the other hand, when the debtor is a member of an LLC, the creditor may only obtain a limited charging order to receive any distributions made to the member from the LLC. Here, because Mr. Baldwin had complete management and control over JPB, Mr. Baldwin could manipulate distributions such that no funds went to Mr. Baldwin, which is precisely what Mr. Baldwin had been doing to avoid the judgment.

Additionally, there was simply no “innocent” member of JPB that could be affected by reverse piercing. Mr. Baldwin held a 99 percent interest in JPB and his wife holds the remaining 1 percent interest, who, based on community property principles, was also liable for the debt owed to Curci.

Based on the above, the Court held that reverse veil piercing may be available to Curci with respect to JPB and sent the case back to the trial court to undertake the fact-driven analysis applicable to piercing a corporate veil. In parting words, the Court held that “the key is whether the ends of justice require disregarding the separate nature of JPB under the circumstances.”

What Now?

The ruling from the Court in Curci will likely be construed quite narrowly and only with respect to fact patterns largely mirroring the facts of Mr. Baldwin and his entity. Additionally, the ruling in Postal Instant Press should still be considered binding law with respect to corporations as the Curci ruling was almost entirely founded on the fact that the entity in question was an LLC. Even with the Curci ruling, when corporate entities and LLCs are structured and operated correctly, they will in all likelihood continue to exist separately from the individuals who form and manage them.

That said, the Curci ruling remains notable and opens the door to reverse veil piercing in California, which is a significant shift in California creditor law and a substantial change in the options previously available to creditors struggling to collect a judgment against an individual debtor. Those setting up corporate entities that will be largely controlled and operated by a single individual should keep the Curci case top of mind. Going forward, when a creditor is dealing with an individual judgment debtor actively misusing an LLC, one can all but guarantee that the creditor will now rely upon the Curci ruling to argue “the ends of justice” require reverse veil piercing to be permitted against the debtor’s LLC.

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[1] Sonora Diamond Corp. v. Superior Court (2000) 83 Cal. App. 4th 523, 538

[2] Robbins v. Blecher (1997) 52 Cal.App.4th 886, 892

[3] Sonora Diamond Corp. v. Superior Court, supra, 83 Cal. App. 4th at 538

[4] In addition to piercing the alter ego and piercing the corporate veil, there is a concept known as the Single-Enterprise doctrine which is also recognized in California. While well outside the scope of this article, the Single-Enterprise doctrine can be used to hold multiple, distinct legal business entities liable as if they were a single entity. See Las Palmas Associates v. Las Palmas Center Associates (1991) 235 Cal.App.3d 1220, 1249-50.