The Pitfalls of Rent Rebates

What do you do now that the rental market is slowly creeping back up and you have “reduced the rent” of some of your tenants who leased their units in ’99-’00 and then demanded a “rent reduction” in ’01 when the market crashed? If you are like many owners who suffered through the dot.com bust, you probably have a tenant or two that threatened to walk and leave you with another vacant unit unless you agreed to lower the rent.

Over the past four years, landlords around town have employed every possible mechanism to temporarily lower the rent without facing the possibility that the collection of the reduced amount would become the tenant’s new lawful base rent. Indeed, during the last recession of the early ‘90s, some landlords did lower the rent, only to find that when they sought to reinstate the “correct” base amount, their grateful tenants responded with a Rent Board petition for an unlawful rental increase. In some cases, the Rent Board held that the owner’s gratuity was permanent and could not be rescinded, thereby leaving the owner with a finding that the “lowered rent” was now the official lawful base rent.

In response, landlords during this last period of high vacancy and soft rents have resorted to new and improved ways to evade the wrath of the Rent Board. Such strategies have ranged from rebating tenants with cash payments every month to long-winded lease addendums wherein the tenants profess understanding that the reduction in rent is nothing more than an agreement to accept less rent for a certain period of time.

No matter the mechanism, everyone who convinced the higher-than-market payers to weather the storm now faces the prospect that the incentive was really a re-adjustment of what can be lawfully charged. Unfortunately for these San Francisco landlords, the local rent law does not address the issue of temporary rent reductions. Rather, owners are told that base rent is the rent charged upon the initial occupancy of the unit. The law then goes on to describe the only instances when rent can be increased. And as we all know, the Rent Board tells us by how much we can increase the rent on an annual basis.

Many owners have made the argument that, as long as the tenant is expressly informed of the initial base rent, nothing precludes the landlord from accepting less rent for a certain period of time. Thus, in theory, if the lease agreement states the base rent to be $1,000 per month, and all parties have agreed to this amount, the owner should be able to accept $750 per month and then re-instate the initial amount ($1,000) plus allowable increases. Incidentally, the law clearly allows owners to “bank” annual allowable rental increases, and there is no policy in effect at the present time that requires owners to impose all lawful increases or to lose their benefit. (Matt Gonzalez made such an attempt, but in the end we only received his roommate legislation.)

Yet the Rent Board has determined on at least several occasions that these rent reductions constitute a new agreement, tantamount to a new tenancy. Ironically, if the owner and tenant agreed to a new lease for a higher rent, such an agreement would be voided under the Rent Ordinance as an illegal contract. However, and not surprisingly, when an accommodation inures to the benefit of the tenant, it is subject to ratification by the Rent Board, even though the owner intended that the change be temporary and rescindable.

Because there is no bright line test by which one can determine whether or not the “favor” was really a new contract, each case will be decided, if challenged by the tenant, on a case-by-case basis. Some factors Administrative Law Judges have weighed in the past include the following:

(1) Was there a written addendum memorializing the terms of the agreement to temporarily accept less rent? The Rent Board may tend to rule in the landlord’s favor if the owner shows up to the hearing with a signed addendum expressly setting forth the terms and conditions of the temporary rent rebate. Some items the addendum should contain are the dates of the reduction period (for example, June 2001 through May 2003), the amount of the rebate, and a statement that the arrangement is being made in order to accommodate the tenant’s request and not because of some decrease in housing services. In one case, the tenants convinced the ALJ that the rebate was really given because of a change in the parking spaces; as such, the Rent Board concluded that the gift was permanent because it was given to compensate the tenants for a decrease in housing services.

(2) Are the same tenants who agreed to the rebate arrangement still the same tenants in occupancy? One serious problem for owners occurs when the deal was struck with a tenant who is no longer in occupancy. The new subtenants show up to the Rent Board and argue that their initial base rent was the lower amount and that they have no knowledge of any deal. If there is no written addendum memorializing the terms of the temporary decrease, the ALJ will weigh the owner’s word against the new tenants who may feign ignorance about the situation.

(3) Has the annual allowable increase(s) been imposed against the initial base rent or the lowered amount? Hopefully, the owner was sending rent increase notices using the lease’s initial base rent as the numerical reference. Conversely, if the rebated amount was used, there is argument that a new contract was established for the lower rent.

There are some Rent Board judges and tenant practitioners who argue, with a degree of credibility, that many of these temporary rent rebates should constitute a permanent re-establishment of base rent. From their ideological standpoint, because the rental market substantially fell over the past five years, a tenant’s agreement to remain in occupancy in exchange for the imposition of corrected fair market value rent inured to the benefit of the owner, who did not have to re-furbish a unit and then watch it sit empty for 6 months. Therefore, the tenant’s agreement to remain is sufficient consideration for a new contract; and simply because the market has improved should not allow the owner to raise that rent beyond the limits imposed under the law. Indeed, absent express legal justification, owners can never raise rent-controlled rent to market levels when the market takes off.

For the owners, there are a couple of suggestions that should be considered when entering into, and rescinding, these agreements to accept less rent.

First, as referenced above, make sure that there is some written lease addendum or contract that sets forth the parameters of the rebate. Some owners argue that it is better to have no such written evidence; however, the tenant will undoubtedly submit proof that you have been sending over a refund every month and/or accepting a lesser rent and it doesn’t take a genius to conclude that this exchange was made to adjust the monthly rental obligation. Instead, have an agreement that states for how long the rebate period will last, and that the tenant is receiving this consideration not because of a decrease in housing services but because the owner wishes to motivate the tenant to stay.

Second, always have a sunset clause. If the rebate lasts forever, it is arguably a housing service. Let the tenant know, up front, when he must start paying all of the rent again. You can always extend the period of accommodation. Incidentally, one popular rebate method is to give the tenant a free month of rent for every eleven months of occupancy, but once again, there must be a sunset clause for this arrangement or it will become a mandatory housing service and could be required every year.

Third, make certain that all subsequent occupants are aware of the rent rebate arrangement. At the time you serve them with 6.14 Notices, obtain their acknowledgment of the accommodation.

Fourth, all rental increases should use the correct base rent as the point of reference. Thus, when you raise the rent by .6% or 1.2%, ensure that the “normal” rent is used in the equation. It is not a bad idea to impose rent increases during the rebate period so as to re-affirm the fact that the lawful base rent has not changed.

Fifth, make sure that in all correspondences and addendums where the rebate is referenced, you refrain from using phrases like “rent reduction” and “new rent.” Rather, state that you are agreeing to accept less rent for a certain period, but that the base rental amount is what is set forth in the lease agreement.

Finally, try to provide advance notice (for example, 60 days) reminding the tenants that the period of accommodation is ending. To this end, prepare yourself for a possible Rent Board hearing when you begin demanding the full amount of the rent. Do not be surprised when the tenants refuse to pay and then file a petition for unlawful rent increase. Treat the hearing as you would any other Rent Board matter: Bring your attorney, court reporter, and evidence to present before the ALJ, and be ready to appeal an adverse determination to the Rent Board Commissioners or, if necessary, the superior court.