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Santa Monica Landlords Victorious in Security Deposit Regulation Suit

Landlords have won a takings case against the City of Santa Monica regarding the city's regulation of tenant deposits. The Second District Court of Appeal ruled that an ordinance requiring landlords to pay tenants 3% interest on security deposits was an unconstitutional taking. Although the city argued, in part, that the amount of money at stake was not enough to damage the landlords, the court said that $2.3 million was at stake, including about $1,500 for one individual plaintiff. "A small taking is still a taking," the court ruled. The court also rejected the city's argument that the case was not ripe because the landlords had not exhausted their administrative remedies. Santa Monica has a long and contentious history of rent control, but the city has successfully defended its regulatory system against numerous court challenges (see CP&DR Legal Digest, February 1999). In the case at hand, the court made it past one common obstacle to takings cases brought by landlords, namely, that the contested regulation promotes a legitimate government interest. The court held that the regulation of security deposits did not advance a government interest, and the court went to lengths to distinguish this case from rent control cases. In January 1999 — the same month that the state Supreme Court upheld its rent control ordinance in Santa Monica Beach Ltd. v. Superior Court, (1999) 19 Cal.4th 952 — the Santa Monica Rent Control Board adopted a new regulation requiring landlords to pay 3% simple interest every year on all security deposits held for at least one year. Under the new law, the city was required to review market interest rates at least every three years and make necessary adjustments to the required rate of return. Two months later, the Apartment Action Association and landlord Herb Balter filed a class action suit arguing that the new regulation was an unconstitutional taking. They argued that because banks were paying only 0.5% to 1.5% on deposited funds, the city was requiring landlords to subsidize a tenant investment. Los Angeles County temporary Judge Bruce E. Mitchell sustained the city's demurrer. But a unanimous three-judge panel of the Second District, Division One, overturned that decision. The appellate court ruled that the city does indeed have the authority to force landlords to pay tenants the interest earned on security deposits. However, the city "has not offered a legitimate reason for making landlords pay 3% interest on security deposits. … It is well settled that a regulation of property ‘effects a taking if it does not substantially advance legitimate state interests," Justice Robert Mallano wrote, citing Santa Monica Beach and Kavanau v. Santa Monica Rent Control Bd., (1997) 16 Cal.4th 761. "The Board has not offered any state interest, much less a legitimate one, for requiring landlords to pay 3% interest when banks are paying a lower rate." "When economic conditions cause banks to pay less than 3% on deposit accounts, as is the case today, a landlord should not become a tenant's cash cow," Mallano continued. The city argued on appeal that the case was not ripe because landlords had sought neither a general rent adjustment nor individual rent increases. But the court ruled that the issue at hand was not rent. "[T]he law applicable to rent is fundamentally different from the law governing security deposits, largely because rent is the property of the landlord, and a security deposit is the property of the tenant," Mallano wrote. "In light of these divergent interests in ownership, we fail to see how an administrative process for setting rents is of any value in determining the rate of return a landlord can be required to pay on a security deposit." The court also rejected the argument that, if it sustained the takings claim, the court would be micromanaging rent control. The court held that the issue was quite narrow and was not as complex as the typical rent control case that has reams of information about operating costs, investment returns and local economic conditions. The Case: Action Apartment Association v. Santa Monica Rent Control Board, No. B146227, 01 C.D.O.S. 10394. Filed December 13, 2001. The Lawyers: For AAA: Rosario Perry, (310) 394-9831. For the city: Doris Ganga, Rent Control Board general counsel, (310) 458-8781.
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