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Major Capital Improvements

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Major Capital Improvements

Postby TenantNet » Thu Nov 03, 2011 11:32 am

Major Capital Improvement 'Useful Life' Requirement
Warren A. Estis and Jeffrey Turkel
New York Law Journal
11-02-2011

Few issues in the field of rent regulation are as hotly contested as major capital improvement (MCI) rent increases. On the surface, an owner's MCI application would not seem overly controversial: the owner installs much needed equipment in a building­ such as a boiler or new windows­and in exchange receives a modest (albeit permanent) rent increase. The tenants get an improved building, and the owner gets an increase in rents. In theory, everybody wins.

The reality is different. Some tenants will oppose any increase, even if they substantially benefit from the work. And some owners may perform shoddy or unnecessary work just to increase rents.

The Division of Housing and Community Renewal (DHCR) has enacted various regulations to clarify eligibility requirements and to diffuse some of these controversies. Thus, §2522.4(a)(2)(i) of the Rent Stabilization Code (RSC) provides that an MCI must meet all of the following criteria:

(a) deemed depreciable under the Internal Revenue Code, other than for ordinary repairs; and

(b) is for the operation, preservation, and maintenance of the structure; and

(c) is an improvement to the building or to the building complex which inures directly or indirectly to the benefit of all tenants, and which includes the same work performed in all similar components of the building or building complex, unless the owner can satisfactorily demonstrate to DHCR that certain of such similar components did not require improvement….

Section 2522.4(a) sets forth a "Schedule of Major Capital Improvements," i.e., a list of work that, assuming all other criteria are met, would qualify an owner for MCI rent increases. The list covers everything from aluminum siding to water tanks. Among the most common MCIs are boiler/burner work, parapet work, pointing and waterproofing, electrical re-wiring, roofing work, and new windows.

Section 2522.4(a)(2)(i)(d) states that work will only qualify as an MCI where "the item being replaced meets the requirements set forth on the following useful life schedule…." DHCR's "Useful Life Schedule for Major Capital Improvements," found in RSC §2522.4, clarifies how long an installation must last before an owner will be granted an MCI rent increase for that installation. In Matter of Ghiggeri v. New York State Div. of Hous. & Comm. Renewal, NYLJ, Nov. 25, 2009, at 29, col. 1 (Sup. Ct. N.Y. Co.). DHCR described the useful life requirement as "intended to protect tenants from repeated or unnecessary rent increases."

However, DHCR recognized that for various reasons, an owner may have to replace an item before its useful life has expired. RSC §2522.4(e)(1) allows an owner to seek a useful life "waiver" from DHCR, as follows:

An owner who wishes to request a waiver of the useful life requirement…must apply to the DHCR for such waiver prior to the commencement of the work for which he or she will be seeking a major capital improvement rent increase. Notwithstanding this requirement, where the waiver requested is for an item being replaced because of an emergency, which causes the building or any part thereof to be dangerous to human life and safety or detrimental to health, an owner may apply to the DHCR for such waiver at the time he or she submits the major capital improvement rent increase application.

'925 D Realty LLC'

All of this brings us to the Appellate Division, First Department's recent decision in 925 D Realty LLC v. New York State Div. of Hous. & Comm. Renewal. FN1 This case concerned two separate elevator projects at the subject building. DHCR's Useful Life Schedule divides elevator work into two categories: (1) "Major Upgrade," and (2) "Controller and Selector." Both have an estimated useful life of 25 years.

In 925 D Realty LLC, the former owner of a building obtained from DHCR on Feb. 25, 1993 an MCI rent increase of $1.97 per room per month based upon elevator work performed at a cost of $16,300 to correct a Department of Buildings violation. The work, which was completed in or about 1991, related solely to the installation of a new controller and brake. The work was thus "controller and selector" work­not a "major upgrade"­as evidenced by its modest cost.

On Jan. 31, 2007, a successor owner of the subject building filed with DHCR an application for MCI rent increases based on a $229,861.43 major upgrade to the elevator. This work consisted of elevator upgrading ($196,100), associated electrical work ($6,400), associated consulting fees ($9,161.43), and associated restoration work ($18,200). In short, the entire elevator, including the controller and selector, were replaced.

On Oct. 25, 2007, DHCR's Rent Administrator (RA) issued an order denying the owner's MCI application. The RA held that because the useful life of the controller and selector work performed at the subject building in 1991 had not yet expired, the owner could not obtain MCI rent increases for the major upgrade.

The owner thereafter filed a Petition for Administrative Review (PAR), arguing that the MCI granted in 1993 for the controller and selector work did not constitute a basis for denying the owner's subsequent MCI application for major upgrade work at approximately 14 times the cost. On Jan. 14, 2009, DHCR denied the owner's PAR, ruling that the RA had properly denied the owner's MCI application for the major upgrade because the owner had not sought a waiver of the useful life requirement.

The owner thereafter commenced an Article 78 proceeding before New York County Supreme Court Justice Eileen Rakower. Justice Rakower denied the owner's Article 78 petition, holding in relevant part:

Equally unavailing is Petitioner's argument that a waiver was not required because the nature of the current elevator upgrading was much greater in scope than the prior upgrading. While this might have been a compelling argument for granting Petitioner a waiver had it timely applied for one, the Rent Stabilization Code provides that, unless a waiver is obtained, the useful life span of a 'major upgrade' to an elevator is twenty-five years. Accordingly, the 1993 MCI rent increase precludes an additional MCI rent increase for the current upgrading.

The owner then appealed to the Appellate Division, First Department. The owner asserted that DHCR's useful life/waiver policy was intended to prevent tenants from paying twice for the same work within its useful life. Because DHCR itself conceded that a major upgrade was different than controller and selector work, there was no such danger. The only overlap between the two projects was that the 2007 major upgrade encompassed controller and brake work, which was the subject of the 1991 project that resulted in the 1993 MCI.

DHCR argued that a useful life waiver was required because although the scope of the work for the two projects was different, the work "was performed on the same component of the building, the elevator."

In response, the owner observed that notwithstanding the de minimis overlap, the two projects were completely different in scope. The owner also pointed out that DHCR's policy created a dilemma for owners and for tenants alike. Assume that a building elevator only requires a new controller and selector. A sensible owner would perform the controller and selector work only, obtaining (as here) a small MCI rent increase and sparing the tenants a much larger MCI rent increase for an unnecessary major upgrade. But if the owner took that sensible course, then, according to DHCR's logic, it would be completely barred from obtaining any form of elevator MCI for the next 25 years.

Thus, if the elevator as a whole needed to be replaced during that 25-year useful life period, the owner would be barred from collecting an MCI rent increase for a major upgrade. The tenants would then get a new elevator without having to pay for it. DHCR's policy, perversely, encourages owners to always perform major upgrade work, whether or not such work is needed.

The Appellate Division, First Department agreed with the owner, stating succinctly:

Under the circumstances of this case, it was arbitrary and capricious for respondent to fail to recognize that the 2007 MCI was completely different from the 1991 MCI. Accordingly, we reverse and remand for further proceedings consistent herewith. To the extent that there may be any overlap, no rent increase should be granted that duplicates the MCI rent increase in 1993.

Justice Luis A. Gonzales disagreed, writing in dissent:

It is also argued that the 25-year useful-life requirement for the prior MCI should not apply because the present application contemplates work different from that which was approved in 1993. Both claims were rejected by the agency, whose expertise in interpreting its statutes and regulations is entitled to deference unless shown to be irrational or unreasonable. Mindful of our limited standard of review, I would affirm the judgment appealed.

The First Department majority offered a pragmatic solution to the problem: grant the major upgrade MCI, but take into account the earlier controller and selector work, which had not yet exhausted its useful life. Conversely, the majority rejected DHCR's rigid "all or nothing" approach, which would have unduly penalized the owner, and would have granted a windfall to the tenants.

Warren A. Estis is a founding partner at Rosenberg & Estis. Jeffrey Turkel is a partner at the firm.

Endnotes:

1. 85 A.D.3d 649, 925 N.Y.S.2d 822 (1st Dept. 2011). In the interest of full disclosure, Jeffrey Turkel of Rosenberg & Estis, P.C., co-author of this article, represented the owner in that case.
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DHCR's Major Capital Improvement Policy Upheld

Postby TenantNet » Thu Mar 08, 2012 4:42 pm

DHCR's Major Capital Improvement Policy Upheld
Warren A. Estis and Jeffrey Turkel
New York Law Journal
03-07-2012

In the recent case of Terrace Court, LLC v. New York State Division of Housing and Community Renewal, 2012 WL 443947, the New York State Court of Appeals unanimously held that where a landlord performs major capital improvement (MCI) work in a building, and where that work does not benefit some apartments due to poor workmanship, the Division of Housing and Community Renewal (DHCR) is authorized to permanently deny MCI rent increases for those apartments. In so holding, the Court affirmed a sharply divided Appellate Division, First Department.

The Terrace Court case provides an excellent opportunity to examine MCI rent increases, and those instances where DHCR will deny or suspend such increases in whole or in part.

MCI: The Basics

Rent Stabilization Code §2524.4(a)(2) provides that a landlord may file with DHCR an application to raise rents throughout a building where the landlord performs MCI work and the work is (1) deemed depreciable under the Internal Revenue Code, other than for ordinary repairs; (2) for the operation, preservation, and maintenance of the structure; and (3) an improvement to the building or the building complex which inures directly or indirectly to the benefit of all tenants.

Typical MCIs include parapet work, pointing and waterproofing, new elevators, rewiring, and the like. DHCR's determination as to whether work qualifies a landlord for MCI rent increases is usually accorded great deference. See, Ansonia Residents Ass'n v. New York State Division of Housing and Community Renewal, 75 N.Y.2d 206, 551 N.Y.S.2d 871 (1989); West Village Assoc. v. New York State Division of Housing and Community Renewal, 277 A.D.2d 111, 717 N.Y.S.2d 31 (1st Dept. 2000).

DHCR will deny an MCI application where the work is performed on a "piecemeal" basis over a long period of time, rather than as a single, unified project. See, Executive Towers at Lido v. New York State Division of Housing and Community Renewal, 236 A.D.2d 397, 653 N.Y.S.2d 630 (2d Dept. 1997). DHCR will also deny an MCI application outright where the landlord fails to file the application within two years of completing the work, see Hampton Mgt. v. New York State Division of Housing and Community Renewal, 255 A.D.2d 261, 680 N.Y.S.2d 245 (1st Dept. 1998), or where the MCI in question duplicates a prior MCI for which the useful life has yet to expire. See, SP 141 E 33 LLC v. New York State Division of Housing and Community Renewal, 91 A.D.3d 575, 937 N.Y.S.2d 220 (1st Dept. 2012).

DHCR will deny an MCI application where the work in question is not performed in a workmanlike manner, i.e., where the work does not "inure[] directly or indirectly to the benefit of all tenants." For example, in the oft-cited case of Garden Bay Manor Assoc. v. New York State Division of Housing and Community Renewal, 150 A.D.2d 378, 540 N.Y.S.2d 665 (2d Dept. 1989), DHCR denied an MCI application where the pointing and waterproofing work "was done in such a poor manner that it did not qualify as a major capital improvement." See also, Weinreb Mgt. v. New York State Division of Housing and Community Renewal, 204 A.D.2d 127, 611 N.Y.S.2d 545 (1st Dept. 1994) (MCI denied where "the roof continued to leak three years after the work was completed and thus the tenants were not benefited").

A more interesting question arises where, due to poor workmanship, the work benefits some, but not all, tenants. In those instances, DHCR has taken three different approaches: (1) outright denial of the MCI application; (2) permanent denial of MCI rent increases with respect to those apartments that did not benefit from the work; and (3) temporary suspension of MCI rent increases for the non-benefitting apartments, contingent upon the landlord making necessary repairs. Those scenarios are discussed below.

Outright Denial

The rule appears to be that where the percentage of non-benefitting apartments is high enough, DHCR will deny the MCI application outright. Thus, in Duell LLC v. New York State Division of Housing and Community Renewal, 269 A.D.2d 235, 703 N.Y.S.2d 37 (1st Dept. 2000), DHCR denied an MCI application where "a substantial portion of the new windows in the subject building were defectively installed and, as such, did not constitute an improvement to the building justifying a major capital improvement rent increase." The court, however, did not divulge the percentage of the windows that were defective. See also, Pickman Realty Corp. v. New York State Division of Housing and Community Renewal, 299 A.D.2d 552, 750 N.Y.S.2d 518 (2d Dept. 2002); Wesley Ave. Assoc. v. New York State Division of Housing and Community Renewal, 206 A.D.2d 378, 614 N.Y.S.2d 58 (2d Dept. 1994).

Somewhat more enlightening is Simkowitz v. New York State Division of Housing and Community Renewal, 256 A.D.2d 51, 680 N.Y.S.2d 525 (1st Dept. 1994). There, the Second Department upheld DHCR's denial of an MCI application where there were "inspections revealing that the windows in at least 18 [percent] of the apartments had substantial defects."

Partial Denial

In Terrace Court, supra, the landlord performed pointing and waterproofing work at 202 Riverside Drive, a building containing 91 apartments. Thirty seven of the apartments were rent regulated. DHCR's inspectors found that notwithstanding the pointing and waterproofing work, there was persistent water damage in five of the 37 rent regulated units (13.5 percent).

DHCR granted the MCI, but permanently exempted the five apartments from MCI rent increases. The Supreme Court (Solomon, J.) affirmed DHCR's order. On appeal to the Appellate Division, First Department, the majority (Justices Angela Mazzarelli, Dianne Renwick and Nelson Román) voted to affirm. The dissent (Justices Eugene Nardelli and David Friedman) wrote that:

…logic dictates that the proper relief would be to suspend any increases for the apartments in question until petitioner had been given an opportunity to cure the defects, but, once the defects were cured, to permit prospective (only) increases. Permanently barring petitioner from obtaining an increase, when other tenants are paying the surcharge, is irrational. Indeed, as this Court stated as recently as September of this year in a case that presented a strikingly similar issue, "[S]imple common sense dictates suspending an increase rather than revoking it permanently" (Matter of Langham Mansions, LLC v. New York State Div. of Hous. & Community Renewal, 76 A.D.3d 855, 908 N.Y.S.2d 10 [2010]).[FN 1]

On appeal to the Court of Appeals, the landlord argued that the Rent Stabilization Code mandated temporary suspension of MCI increases with respect to those apartments that did not benefit from the work. The Court saw no such regulatory command. Instead, the Court observed that in the past, DHCR had in some cases permanently denied MCI rent increases where individual apartments did not benefit from the MCI, and in other cases temporarily suspended MCI increases for such apartments until the landlord made necessary repairs. The Court aconcluded:

It is therefore apparent that DHCR is not limited to temporarily suspending an MCI rent increase; the agency may permanently exempt an apartment in certain situations. Its choice is deferentially reviewed by the courts to determine whether there is a rational basis for the decision and, if so, DHCR's conclusion must be upheld even if a court would have reached a different result (citations omitted).

In a concurring opinion, Judge Robert S. Smith added:

There are a number of cases in which DHCR has ruled that a rent increase based on a major capital improvement should be suspended as to certain apartments until particular problems are fixed. There are also a number of cases…in which DHCR has permanently exempted certain apartments from the increase. I accept the idea that both remedies are sometimes appropriate, and that DHCR has discretion to choose between them. What troubles me is that it is not easy to tell from DHCR's decisions on what basis it is making the choice (internal citations omitted).

In its brief to the Court of Appeals, DHCR attempted to explain when it will permanently deny rent increases and when it will merely suspend those increases. As the Court of Appeals observed:

DHCR claims that one of the relevant considerations in these situations is whether an owner has demonstrated good faith in diligently addressing the problems caused by an MCI. The agency apparently reasons that an owner who does so is more likely to remedy a defective condition (justifying a temporary suspension of the rent increase), whereas an owner who denies the existence of MCI-related problems or does not undertake repairs within a reasonable amount of time is unlikely to extend the benefits of the project to the affected apartments (thereby justifying a permanent exemption from the MCI adjustment).

The Court of Appeals then noted, however, that "the agency's order did not cite this as a basis for its decision and we therefore do not consider it," and added that in future cases, DHCR should explain why it has permanently or temporarily suspended MCI rent increases for affected apartments "to allow for adequate review by the courts."

Based on the foregoing, practitioners should assume the following:

• If the percentage of apartments that have not benefitted from an MCI is high enough, DHCR will likely deny the MCI application outright. It is unclear, however, what percentage will trigger the complete denial of an MCI application.

• If the percentage of apartments that have not benefitted from an MCI is reasonably small (say, under 10 percent), DHCR will probably grant the MCI increase but will permanently or temporarily deny the increase for the non-benefitting apartments.

• DHCR's determination as to permanent versus temporary denial will most likely depend on DHCR's view of the landlord's good faith efforts to make necessary repairs. Thus, landlords, instead of reflexively denying allegations of poor workmanship, should take tenant complaints seriously, conduct physical inspections, and, where necessary, perform corrective work as soon as possible.

Warren A. Estis is a founding partner at Rosenberg & Estis. Jeffrey Turkel is a partner at the firm.

Endnote:

1. 79 A.D. 3d at 50.
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