Opinion ID: 2631196
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Heading: Does a Kavanau Adjustment Apply When Section 1983 Damages Are Sought?

Text: In order to answer the above question, we must first clarify the precise nature of the constitutional injury that the Gallands are purported to have sufferedthe denial of a fair return on their rent-controlled property. As we recognized in Birkenfeld v. City of Berkeley (1976) 17 Cal.3d 129, 165, 130 Cal.Rptr. 465, 550 P.2d 1001 ( Birkenfeld ), and later in Kavanau, price control regulation, including rent control, involves a distinct branch of constitutional inquiry under the due process clause. Such regulations are generally found to pass constitutional muster so long as the law does not deprive investors of a `fair return' and thereby become `confiscatory.' [Citations.] Determining prices that will provide a fair return `involves a balancing of the investor and the consumer interests.' [Citation.] `It is the product of expert judgment which carries a presumption of validity.' [Citation.] A reviewing court focuses on whether the regulatory agency took relevant investor interests into account. [Citations.] ... `... It is not theory but the impact of the [price regulation] which counts.' [Citation.] In sum, when considering whether a price regulation violates due process, a `court must determine whether the [regulation] may reasonably be expected to maintain financial integrity, attract necessary capital, and fairly compensate investors for the risks they have assumed, and yet provide appropriate protection for the heart of relevant public interests, both existing and foreseeable.' ( Kavanau, supra, 16 Cal.4th at pp. 771-772, 66 Cal.Rptr.2d 672, 941 P.2d 851.) In other words, rent regulation must not prevent an efficient enterprise from `operating successfully,' but rent regulators are permitted to adjust prices within a broad zone of reasonableness,' balancing the interests of landlords and tenants. ( Id. at pp. 778-779, 66 Cal.Rptr.2d 672, 941 P.2d 851.) In Kavanau, we further held that a landlord may not obtain inverse condemnation damages against a government agency for temporarily imposing rent ceilings that a court had deemed confiscatory so long as the landlord was able to obtain an adequate adjustment of prospective rents that would compensate for past losses. ( Kavanau, supra, 16 Cal.4th at pp. 783-784, 66 Cal.Rptr.2d 672, 941 P.2d 851.) As we explained: An adjustment of future rents that takes into consideration past confiscatory rents is the converse of the refund that producers in price-regulated industries may have to pay if, during litigation over price levels, they charge prices that a court later determines to be excessive. [Citation.] Moreover, this remedy, as opposed to an award of damages against the Rent Board, places the cost of compensating [the landlord] roughly on those tenants who benefited from unconstitutionally low rents. [Citations.] ... Finally, the remedy of future rent adjustments avoids putting a reviewing court in the position of declaring the appropriate regulated rent ceiling for a particular apartment in order to measure damages. [Citation.] Setting rent ceilings is essentially a legislative task, and agencies, not courts, choose which administrative formula to apply. [Citation.] The state and federal Constitutions require only a fair process that reasonably takes into consideration the landlord's interests, and a landlord's return need only fall within a `broad zone of reasonableness.' [Citation.] Accordingly, courts are in no position to determine the appropriate rent ceiling for an apartment as a means of assessing damages. We strongly resist any rule that would impose on a reviewing court the impossible task of finding somewhere in the penumbra of the Constitution a stipulation that a particular apartment in a particular building should rent for $746 per month rather than $745. ( Kavanau, supra, 16 Cal.4th at pp. 783-784, 66 Cal. Rptr.2d 672, 941 P.2d 851.) As we made clear in Kavanau and elsewhere, a landlord under rent control who is permitted no or excessively low rent increases has the means, via a writ of mandate, to judicially challenge a rent board's actions. (See, e.g., Kavanau, supra, 16 Cal.4th at p. 767, 66 Cal.Rptr.2d 672, 941 P.2d 851; Carson Harbor Village, Ltd. v. City of Carson Mobilehome Park Rental Review Bd. (1999) 70 Cal.App.4th 281, 287, 82 Cal.Rptr.2d 569.) As we also made clear, a landlord is charged with the duty to take advantage of such a remedy before seeking damages against a municipality: A landlord who unnecessarily permits large losses to accumulate cannot complain if the market prevents him from recouping those losses. ( Kavanau, supra, 16 Cal.4th at p. 785, 66 Cal.Rptr.2d 672, 941 P.2d 851.) Of course, the fact that overlapping state remedies are available is generally irrelevant to the question whether a cause of action exists under section 1983. ( Zinermon, supra, 494 U.S. at pp. 124-125, 110 S.Ct. 975.) We expressly left undecided the question whether the availability of an adequate Kavanau adjustment precludes a section 1983 claim. ( Kavanau, supra, 16 Cal.4th at pp. 768, 783, 66 Cal.Rptr.2d 672, 941 P.2d 851.) The answer to this question depends upon whether a Kavanau adjustment is most appropriately characterized as preventing a substantive due process injury from occurring, or if it is better characterized as compensating for a substantive due process injury that has already occurred. If the former, then there would be no substantive due process injury, and no section 1983 claim. If the latter, then the contrary would be true. The answer to this question in turn lies in the peculiar nature of the constitutional injury inflicted by a confiscatory rate regulation, as suggested by the above discussion. The term confiscatory is often used in the context of price regulation to describe a rate ceiling or ordinance that potentially or eventually will cause confiscation. (See Birkenfeld, supra, 17 Cal.3d at p. 169, 130 Cal.Rptr. 465, 550 P.2d 1001.) But this is not to say that a delay in the upward adjustment of rents to nonconfiscatory levels works substantive due process injury. Indeed, in the field of public utility regulation, the proper remedy for delay in the upward adjustment of rents, or regulatory lag, has been equitable relief to enforce the proper rates, not monetary damages against the regulator. (Priest, Principles of Public Utility Regulation (1969) pp. 204-206; see, e.g., Smith v. Ill. Bell Tel. Co. (1926) 270 U.S. 587, 591-592, 46 S.Ct. 408, 70 L.Ed. 747.) Thus, a rent control regime that permits landlords to challenge confiscatory regulations in state court via a writ of mandate, and which permits the timely adjustment of future rents to compensate for any regulatory lags that may have occurred, is one that passes constitutional muster. We suggested as much in Kavanau when rejecting the landlord's takings argument in that case. Just as a reviewing court averages the effects of subsidiary aspects of a price-setting scheme by looking at `net effect' [citation], a reviewing court can also average the effects of a price-setting scheme over time. Thus, a fair return over the course of several years will offset a confiscatory return during a particular year. Recognizing that [the landlord] has a continuing right under the due process clause to future rent adjustments that will enable him to earn a fair return, we believe he has not suffered a taking. Put another way, the ongoing process of setting rent ceilings dispels the due process violation, which in this case is the sole basis for a potential takings clause violation. ( Kavanau, supra, 16 Cal.4th at pp. 785-786, 66 Cal.Rptr.2d 672, 941 P.2d 851; see also Yee v. Mobilehome Park Rental Review Bd. (1998) 62 Cal.App.4th 1409, 1423-1427, 73 Cal.Rptr.2d 227 [because of available Kavanau adjustment, no damages available under section 1983 for lost rents due to excessively low rent ceilings].) Kavanau therefore implies that a system of rent regulation sufficiently flexible to adjust rates upward to compensate for delay inflicts no constitutional injury. To be sure, Kavanau involved a takings claim, and this case is concerned with what is labeled substantive due process. But we have recognized that a price regulation that causes confiscation may be designated interchangeably as either a taking of property under the Fifth and Fourteenth Amendments of the United States Constitution or a violation of due process. ( Santa Monica Beach, Ltd. v. Superior Court (1999) 19 Cal.4th 952, 967, 81 Cal.Rptr.2d 93, 968 P.2d 993; Kavanau, supra, 16 Cal.4th at pp. 776-777, 66 Cal.Rptr.2d 672, 941 P.2d 851; see also Duquesne Light Co. v. Barasch (1989) 488 U.S. 299, 307-308, 109 S.Ct. 609, 102 L.Ed.2d 646.) It would be incongruous for us to conclude, on the one hand, as we did in Kavanau, that a landlord permitted adequate rent adjustments has not suffered a constitutional injury under the takings clause, but, on the other hand, that he or she has suffered such an injury under the due process clause. [3] This conclusion is also consistent with the recognition that mobilehome rental property is a long-term capital asset, the value of which is determined by a stream of income expected over a number of years. (See Radford, Regulatory Takings Law in the 1990's: The Death of Rent Control? (1992) 21 Sw.U. L.Rev. 1019, 1035; see also Brealy & Stewart, Principles of Corporate Finance (4th ed.1991) p. 30.) An excessively low rate of return followed by an adequate adjustment of future rents will allow a reasonable average return over the life of the investment and therefore avoid confiscation. Of course, an excessively low rent sustained over a long duration may well inflict losses that no rent adjustment can cure. But as noted, we emphasized in Kavanau that a landlord generally has the capacity to prevent large losses through resort to available state remedies: [I]f a landlord acts promptly to challenge a confiscatory regulation, and seeks a stay of that regulation during litigation, his losses, and thus any future rent adjustments, are likely to be relatively small. A landlord who unnecessarily permits large losses to accumulate cannot complain if the market prevents him from recouping those losses. ( Kavanau, supra, 16 Cal.4th at p. 785, 66 Cal.Rptr.2d 672, 941 P.2d 851.) A section 1983 remedy is available for constitutional injury inflicted by those acting under color of state law. When the state makes available a judicial procedure that can feasibly prevent a constitutional injury from occurring, no section 1983 remedy will lie when a plaintiff fails to avail himself or herself of that procedure. It may be, of course, that even if the landlord acts reasonably to prevent large losses from accumulating, a Kavanau adjustment would be inadequate. In Kavanau, we stated that we did not need to decide what alternative remedy might be appropriate if a landlord can establish that the remedy of future rent adjustments is for some reason unavailable.... [B]efore [a landlord] can allege the unavailability of future rent adjustments, he must petition for those adjustments, the Rent Board must determine, subject to judicial review, their appropriate amount, and he must attempt to impose them. ( Kavanau, supra, 16 Cal.4th at p. 785, 66 Cal.Rptr.2d 672, 941 P.2d 851.) Accordingly, when landlords seek section 1983 damages from allegedly confiscatory rent regulation, we hold that they must show (1) that a confiscatory rent ceiling or other rent regulation was imposed and (2) that relief via a writ of mandate and a Kavanau adjustment is inadequate. Applying this test to the present case, we first consider whether the rent ceilings imposed from 1988 to 1990 were confiscatory. Although the trial court concluded that they were, that conclusion was based at least in part on the questionable assumption that the Gallands were constitutionally entitled to an ROI of between 20 and 25 percent. Because there appears to have been considerable confusion in the courts below as to what constitutes a confiscatory rate of return, we offer the following guidance on remand: Although the term fair rate of return borrows from the terminology of economics and finance, it is as used in this context a legal, constitutional term. It refers to a constitutional minimum within a broad zone of reasonableness. As explained above, within this broad zone, the rate regulator is balancing the interests of investors, i.e., landlords, with the interests of consumers, i.e., mobilehome owners, in order to achieve a rent level that will on the one hand maintain the affordability of the mobilehome park and on the other hand allow the landlord to continue to operate successfully. ( Kavanau, supra, 16 Cal.4th at pp. 778-779, 66 Cal.Rptr.2d 672, 941 P.2d 851.) For those price-regulated investments that fall above the constitutional minimum, but are nonetheless disappointing to investor expectations, the solution is not constitutional litigation but, as with nonregulated investments, the liquidation of the investments and the transfer of capital to more lucrative enterprises. Of course, a valid price control scheme must permit an efficiently run company, subject to market constraints, to earn a `return ... commensurate with returns on investments in other enterprises having corresponding risks.' ( Kavanau, supra, 16 Cal.4th at p. 772, 66 Cal. Rptr.2d 672, 941 P.2d 851.) The Gallands correctly cite our opinion in Fisher v. City of Berkeley (1984) 37 Cal.3d 644, 683, 209 Cal.Rptr. 682, 693 P.2d 261 for the proposition that rent regulators must generally permit profits to be adjusted over time for inflation so that the real value of that profit does not shrink toward the vanishing point. But as we also held in Fisher, it is obviously not the case that a rent-controlled investment must earn the same as a non-rent-controlled one: `[S]ome lessening of appreciation is a necessary consequence of any rent control, since future appreciation is to a significant extent a function of increased rental income. [Citation.] It is one of the very sources of long-term appreciationinflated rents that rent control measures are intended to restrict.' [Citation.] [¶] ... Any price-setting regulation, like most other police power regulations of property rights, has the inevitable effect of reducing the value of regulated properties. But it has long been held that such reduction in property value does not by itself render a regulation unconstitutional. Police power legislation results in a confiscatory `taking' only when the owner has been deprived of substantially all reasonable use of the property. [Citation.] Even a significant diminution in value is insufficient to establish a confiscatory taking. ( Fisher v. City of Berkeley, supra, 37 Cal.3d at pp. 685-686, 209 Cal.Rptr. 682, 693 P.2d 261, fn. omitted.) Thus, comparison of the rate of return of rent-controlled mobilehome parks with those of non-rent-controlled parks, as the Gallands made and the trial court accepted in the present case, is of limited utility in establishing the constitutional minimum rate of return. Moreover, there is nothing in the record to indicate that the average rate of return of the 16 PMS parks surveyed, which were not randomly chosen, was the same as or similar to the average return on mobilehome parks nationally, or, more to the point, the average return on mobilehome parks in the Clovis area. Furthermore, PMS's own data indicates that market forces, rather than rent control, were primarily responsible for the Woods's relatively poor performance in relationship to other PMS mobilehome parks surveyed. This data shows, for example, that in 1987, the year before the present controversy commenced, the ROI for the Woods was 11.8 percent, whereas the average for ROI for the 16 other parks was 22.6 percent. But the data also reveals that in 1987, the base monthly rent charged at the Woods, $269, was equal to the market rate rents. Thus, although the Woods had only a 9 percent ROI in 1988 and 1989, according to its own data, the same data also indicate that this rate of return for rent-controlled property was only slightly below the return the market afforded, and that the wide gap between the Woods and other PMS parks was largely due to factors other than Clovis's rent control. (See Yee v. Mobilehome Park Rental Review Bd., supra, 62 Cal. App.4th at pp. 1414-1415, 73 Cal.Rptr.2d 227 [10 percent return on equity in 1994 considered fair by both parties].) [4] Moreover, as explained above, one measure of whether a regulated enterprise is allowed to operate successfully is whether it continues to attract necessary capital. ( Kavanau, supra, 16 Cal.4th at p. 772, 66 Cal.Rptr.2d 672, 941 P.2d 851.) We note that in 1993, during the period that the Gallands were subject to supposedly confiscatory rent ceilings, they were able to obtain a $3 million refinancing loan on the Woods on standard terms for commercial property. Thus, on remand, the trial court must consider not whether the return on the Woods measured up to some benchmark established by nonregulated investments, but rather whether the 1988 to 1990 rent ceilings were within the constitutionally permitted broad zone of reasonableness. On the other hand, the Gallands are correct that the substantial legal and administrative costs attributable to the rent review process, discussed at greater length in the next part of this opinion, should be properly included as expenses when calculating the proper rent readjustment. Under the fair ROI method used in practice by Clovis, it may not arbitrarily exclude the reasonable expenses of seeking legitimate rent increases. Clovis argues that Oceanside Mobilehome Park Owners' Assn. v. City of Oceanside (1984) 157 Cal.App.3d 887, 204 Cal.Rptr. 239 stands for the proposition that a city may not be constitutionally required to include the landlords' costs of obtaining rent increases as operating expenses when calculating the proper rent levels. Clovis is correct, but only up to a point. In City of Oceanside, the court considered a facial challenge to an ordinance, including a challenge to a provision excluding attorney fees from operating expenses. The court correctly rejected this facial challenge. As explained above, it is the overall result of the rent-setting process, not the method employed or any particular exemption legislated, that determines whether a rent control regime is confiscatory. ( Kavanau, supra, 16 Cal.4th at pp. 771-772, 66 Cal.Rptr.2d 672, 941 P.2d 851.) Thus, the exclusion of costs associated with obtaining rent increases is not per se confiscatory. On the other hand, if a rent control ordinance as applied operates to impose large and unnecessary costs on landlords, and if as a result of that imposition a landlord is only able to garner a rate of return that is deemed confiscatory, we may not ignore the confiscation simply because these costs have been classified as exempt expenses. Accordingly, these expenses must also be considered on remand when determining whether and to what extent Clovis's rent regulation has been confiscatory and whether remand for a determination of Kavanau adjustment is appropriate.