Opinion ID: 18498
Heading Depth: 2
Heading Rank: 3

Heading: Village's Request for a Declaratory Judgment

Text: 20 Village seeks a declaratory judgment stating that HUD acted arbitrarily and capriciously by (1) refusing to consider Village's rent increase request; (2) declaring Village in default and subsequently foreclosing on Mockingbird because Village failed to adequately maintain the property; and (3) refusing to review its rent increase request unless Village escrowed $2 million for repairs on Mockingbird. 21 Village argues that its obligation to maintain the property was dependent upon HUD's providing sufficient rent revenues to pay for maintenance. According to Village, because HUD refused to approve a sufficient rental schedule, HUD acted arbitrarily and capriciously in citing poor maintenance as the reason for declaring Village in default. HUD counters that Village had an absolute duty to maintain the property, regardless of its rental income. This means that if Village's rental income was insufficient to pay all of its operating and maintenance costs, Village and its financial partners must either invest additional equity to make up any deficiencies or risk default and foreclosure. 22 HUD's argument would perhaps be convincing if it had undertaken to review Village's rental increase request and to rule upon it. Both the Regulatory Agreement and HUD's regulations require HUD at least to entertain a rent increase request. 8 See Regulatory Agreement, ¶¶4(g) (stating that HUD will at any time entertain a written request for [a rent] increase); 24 C.F.R. §§ 886.312(b) (stating that once HUD receives a request, it shall approve a rental schedule . . . or shall deny the increase stating the reasons therefor) (emphasis added). HUD violated its contractual and regulatory duty to consider the rent request. This defect renders suspect HUD's other actions, particularly when the full regulatory context is considered. 23 Village certainly had the duty to maintain Mockingbird so as to provide decent, safe and sanitary housing. HAP Contract, §§ 14(a); see also Regulatory Agreement, §§ 7 (Owners shall maintain the mortgaged premises . . . in good repair and condition.). Village's duty, however, was not absolute. Nothing in the National Housing Act, HUD's regulations, the Regulatory Agreement, or the HAP contract requires Village, as a low income property owner, to absorb or subsidize operating and maintenance deficiencies. Instead, the programs are designed to ensure that HUD establishes rental rates so that property owners receive enough revenue to cover all of the property's expenses including maintenance, repairs, debt service, taxes, and a six percent return on investment. See 12 U.S.C.A. §§ 1747c. Thus, the HUD reimbursement scheme resembles cost-plus contracts or public utility regulation, in either of which situations the private party who performs the work is assured of recovering reasonably incurred costs as well as a reasonable return on investments. 24 That the cost of operating and maintaining the property, in addition to the cost of complying with the Regulatory Agreement, 9 must be paid for out of the regulated rental revenues is reinforced in several ways. First, HUD's internal interpretation of its regulations indicates that operating and maintenance costs are to be derived from the rental revenues. Albert Cason, the Director of Multifamily Housing (Houston, Texas Office) and the HUD official who oversaw Mockingbird, testified that [e]verything that comes from the project's operation is paid from the rents, and [w]e've all agreed that the operation and maintenance of the property comes out of the rents. Similarly, HUD's handbook states that [i]n reviewing requests from owners concerning rents and charges, the Field Office should be guided by the fact that these rents and fees should and must provide sufficient and adequate funding to operate the projects. Multifamily Asset Management and Project Servicing, United States Department of Housing and Urban Development, Handbook 4350.01 Rev-1,7-1 (September 1992); see also 42 U.S.C. §§ 1437f(c)(2)(B) (stating that HUD shall adjust the HAP contract to provide for sufficient monthly rents to reflect increases in the actual and necessary expenses of owning and maintaining the units); 12 U.S.C. §§ 1747c.; Beck Park, 695 F.2d at 371 (HUD has the duty to maintain reasonable rents, based on operating costs, and to allow project owners a reasonable return on their investment.). 25 Second, HUD forced Village to be organized as a single asset entity, which can neither own or operate any other property nor conduct any other business besides owning the property. See Regulatory Agreement §§ 6(f) (prohibiting Village from engaging in any other business or activity, including the operation of any other rental project). Because of this requirement, Village had no source of income to maintain the property other than the rental revenues. The only way for it to obtain a sufficient amount of money to pay for the needed repairs was by seeking a rent increase. HUD's refusal to consider a rent increase effectively forced Village either to default or, as HUD well knew, to seek additional equity or debt financing without assurance that these investments would be recouped. 26 Third, Village signed a non-recourse note, guaranteed by HUD. From the inception of HUD's program, therefore, Village was not required to support the property financially after its initial investment. Had Village not obtained a non-recourse loan, then either Village as an entity or perhaps its investors could have been made responsible to the lender (and HUD) for failure to repay or comply with terms of the loan. One HUD official put it this way: [HUD} does not require owners to make outright cash gifts to the projects they own. After final endorsement of a mortgage, there is no requirement of owners to provide additional funds to a project. Letter from Dean K. Reger, Deputy Director of Multifamily Housing Management, to Mr. Streuby L. Drumm, Jr. (October 21, 1994). 27 The interplay among these aspects of the regulatory program makes clear that all of the expenses of operating and maintaining a low income housing project must be paid out of the rental revenues, which in turn are subsidized by HUD. The regulatory scheme does not contemplate that property owners must bear the risk of maintaining properties based on insufficient rental revenues. HUD could understandably refuse to provide financial assistance to an owner that has misappropriated funds, mismanaged the property, taken a profit instead of maintaining the property, or been negligent in its management in some other regard. When those elements are absent, however, thestatutes provide that HUD must ensure that the owner receives rents sufficient to meet at least the operating and maintenance expenses of the property. There is no statutory or regulatory basis for imposing on a conscientious low-income housing operator the risk of uncompensated dilapidation or deterioration; the federal government, not the private contractor, is charged with funding the public program. 28 In the case at hand, it is alleged that rental revenues approved by HUD were consistently insufficient to cover the cost of operating and maintaining the property. 10 Village sought several rental increases over the course of its ownership of Mockingbird, but it never received the full amount requested, nor the amount it thought was necessary to maintain the property. 11 Annual financial audits appear to have routinely showed, moreover, that Village never misappropriated funds or squandered its revenues. Village never received a profit from Mockingbird and appears to have applied all of its revenues to cover costs of operating and maintaining the property. In addition, there was no evidence that the property was mismanaged, 12 nor did HUD ever attempt to remove the management company as it had a right to do. See Regulatory Agreement, 9(a) (Any management contract entered into by Owners . . . involving the project shall contain a provision that it shall be subject to termination, without penalty, and with or without cause, upon written request by the Commissioner addressed to the Owners.). 29 These facts reinforce Village's contention that HUD's $2 million demand was arbitrary and capricious. As noted supra, instead of considering Village's rent request, HUD determined that no action would be taken unless Village first escrowed $2 million. HUD cannot point to any statute, regulation, or agreement with Village giving it the discretion to table Village's rent increase request and use it as leverage to demand $2 million new equity for repairs. 13 30 Because HUD acted without statutory or regulatory authority, the agency arbitrarily and capriciously demanded Village to escrow $2 million before it would consider the rent request. 31 HUD argues that a holding in Village's favor would mean that HUD has the duty to pay for all of a property's maintenance expenses, thus giving owners the incentive to neglect the maintenance needs of their property. We disagree. This decision has no bearing on those cases where a property owner has negligently permitted the property to deteriorate or has misused its rental income in a way that has caused the maintenance problem. As noted supra, rental increase decisions are discretionary and are generally unreviewable by the courts. In this case, however, HUD acted arbitrarily and capriciously when it refused to abide by its legal obligation to consider a rental increase request from a non-negligent owner and instead demanded a $2 million cash infusion and then declared the property in default for those very reasons.