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515 ASSOCIATES

January 12, 1977

515 ASSOCIATES, a limited partnership and Mt. Prospect Associates, a limited partnership, plaintiffs,
v.
CITY OF NEWARK and Rent Leveling Board of the City of Newark, Defendants, and Joseph Worth et al., Intervenors



The opinion of the court was delivered by: STERN

 The center of this controversy is the conflict between the United States Department of Housing and Urban Development (HUD) and the Newark Rent Control Board over the regulation of rental rates in two Newark apartment houses. Plaintiffs are landlords who own and operate the buildings. They filed suit to challenge actions taken by the Newark Rent Control Board. The Board twice denied plaintiffs' applications for an increase in rental rates. Plaintiffs contend that HUD has preempted the authority of the Newark Rent Control Board to regulate rents in their buildings. They seek an injunction barring the City of Newark or its agencies from interfering with their efforts to raise rents. HUD has been joined as a nominal party plaintiff; several tenants have been granted leave to intervene. *fn1" The landlords and HUD have now moved for summary judgment.

 Most of the facts which gave rise to this lawsuit are not in dispute. Plaintiffs 515 Associates and Mt. Prospect Associates are New Jersey limited partnerships. They presently own and operate high-rise apartment buildings located at 515 and 555 Mt. Prospect Avenue in Newark. Both buildings were constructed in the mid-nineteen-sixties, pursuant to § 207 of the National Housing Act, Title 12 U.S.C. § 1713 (1969).

 Section 207 established a program of federal mortgage insurance to facilitate the construction of rental accommodations for families. This program, which represents the major federal commitment to non-subsidized housing, is designed to serve the housing needs of a broad spectrum of citizens by stimulating private mortgage lending. See 1950 U.S. Code Cong. Serv., 81st Cong., 2nd Sess. pp. 2026, 2038. Projects constructed under § 207 must meet numerous government requirements. See 24 C.F.R. §§ 207.1 et seq. (1976). *fn3" When the mortgagor, the mortgagee and the project have satisfied the conditions of eligibility, HUD undertakes to insure virtually the entire principal amount of the mortgage loan. See 24 C.F.R. § 207.259 (1976). Once this commitment is made, HUD oversees the mortgagor's business operations, 24 C.F.R. § 207.19(f) (1976), and regulates the rents and charges made by the mortgagor. 24 C.F.R. § 207.19(e) (1976).

 Despite the careful regulation of § 207 mortgage insurance commitments, neither project at issue here proved to be economically viable. The original owners-mortgagors fell into default and the government was called upon pursuant to the mortgage insurance contracts to satisfy the mortgage debts. HUD did so, paying the insurance proceeds to the mortgagees, in exchange for assignment of the notes and mortgages. Subsequently, HUD acquired the buildings by foreclosure. *fn4"

 The funds which HUD may use to satisfy the claims of insured mortgagees under § 207 come from the General Insurance Fund created by § 519 of the National Housing Act, Title 12 U.S.C. § 1735(c) (1970). This fund is intended to operate as a self-sustaining source of monies for various National Housing Act programs, including § 207. In order to achieve this goal of a self-sufficient housing program, the Secretary of HUD is authorized to manage, sell, or sell for credit properties acquired by foreclosure ". . . for the protection of the interests of the General Insurance Fund." Title 12 U.S.C. § 1713(l). In the instant cases, the Secretary determined that continued HUD ownership of the buildings was not desirable. Accordingly, both buildings were offered for sale in 1973.

 The offering was made by means of a prospectus and invitation to bid. The prospectus for each building noted that the purchaser was obliged to execute a standard regulatory agreement with HUD providing for ". . . the customary controls, including rent." *fn5" During the period that HUD had owned the two buildings directly, no rental increases had been imposed. In each case, the prospectus offered HUD approval of maximum rental rates in excess of the prevailing rental levels. Any further increases, however, were to be processed normally according to HUD procedures. *fn6" Plaintiffs here were the high bidders on each project. They executed the required Regulatory Agreements embodying the provisions of 24 C.F.R. §§ 207 et seq. and closed the transactions in the latter part of 1973. *fn7" HUD took back a purchase money mortgage on each of the buildings in substantial amounts.

 The conflict which engendered the present lawsuit was created by the enactment, in December 1973, of a rent control ordinance by the City of Newark. *fn8" The ordinance, which by its terms was made retroactive to November 1973, applied to plaintiffs' newly acquired buildings. The ordinance permitted no more than a five percent increase in rental rates in any year. Because of the passage of this ordinance, the plaintiffs were unable to implement the increases in rental rates contemplated by the bid prospectuses and approved in advance by HUD. Section 9 of the Newark ordinance provided that a landlord could apply to the newly created Newark Rent Control Board for a hardship increase. Although § 10 of the ordinance created the Rent Control Board, the group did not constitute itself until November 1974.

 During the year that the ordinance was in effect without a functioning Rent Control Board, plaintiffs were in serious financial difficulty. Debt service on HUD's purchase money mortgages had been calculated on the assumption that the increases in rental rates contemplated by the bid prospectuses would be implemented. When the increases were blocked by the enactment of the Newark ordinance, plaintiffs defaulted on their mortgage payments. HUD entered into Provisional Work-Out Agreements with respect to each of the buildings. Under these agreements, HUD approved a two-year moratorium on the repayment of principal and the payment of interest, from May 1, 1974 to April 1, 1976, subject to any change in the financial conditions of the projects.

 The Newark Rent Control Board constituted itself in late 1974. In February of 1975, plaintiffs made simultaneous application to HUD and the Board for permission to raise their rents in an amount significantly greater than five percent. Plaintiffs were heard by the Newark Rent Control Board on February 28, 1975. Despite a provision of the Rent Control Ordinance which required that the Board make its decision within 15 days of the hearing, plaintiffs' applications pended until April 25, 1975, at which time their applications for increased rental levels were denied for failure to "substantiate hardships." On the advice of HUD, plaintiffs thereupon reapplied simultaneously to HUD and to the Newark Rent Control Board. These applications were filed on July 30, 1975. Again approval from HUD came within days. The Newark Board held no hearings until October 23, 1975, despite a provision of the Rent Control Ordinance requiring that any such hearings be held within 60 days of the filing of such an application.

 While this second application was pending before the Newark Rent Control Board, plaintiffs applied to HUD to have the agency act pursuant to interim regulations which permitted HUD to assert exclusive jurisdiction over rentals where ". . . the action or inaction of a local rent control board jeopardizes HUD's economic interest in a project." *fn9" Final regulations were published on October 22, 1975, *fn10" and formal certificates of preemption were delivered to the Newark Rent Control Board one week later. In accordance with the preemption certificates, plaintiffs notified their tenants that rents would be increased. On December 5, 1975, the Newark Rent Control Board released its decision, again denying plaintiffs' applications for increased rentals. The Board's decision did not refer to the Certificate of Preemption served a month earlier. The Board did, however, send letters to all tenants in the two buildings notifying them of the Board action and thus suggesting that the increased rentals need not be paid. On December 19, 1975, plaintiffs filed the instant suit against the City of Newark.

 This lawsuit involves the validity of the effect of the HUD regulations, 24 C.F.R. §§ 403.1 et seq. (1976), which permit the Secretary to preempt local rent controls as they apply to § 207 unsubsidized, insured housing projects upon a determination that a local rent control board's delay or decision "jeopardizes the Department's economic interest in a project."

 The validity of the regulations must be tested by a three-fold inquiry: (1) Are the rules within the delegated authority? (2) Are the rules reasonable? (3) Were the rules issued pursuant to proper procedures? See Kenneth Culp Davis, Administrative Law Treatise, § 5.05 (1958). No attack has been made on the procedure by which the regulations ...


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