Kavanau v. Santa Monica Rent Control Board

MOSK, J.

I concur in the majority opinion. I write separately to attempt further clarification of the relationship between due process and takings jurisprudence in the context of rent control and rate regulation generally.

The term “due process” has at least two distinct meanings or applications in the field of rate regulation: (1) substantive due process, i.e., whether the scheme of regulation in question is “ ‘ “arbitrary, discriminatory, or demonstrably irrelevant to the policy the Legislature is free to adopt . . . ” (Pennell v. San Jose (1988) 485 U.S. 1, 11 [ 108 S.Ct. 849, 857 , 99 L.Ed.2d 1 ] (Pennell)); (2) what can be termed “confiscatory” due process, i.e., whether a given scheme of rate regulation, although not per se or facially invalid, is confiscatory in its result and has prevented an opportunity to obtain a just and reasonable rate of return on investment. (See Duquesne Light Co. v. Barasch (1989) 488 U.S. 299, 307-308 [ 109 S.Ct. 609, 615 , 102 L.Ed.2d 646 ] (Duquesne Light Co.).) As explained below, it is this latter confiscatory due process analysis that significantly overlaps the takings clause.

Substantive due process analysis of price and rate regulation is fairly straightforward. Price regulation is presumed to be constitutional, and "‘The *787 burden of proving* otherwise ‘rests on the party asserting the violation . . . [Citation.] It ‘is not easily met. For the last half-century, courts have upheld challenged governmental acts unless no reasonably conceivable set of facts could establish a rational relationship between the regulation and the government’s legitimate ends.’ [Citation.] ‘It is enough that there is an evil at hand for correction, and that it might be thought that the particular . . . measure was a rational way to correct it.’ ” (20th Century Ins. Co. v. Garamendi (1994) 8 Cal.4th 216, 292 [ 32 Cal.Rptr.2d 807 , 878 P.2d 566 ], italics added (20th Century Ins. Co.).)

Rent control is simply a form of price control. “For constitutional purposes rent control is indistinguishable from other types of governmental price regulation. Despite the permanence and concreteness of real property, and the special place accorded it by the common law and expounded by the early commentators, its commercial use is no less subject to regulation under the police power than other, more ephemeral, goods and services. ... To ascertain the limitations imposed by the . . . federal constitution[ ] upon municipal efforts to regulate rents, it is therefore appropriate to consider the constitutional limits on governmental regulation of prices generally.” (Hutton Park Gardens v. Town Council (1975) 68 N.J. 543 [ 350 A.2d 1, 7-8 ], fn. omitted.)

As the United States Supreme Court affirmed in Pennell , a rent control case: “[W]e have long recognized that a legitimate and rational goal of price or rate regulation is the protection of consumer welfare.” (Pennell, supra, 485 U.S. at p. 13 [ 108 S.Ct. at p. 858 ].) Thus, that court upheld a facial challenge to a rent control ordinance that “represents a rational attempt to accommodate the conflicting interests of protecting tenants from burdensome rent increases while at the same time ensuring that landlords are guaranteed a fair return on their investment.” (Ibid.) Accordingly, the notion advanced by some commentators (see Radford, Regulatory Takings Law in the 1990’s: The Death of Rent Control? (1992) 21 Sw.U.L.Rev. 1019) that rent control laws are subject to a heightened constitutional scrutiny that goes beyond the substantive due process “rational relationship” analysis to which other economic regulation is subject, is without constitutional basis. Nor is it constitutionally sound to assert that a trial court, sitting as trier of fact, may act as a kind of “Super City Council” that can evaluate whether a rent control law has been successful in achieving its stated purposes. (See ibid.) A trial court may not arrogate to itself such a role. Neither may an appellate court. “In a substantive due process challenge, we do not require that the City’s legislative acts actually advance its stated purpose, but instead look to whether “ ‘ “the governmental body could have had no legitimate reason for its decision.” ’ ” (Kawaoka v. City of Arroyo Grande (9th Cir. 1994) 17 F.3d *788 1227, 1234 , italics in original.) Whether rent control is the best way to remedy the problem of excessive rents in a given locale, and whether the benefits it brings in terms of lower-than-market rents for some tenants outweigh its costs, is a matter to be addressed to legislative bodies. 1

Although a government agency’s capacity under the police power to regulate rents in some manner is seldom in doubt, the particular form the regulation takes will not pass constitutional scrutiny if it is confiscatory. This confiscatory analysis, although it also goes under the rubric of “due process,” is substantially different from the substantive due process analysis discussed immediately above. The fixing of a “ ‘just and reasonable’ rate[] involves a balancing of the investor and the consumer interests. . . . [T]he investor interest has a legitimate concern with the financial integrity of the company whose rates are being regulated.” (Power Comm’n v. Hope Gas Co. (1944) 320 U.S. 591, 603 [ 64 S.Ct. 281, 288 , 88 L.Ed. 333 ] (Hope).) In determining a just and reasonable rate, “it is the result reached not the method employed which is controlling. [Citations.] It is not theory but the impact of the rate order which counts. If the total effect of the rate order cannot be said to be unjust and unreasonable, judicial inquiry under the Act is at an end. The fact that the method employed to reach that result may contain infirmities is not then important.” (Id. at p. 602 [64 S.Ct. at pp. *789 287-288].) Thus in Hope, for example, Justice Douglas discussed the utility’s historical earnings and financial status in considerable detail and concluded that it was able to maintain its “financial integrity.” ( Hope, supra, 320 U.S. at pp. 604-605 [ 64 S.Ct. at p. 289 ].) The court more recently did the same in Duquesne Light Co., supra, 488 U.S. at page 312 [ 109 S.Ct. at page 618 ].

Some rent control cases speak of confiscatory regulations without engaging in “end result” analysis. (See Birkenfeld v. City of Berkeley (1976) 17 Cal.3d 129, 165 [ 130 Cal.Rptr. 465 , 550 P.2d 1001 ].) In Birkenfeld , we found that Berkeley’s rent control law, as then drafted, was partly unconstitutional because it failed to make adequate provision for adjusting base rents. (Id. at p. 169.) Although Birkenfeld used the language of confiscation, it is in fact closer to substantive due process analysis. As we stated: “The provisions [of a rent control law] are within the police power if they are reasonably calculated to eliminate excessive rents and at the same time provide landlords with a just and reasonable return on their property. However, if it is apparent from the face of the provisions that their effect will necessarily be to lower rents more than could reasonably be considered to be required for the measure’s stated purpose, they are unconstitutionally confiscatory.” (Id. at p. 165.) Turning to Berkeley’s rent control scheme, we concluded that “Here the [law] drastically and unnecessarily restricts the rent control board’s power to adjust rents, thereby making inevitable the arbitrary imposition of unreasonably low rent ceilings.” (Id. at p. 169.) Thus, this particular feature of Berkeley’s scheme was deemed to be constitutionally invalid not because its end result was actually “confiscatory,” in the sense in which Hope and its progeny employ that term, but because it was arbitrary and could not be rationally related to the legitimate state purpose of “eliminat[ing] excessive rents and at the same time provid [ing] landlords with a just and reasonable return on their property.” (Birkenfeld, supra, 17 Cal.3d at p. 165 .)

Similarly, regulation that set rates for insurers at less than a fair rate of return in order to compensate for supposedly excess profits was determined to be a violation of due process in Calfarm Ins. Co. v. Deukmejian (1989) 48 Cal.3d 805, 819 [ 258 Cal.Rptr. 161 , 771 P.2d 1247 ]. “[T]he concept that rates may be set at less than a fair rate of return in order to compel the return of past surpluses is not one supported by precedent.” (Ibid.) Again, this aspect of the law was declared unconstitutional because it failed to pursue a legitimate state purpose—an essentially substantive due process violation— not because it resulted in fact in the undermining of the financial integrity of the various insurance companies.

In Duquesne Light Co., supra, 488 U.S. 299 , the court appeared to use the terms “due process” and “taking” interchangeably in referring to utility rate *790 regulation that is confiscatory and therefore constitutionally defective. As the court stated, “[t]he guiding principle has been that the Constitution protects utilities from being limited to a charge for their property serving the public which is so ‘unjust’ as to be confiscatory. Covington & Lexington Turnpike Road Co. v. Sanford, 164 U. S. 578, 597 (1896) [ 17 S.Ct. 198, 205 , 41 L.Ed. 560 ] (A rate is too low if it is ‘so unjust as to destroy the value of [the] property for all the purposes for which it was acquired,’ and in so doing ‘practically deprive[s] the owner of property without due process of law’); [citations]. If the rate does not afford sufficient compensation, the State has taken the use of utility property without paying just compensation and so violated the Fifth and Fourteenth Amendments.” (Duquesne Light Co., supra, 488 U.S. at pp. 307-308 [ 109 S.Ct. at p. 615 ], italics added.) However, it is clear that the Duquesne Light Co.’s equation of the two constitutional provisions was made only in reference to rate regulations that are confiscatory in their end result. (Duquesne Light Co., supra, 488 U.S. at p. 310 [ 109 S.Ct. at p. 617 ].) In other words, a rate regulation is judged to be a taking when its effect has been actually confiscatory, not when it violates substantive due process. As has been stated, “[A]bsent. . . deep financial hardship [of a regulated public utility], there is no taking, and ... no obligation to compensate . . . .” (Jersey Cent. Power & Light Co. v. F.E.R.C (D.C. Cir. 1987) 810 F.2d 1168, 1181, fn. 3 [ 258 App.D.C. 189 ]; accord, 20th Century Ins. Co., supra, 8 Cal.4th at p. 297 .)

The notion that a price regulation that leads to the actual confiscation of property is a “taking” of that property is congruent with the Supreme Court’s evolving takings jurisprudence in the field of land use law, wherein the impact of land use regulation, either in economic terms or in terms of physical intrusion on real property, is paramount in any takings analysis. (See Lucas v. South Carolina Coastal Council (1992) 505 U.S. 1003, 1015-1016 [ 112 S.Ct. 2886, 2893 , 120 L.Ed.2d 798 ].) But nothing in the land-use cases, or in Duquesne Light Co., suggests that any regulation that violates substantive due process is a taking for which just compensation must be paid. 2

In the present case, the basis of the Court of Appeal’s holding in the original Kavanau decision (see Kavanau v. Santa Monica Rent Control Bd. *791 (1993) 19 Cal.App.4th 730 [ 23 Cal.Rptr.2d 724 ] (Kavanau I)) is unclear. The opinion can be read as a substantive due process case, concluding that the 12 percent cap found in the Santa Monica ordinance is arbitrary. As the majority herein explain, however, there is no reason why a 12 percent cap cannot “be one aspect of a comprehensive scheme that as a whole provide[s] landlords a fair return.” (Maj. opn., ante, at p. 778.) It appears from the dollar figures alleged in Earl W. Kavanau’s complaint and stated in the majority opinion (maj. opn., ante, at p. 767), that Kavanau may have made a bad business decision purchasing the rental property in question, since the amount of debt service and operating expenses exceed rental income. These facts on their face do not indicate a constitutional violation. “ ‘A regulated firm has no constitutional right to a profit.’ ” ( 20th Century Ins. Co., supra, 8 Cal.4th at p. 294 , brackets omitted.) Although, as the majority point out, we are bound by the law of the case to the Court of Appeal’s conclusion that a 12 percent cap was arbitrary, this conclusion does not signify that Kavanau was in fact subject to “deep financial hardship” as the result of the rent regulation. The judgment of the Kavanau I court does not translate into the claim that Kavanau deserves just compensation under the Fifth Amendment to the United States Constitution.

As the majority properly conclude, the cost of past confiscatory rent regulation is “one of the costs associated with rent control that the Rent Board must consider” in setting a present just and reasonable rent. (Maj. opn., ante, at p. 783.) If Kavanau can establish not only that the 12 percent cap was arbitrary, but that as the result of its imposition, he in fact suffered a sustained period of financial hardship that defeated any reasonable investment-backed expectation for the market in which he operated, then he may be entitled to a rate increase that compensates for such a .confiscatory rate. But since, even if Kavanau I is taken at face value, it is far from clear that the result of the Santa Monica Rent Control Board’s rate order was the actual imposition of an unfairly low rate of return, and since the po&t-Kavanau I remedy may have adequately compensated Kavanau for whatever supposed losses he suffered at the hands of the rent board, the majority is correct to conclude that Kavanau may not be entitled to any further rent readjustment. (See maj. opn., ante, at pp. 785-786.)

There is yet another reason why a landlord’s claim for damages would be, at the very least, vitiated under a scheme of rent regulation. As I stated in my concurring opinion in 20th Century Ins. Co., supra, 8 Cal.4th at page 330 , it is evidently the case that “ ‘[a] property owner must be legally compelled to engage in price-regulated activity for regulations to give rise to a taking. *792 [Citations.] For example, public utilities generally are under a state statutory duty to serve the public, and must furnish “service on demand to all applicants” at government-determined rates. [Citations.] Because utilities generally are compelled to employ their property to provide services to the public, the Fifth Amendment requires regulators to provide utilities with reasonable compensation for their services. [Citations.] [*][] By contrast, where a service provider voluntarily participates in a price-regulated program or activity, there is no legal compulsion to provide service and thus there can be no taking.’ ” A “voluntary” participation in a price-regulated program is said to occur when an individual or company has the “ ‘right to withdraw’ therefrom.” (Id. at p. 331.)

Thus, one who persists in engaging in a regulated activity over an extended period of time, when withdrawal from that activity is an option, cannot lay at the doorstep of government regulation the reason for its economic failure. Government regulation may indeed place some firms in financial jeopardy, but that in itself does not give rise to a constitutional violation when the government does not block the outflow of assets from these no-longer-profitable enterprises. Some features of the rate regulation may be a violation of substantive due process if they cannot be said to be part of a rational regulatory scheme, and these would therefore be subject to invalidation through injunctive and declaratory relief. But it does not follow that one who has a right to withdraw his capital from the regulated enterprise in question may press a damages claim against the government, either a just compensation claim for a taking or a statutory claim for damages under section 1983 of title 42 of the United States Code. It appears doubtful therefore that a landlord who is subject to lower-than-reasonable rents, and has the option of withdrawing from the rental market, or recouping his previous losses prospectively through a compensatory rent order, can ever press such a claim.

The notion that rent control laws may now be subject to a more exacting form of constitutional scrutiny is predicated on a reading of Nollan v. California Coastal Comm’n (1987) 483 U.S. 825 [ 107 S.Ct. 3141 , 97 L.Ed.2d 677 ]. (See Radford, Regulatory Takings Law in the 1990’s: The Death of Rent Control?, supra, 22 Sw.U.L.Rev. at p. 1030.) We have rejected elsewhere the contention that Nollan and the related case of Dolan v. City of Tigard (1994) 512 U.S. 374 [ 114 S.Ct. 2309 , 129 L.Ed.2d 304 ] represent a new standard of scrutiny of government regulation other than those regulations that require either a physical dedication of property, or a development fee levied on an “individual and discretionary basis.” (Ehrlich v. City of Culver City (1996) 12 Cal.4th 854, 876 [ 50 Cal.Rptr.2d 242 , 911 P.2d 429 ].) In the present case, rent control neither requires a physical dedication nor amounts to an individual and discretionary development fee. ¿ideed, as explained above, it is not a land-use regulation at all but a form of price control.

Moreover, the fact that the Pennell decision, which postdates Nollan , relies on traditional substantive due process analysis in determining whether a rent control law is within a city’s police power ( Pennell, supra, 485 U.S. at pp. 11-12 [ 108 S.Ct. at p. 857 ]) indicates that Nollan does nothing to undermine the fundamental constitutional validity of rent control laws. “[W]e have ‘consistently affirmed that States have broad power to regulate housing conditions in general and the landlord-tenant relationship in particular without paying compensation for all economic injuries that such regulation entails.’ ” (Pennell, supra, 485 U.S. at p. 12, fn. 6 [ 108 S.Ct. at p. 857 ].) In short, nothing in recent Supreme Court case law indicates an intent to replace the traditionally deferential substantive due process standard with some heightened takings standard when reviewing the basic validity of a rent control law or other form of price regulation. And the mere fact that a plaintiff chooses to label his or her action as a suit for just compensation after a “taking,” when it is in essence a substantive due process challenge to an economic regulation, is without constitutional significance.

It is admittedly true that Supreme Court precedent is not entirely clear on where substantive due process ends and takings law begins. In the area of land-use regulation, the court has held that a general zoning law is a taking of property if it “does not substantially advance legitimate state interests.” (Agins v. Tiburon (1980) 447 U.S. 255, 260 [ 100 S.Ct. 2138, 2141 , 65 L.Ed.2d 106 ].) Whether and to what extent this standard differs from the ordinary substantive due process “rationally related” standard is a question beyond the scope of this opinion. The “substantially advance” standard has not been applied by the Supreme Court outside the special area of forced dedications of property in exchange for development permits. (See Nollan v. California Coastal Comm’n, supra, 483 U.S. 825 ; Dolan v. City of Tigard, supra, 512 U.S. 374 .) In any case, the Supreme Court has not indicated any intent to *791 extend the “substantially advance” test beyond the realm of zoning and similar laws which restrict the use of land, and has not applied such a test to price regulations. (See fn. 1, ante).