Under Regina, Just What Is Fraud?
By Adam Leitman Bailey and Dov Treiman
Introduction
The most talked about recent case in the real estate industry is Regina Metro v. DHCR (2020). In it, New York’s highest court, the Court of Appeals, set bright line standards in rent overcharge cases in rent stabilized apartments. Unfortunately, one of those lines was not bright enough. The question the Court of Appeals did not answer clearly was when to base an overcharge calculation on the rent charged four (or six) years prior to the complaint, and when to go back further. Regina says the answer to that question depends on whether the landlord committed fraud. The definition of “fraud,” however, although essential to determine the level of the landlord’s liability, is only hinted at in Regina. Nor have the lower courts actually provided clear answers to these questions. This article can only suggest what the answers ought to be.
Common Law Fraud
At first blush, it would seem easy to define “fraud”. The law historically recognizes the elements of fraud as the making of a false statement, knowledge of the falsity by the speaker, reliance by the victim on the truth of the statement, and damage inflicted on the victim. In order to bring rent overcharges under the rubric of “fraud,” the false statement could simply consist of such words as “this is the rent.” The recipient of that statement could be a tenant or the New York State Division of Housing and Community Renewal (DHCR). Because rent stabilization requires owners to annually register rents with that agency, such statements are ubiquitous.
Thornton Fraud
However, in looking at overcharge cases, we immediately see that they potentially conflate the age-old understandings of “common law fraud,” particularly those elements of fraud that pertain to the victim: reliance by the victim on the truth of the statement and the resulting damages inflicted on the victim. If the tenant is in on the scheme, then it is not the tenant, but the DHCR or the entire renting public that is relying on the truth of the false statement. However, while the DHCR might in a sense be victimized by the landlord’s lie, the DHCR will not suffer monetary damages from it and neither will anyone that does not actually rent the apartment. The next tenant in such a fraudulent scheme would be overcharged, but having agreed to pay the contract rent in an arm’s length transaction, can they really be said to have suffered monetary damages? And such a tenant may not even exist, as the tenant who participated in the lie could still be in residence.
Therefore, to try to understand “fraud” within the meaning of Regina, we need a broader definition of “fraud” that, while including common law fraud, allows for other actions as well— actions that do not depend on the owner lying to the tenant, but which might allow for the tenant to be in on the scheme.
The Court of Appeals itself, in Thornton v. Baron (2005), in effect created such a category of “fraud” without further qualification. In Thornton, because the tenants were co-conspirators in the phony rent, the court appeared to adhere to a layperson’s understanding of fraud as “an act of deceiving or misrepresenting”—without getting into the niceties of who said what to whom and who was hurt by it. This ordinary English language understanding of fraud includes common law fraud, but adds other possible scenarios to it, which we shall call “Thornton fraud”.
First, anything that is common law fraud is also Thornton fraud; that much is clear.
But Thornton fraud also includes situations in which the owner and the tenant are in on the scheme together, and work together to invent and perpetuate the lie. In that scenario, the scheming tenant may or may not be paying a higher rent than legally allowed, but the next tenant in the apartment certainly will.
Such schemes include when the landlord and the tenant pretend that the tenant is not really a tenant, but is actually a sub-tenant. In that scheme, the so-called “real tenant” may perhaps be some family member of the landlord’s who has never seen the apartment and certainly has no interest in it. The law calls such a person an “illusory tenant”. Another variation on the illusory tenancy is when the real tenant has a two-year lease, but during the first year, some nonexistent person is named as the tenant, whom the real tenant replaces during the second year of the lease, with the landlord having taken a vacancy increase for both the nonexistent person during the first year and the real tenant during the second year. In a third variation, the apartment may have been empty for several years, during which the landlord created a series of fictitious tenants, claiming a vacancy increase for each. Whether the eventual real tenant knows about this scheme or not, this appears to be what is meant by the sorts of actions that, although not qualifying as common law fraud, appear to qualify as Thornton fraud. Grimm v. DHCR (2010) emphasized that illusory tenancies created by the owner are not the only kind of conduct that may constitute Thornton fraud.
In another common scheme, the landlord claims to be able to boost the rent because of improvements made to the apartment during a period of vacancy. If there were no such improvements, or if some of the improvements were phony (for example, the landlord falsely claimed to have replaced the kitchen countertops), this is probably Thornton fraud, regardless of whether the incoming tenant knew about the fictitious improvements. But Regina makes clear that fraudulent conduct must be willful, and does not exist simply because of an improperly charged rent. However, the trial courts, in some cases, are disregarding the criteria of willfulness and deregulation; instead characterizing much more mild misconduct as fraud. They may need further guidance from the Court of Appeals.
Why does it matter?
Under Regina, only fraud can overcome the four- or six-year rule in calculating an overcharge, so that a court may reach back further than that to calculate a rent equal to the lowest registered rent in a comparable apartment in the building; or, under certain circumstances, lower still. This is the so-called “default formula”. The imposition of the default formula is, under current law, the most severe penalty a landlord can face in an overcharge proceeding—and it can be very severe indeed.
Levels of Misconduct, Levels of Penalty
In calculating overcharge damages, there are three levels of wrongfulness of which a landlord can be guilty: (1) mistake, (2) willfulness, and (3) fraud.
These levels of wrongfulness correspond to three levels of penalty for an overcharge. The penalty for an overcharge by ignorance is a refund of the rent overpaid within the statute of limitations, plain and simple. The penalty for an overcharge by willfulness is triple the rent overpaid within the statute of limitations. The penalty for Thornton fraud (which, we recall, includes common law fraud) is to lower the rent to some artificial rate reaching back to the initiation of the tenancy, and tripling that.
Having three levels of wrongfulness with three corresponding levels of penalty accords well with Anglo-American common law. Victorian England’s “one gallows fits all crimes” policy was a notorious fiasco. Where there is willfulness, the landlord is punished by the exaction of a triple penalty. The more extreme penalty of tripling damages calculated by an artificially lowered rent is reserved those who practiced Thornton fraud. Regina calls these a “limited category of cases.” That limit can only be honored if any sort of wrongdoing does not get lumped into Thornton fraud. But the lower courts have not given definite guidance as to where to draw that line.
Level 1: Mistake
Roberts v. Tishman Speyer Props. LP (Court of Appeals 2009) is a classic case of mistake. The landlords in that case, along with the DHCR, believed incorrectly that apartments could be deregulated during the J-51 tax benefit period. For their ignorance, the landlords were obligated to refund to the tenants the difference between the rent that was paid and the lower rent that should have been paid (“simple damages”). But reliance on incorrect legal authority is not the only example of ignorance. Courts generally regard good-faith reliance on erroneous legal advice as another species of ignorance, the penalty for for which is to refund the rent overcharged in ignorant reliance on the bad advice.
Level 2: Willfulness
The next tier of landlord culpability is willfulness. Here, not only is the landlord wrong in calculating the rent, but the landlord lacks the proof to demonstrate that the rent was correct. While the English word “willful” ordinarily mean “on purpose,” in rent stabilization litigation, it merely means “unable to prove ignorance.” Current cases indicate that the mere exaggeration of individual apartment improvement costs, as long as the improvements really were performed, would be considered a willful overcharge. The punishment for willfulness is that the landlord must pays the tenant triple what the landlord would have paid under ignorance.
Level 3: Fraud
The worst level of landlord culpability is fraud, which includes both common law fraud and the landlord’s fabrication of rental events in collaboration with the tenant. As a penalty, the landlord must pay the tenant (innocent or guilty) three times the difference between the rent reset according to the default formula and what was actually paid.
The “default formula” is not a formula at all, but in many cases an examination of the history of the entire apartment building; and in others, an arcane examination by DHCR of the entire neighborhood, using criteria that are so opaque that this method may be rightly termed “setting the rent by dartboard.” However, when the rent is set by the default formula, it is reliably much lower than when it is set under willfulness, i.e., the reliable rent from four (or six) years earlier than the tenant asserted the complaint against the landlord. As applied, the default formula often has the effect of raising damages from six to seven figures—particularly once the default formula has lowered the legal regulated rent from four to three figures.
Fixing Mistakes
Another giant question was left unanswered by Regina: Once a landlord becomes aware of the rent being incorrect and fails to fix it, is this willfulness or fraud?
Unfortunately, no reported appellate case states a rule for failure-to-fix in isolation. All the cases that mention it involve other kinds of misconduct as well. Fixing such misconduct generally consists of setting the rent at the correct rate and then re-registering the apartment with DHCR at that amount.
Two aspects of Regina militate against construing mere failure to-fix as Thornton fraud.
First, Regina itself modified a calculation by the Appellate Division which shortchanged the landlord. Had the landlord re-registered the apartment at the rent determined by the Appellate Division, it would have been wrong. (Indeed, prior to Regina, it could not have known what was right.) Thus, it would have been impossible for the landlord to re-register the rent at the correct level. To this tenant advocates respond, “Then the landlord should have registered the rent at the wrong level,” but that argument rings hollow. For how does one rationalize doing the wrong thing purposely?
Second, the examples Regina gives of fraud are all doing things dishonestly (malfeasance). But failure-to-fix is failing to do something (nonfeasance). Regina itself gives no example of fraud that consists of a failure to act, and the Court presumably omitted such examples on purpose.
Acting Quickly
Often, landlords do try to fix things. However, tenants’ counsel have consistently claimed that these actions were “Too little, too late.” The landlord who does not fix the problem as thoroughly and quickly as possible is going to face a more difficult battle to convince a judge that the landlord did not wait to get caught before making the fix. In Montera v. KMR Amsterdam (2021), the Appellate Division deemed it “too late” when “[t]he owner finally addressed deregulation only after its conduct was revealed by an anonymous complaint.” Clearly, under Montera, “waiting to get caught” is a very low standard. The landlord has to act before then. But conversely, Montera allows for the landlord to avoid the most dire consequences by being prompt in its remedial measures.
It would be wiser policy for “delayed fixing,” standing alone, not to be construed as fraud, in which case the landlord will be motivated to correct the improper rent and registration, because if it does so, it will suffer only the lower penalty associated with willfulness. But if there is no such incentive, then the landlord, knowing it will be punished as severely for willfulness as for fraud, will be motivated to attempt a cover-up of the mistake, in the hope that the cover-up won’t be discovered. In other words, it becomes worth the risk to cover up, if the penalty for doing so and delayed fixing is the same, and if it is the fixing that will expose the wrongdoing.
Piled-Up Misconduct
Some would argue that enough discrete willful acts can add up to fraud without there being any clear guidance as to how many such acts would constitute “enough”. However, there are no higher court cases showing such a collection of examples actually crossing from willfulness to fraud—and none holding that it can’t. Nolte v. Bridgestone Assoc. LLC (1st Dept. 2018) is a mixture of the kinds of conduct that merit a mere finding of willfulness, together with fabricated IAI records. In such circumstances, the other misconduct is merely additive. At least in Nolte, the fiction of the IAI records is the key to the finding of fraud by the court.
Investigation
All of this discussion is predicated on the idea that the facts are clear. But often, this is not the case. In Grimm, the Court of Appeals implicitly charged DHCR with a duty to investigate when there are serious allegations in a tenant’s complaint of Thornton-type fraud. By extension, this means that when the overcharge complaint is first filed in State Supreme Court, the court is obligated to allow the tenant to conduct such an investigation via the discovery process.
Conclusion
Although Regina does not actually acknowledge it, the kind of “fraud” it refers to in rent overcharge cases is broader than common law fraud. Landlords who are guilty of this new kind of fraud face treble damages based on rents reset using the default formula—the most severe penalty known in rent stabilization. Landlords who act quickly to correct their prior mistakes stand the best chance of avoiding that fate.