The Proposed New Law

Introduced by State Senator Scott Wiener (D-San Francisco) and Lena Gonzalez (D-Los Angeles), Senate Bill 939 proposes to give commercial tenants the right not to pay rent without fear of eviction for a full year after the current COVID-19 emergency ends. If it passes, SB 939 will also eliminate late fees and make any “endeavor to evict a tenant of commercial real property” an unfair business practice, and make “harassment or mistreatment of or retaliation against” a tenant refusing to pay rent “punishable by a fine of not more than two thousand dollars ($2,000) for each violation.” SB 939 would do so by adding a new “Section 1951.9” to California’s Civil Code.

“Section 2” of the new law would also permit commercial tenants to serve notices demanding their landlords renegotiate their leases “in good faith.” If negotiations fail, tenants could then terminate their remaining lease terms, and any associated “third-party guarantees,” with no liability for the payment of future rent.

At present, it is unclear whether all, or just certain, commercial tenants will benefit. This is because Section 2 says only “small” businesses (at present, an undefined term), or eating or drinking establishments, places of entertainment or performance venues operating “primarily in California” that meet certain “financial criteria” will be considered eligible “commercial tenants.” If this restrictive language applies across-the-board, only small businesses that suffered a decline of 40% or more in monthly revenue as compared to either two months before the shelter-in-place orders went into effect, or the same month in 2019, will be covered. Restaurants, bars and performance venues that suffered a decline of 25% or more and are “subject to regulations to prevent the spread of COVID-19 that will financially impair the[ir] business” will be covered. Conversely, if these criteria apply only to Section 2, commercial tenants of all size and type will be allowed to defer paying rent for more than a year without fear of eviction or late fees, but only those meeting these narrower requirements will be able to seek renegotiation backed by the threat of terminating their leases and accompanying guarantees.

Either way, if it passes and becomes law, SB 939 will shift the economic cost of the COVID-19 pandemic from commercial tenants to landlords. It will override existing law, make it “unlawful” to enforce existing lease terms and provide tenants with a new, complete affirmative defense in unlawful detainer proceedings. It will remain in effect until at least December 31, 2020.

The proposed law will also negatively impact local governments who, by law, are normally entitled to reimbursement from the state to compensate for “unfunded mandates.” Even though barring the long-term collection of rent will inevitably diminish property values, which in turn will reduce property tax collections — the primary source of funding for public schools, community colleges and local governments — SB 939 expressly provides the state will not accept responsibility for replacing such lost local revenue.

The next hearing on SB 939 is this coming Friday at 9:00 a.m. before the Senate Judiciary Committee. It will be held in Room 4203 of the State Capitol.

Is This Constitutional?

The contract clause in the U.S. Constitution states, “No State shall . . . pass any . . . law impairing the obligation of contracts . …” (U.S. Const., art. I, § 10.) The equivalent clause in the California Constitution states, “A … law impairing the obligation of contracts may not be passed.” (Cal. Const., art. I, § 9.)

Even though, on their face, these commandments appear absolute, they are not.[1] Both the U.S. and California Supreme Courts instructed long ago that for “state” or legislative action to violate either clause, it must also amount to a Due Process or Equal Protection violation. Thus, the mere fact a law “abridges” a contractual right “does not in and of itself” make it unconstitutional. According to both high courts, “[i]t is the beginning, not the end of the analysis. A finding of [contract] impairment merely moves the inquiry to the next and more difficult question … whether the alteration of contractual rights and obligations … is ‘sufficiently necessary to the public welfare as to justify the impairment.’” “Probably the single most important factor to consider … is the nature and extent of the impairment. … The severity of the impairment measures the height of the hurdle the state legislation must clear. … Other important factors … are the nature, importance and urgency of the interest to be served by the challenged legislation; and whether the legislation was appropriately tailored and limited to the situation necessitating its enactment.’”

If passed and signed into law by Governor Newsom, there can be no doubt SB 939 will severely impair the ability of commercial landlords to exercise their preexisting contractual (and statutory) rights. Indeed, it will make it “unlawful” to collect rent; declare defaults; serve termination notices; seek and obtain evictions; obtain judgments for unpaid rent, late, attorney and collection fees; and enforce negotiated third-party guarantees. By forcing landlords to give tenants more than a year’s deferred rent (i.e., extend such unsecured credit), it will also radically increase the chance landlords ultimately will be forced to write-off deferred rent as uncollectable.  Conversely, the backers of SB 939 will argue the “nature, importance and urgency of the interest to be served” – i.e., the prevention (or at least long-term postponement) of tens of thousands of commercial evictions and related likely bankruptcies – justifies this “Robin Hood” like legislative behavior.

But, such competing harm vs. benefit arguments aside, would SB 939, resulting in the wholesale transfer of the economic cost (no doubt now measured in the billions) of the present health crisis from the backs of one class of individuals, commercial tenants, onto the backs of another, commercial landowners, not constitute a per se violation of Equal Protection? Is a law that deprives landlords of their property rights for over a year without fair compensation not a Fifth Amendment (Due Process) “taking”?

In the latter regard, the Ninth Circuit’s decision in Hall v. Santa Barbara, 833 F.2d 1270, 1273 (9th Cir. 1986) may prove instructive. In Hall, husband and wife mobile home park owners sued in federal court to declare a Santa Barbara rent control ordinance unconstitutional. The ordinance required mobile home park owners to offer leases of unlimited duration terminable at will by tenants, but only for cause by the owners, and strictly limited rent increases. Ruling for the couple, and sending the case back to District Court for further proceedings, the Ninth Circuit concluded a law that forces landlords to continue to allow tenants to indefinitely occupy land on prescribed terms is a form of compensable governmental “taking” by means of physical occupation (as opposed to regulatory restriction), even if the occupation was not by agents of the government itself.

In one respect, SB 939 arguably amounts to a greater taking than that described in Hall. This is because SB 939 seeks to prohibit commercial landlords from doing anything to collect rent (or receive any “compensation”) for at least a year after the governor’s current “emergency” order is lifted. On the other hand, under SB 939 the compelled continued occupancy will ultimately end, whereas in Hall it would continue indefinitely unless and until Santa Barbara changed its ordinance.

Hall is just one of many cases that will be debated in the forthcoming high stakes legal battle if SB 939 passes.

Enterprise Counsel Group is a full-service business litigation, transactional and appellate law firm located in Irvine, California.  For more information, please visit www.ecg.law.

[1] City of Torrance v. Workers’ Comp. Appeals Bd., 32 Cal. 3d 371, 376-77, 185 Cal. Rptr. 645, 647-48, 650 P.2d 1162, 1164-65 (1982), citing Home Bldg. & L. Assn. v. Blaisdell, 290 U.S. 398, 428, 78 L.Ed. 413, 423, 54 S.Ct. 231 (1934).

Author: David A. Robinson, President and Founding Shareholder, Enterprise Counsel Group