Stabilization Code – Successor Liability for Lenders

July 2019

The New York City Rent Stabilization Code (the “Code”) provides that the current owner of a multi-family building (the purchaser) shall be responsible for all overcharge penalties, including penalties based upon overcharges collected by the prior owner (the seller).  This successor liability may extend to a lender who credit bids at a foreclosure sale and takes title to the property encumbered by its mortgage under certain circumstances.  The recent changes to the rent regulatory scheme do not change existing law governing successor liability; however, the statute of limitations and “look back” period have been increased from four (4) to six (6) years.  The implications of this for lenders will be discussed in more detail below.

The Code provides a limited exception to successor liability for all purchasers at a foreclosure sale, which includes lenders that credit bid.  As long as there is no collusion or any relationship between the lender and any prior owner, if the purchaser is not provided with rent records for the property at the sale, then it should not be liable for any overcharges collected by the owner prior to such sale. 

The Code has a two-pronged test to determine successor liability - (a) was there “collusion” or a “relationship” between the prior owner and the purchaser? and (b) did the purchaser at the sale have notice about any rent overcharges?  With respect to the first prong, courts in New York have held that the words “any relationship” were not intended to include the ordinary mortgagor/mortgagee relationship, where there is no unity of interest between the parties. 

The second prong of the test, which remains unchanged by the recent changes to the Code, is a bit trickier for lenders.  As long as the foreclosing lender is not provided with rent records at the sale, it should not be liable for any overcharges collected by the owner prior to the sale.  Such purchaser would be liable for overcharges that it collects.  However, most lenders require that borrowers provide DHCR rent records for the property, as part of their due diligence prior to making the loan, and also require periodic updates during the loan term.  A foreclosing lender should determine (i) what records do I have in my possession, (ii) when were they provided and (iii) whether they show any potential overcharges by the borrower.  New York courts have found successor liability because the records were available to the foreclosing lender and such records demonstrated that there had been one or more overcharges by the borrower.  Moreover, if a receiver in a foreclosure action becomes aware of overcharge claims, that could be sufficient to place any purchaser, including the foreclosing lender, on notice of the claims.

Under the prior law, there was a four (4) year statute of limitations on filing claims for rent overcharges.  This has been increased to six (6) years.  At a minimum, lenders must now review at least six (6) years’ worth of rent records prior to making a loan on a rent regulated building in order to determine whether there have been any overcharges or overcharge complaints.  If the overcharges are found to be willful, there could be exposure to a treble damage claim.  In addition, the prior law only permitted a four (4) year “look back” to calculate the legal rent.  The new law permits a six (6) year “look back” and the court can consider “all available rental history” to determine legal rent beyond the six (6) years.  Finally, the prior law permitted a building owner to avoid treble damage penalties if it voluntarily recalculated the rent and issued a refund when a tenant made a claim.  That provision has now been repealed.

©2019 Herrick, Feinstein LLP. This memorandum is provided to inform clients and other parties about legal news and legal developments that may affect or interest them. The information is not intended as legal advice or legal opinion and should not be construed as such. Some provisions of the recent legislation appear to be unclear and ambiguous and must await clarification by the courts, agencies and/or the Legislature.