Friday, July 26, 2013

In Leasing an "In-Law" Apartment Don't Be "In Pari Delicto" - Beware of an Exception for Legal Enforcement of Illegal Contracts

Leasing an "unwarranted" unit contains inherent risks: recent court cases often treat such lease agreements as illegal contracts, a finding leading to a set of scary, but possible discussions, ranging from such lease being simply unenforceable to a claim for restitution of back rents. A question then naturally arises, what can be done with an illegal contract, and are there any exceptions or conditions for its enforcement. The basic rule is that the contracting parties are both "in pari delicto" and neither can enforce the contract or recover therefrom. There is, however, an exception developed in California, which still lets one side to such allegedly illegal contract to recover from the other. An exception itself is not new, but its application to "illegal" leases developed more recently.

Update 03-07-14: San Francisco pilot program for legalizing in-law apartments got approved at the Planning Commission level.
Update 04-07-14: Board of Supervisors approves the pilot program
Update 02-21-16: Decision in Chen v Kraft invalidated a lease with an unlawful object, under CC § 1598.

Relevant thoughts on the exception were expressed over 60 years ago. Among notable cases is Norwood v. Judd, 93 Cal. App. 2d 276 (Cal. App. 1949), which started with the general rule that "[t]he principle that participants to an illegal contract who are in pari delicto can secure no relief based on such contract, is an ancient and most salutary one," (Id. at 283), and then proceeded to explore a possibility of relief for one of the participants.

After discussing the issue in detail, the court in Norwood shaped the exception as the following test: "[t]he rule that the courts will not lend their aid to the enforcement of an illegal agreement or one against public policy is fundamentally sound. The rule was conceived for the purposes of protecting the public and the courts from imposition. It is a rule predicated upon sound public policy. But the courts should not be so enamored with the Latin phrase "in pari delicto" that they blindly extend the rule to every case where illegality appears somewhere in the transaction. The fundamental purpose of the rule must always be kept in mind, and the realities of the situation must be considered. Where, by applying the rule, the public cannot be protected because the transaction has been completed, where no serious moral turpitude is involved, where the defendant is the one guilty of the greatest moral fault, and where to apply the rule will be to permit the defendant to be unjustly enriched at the expense of the plaintiff, the rule should not be applied. ... we think it is the correct and more enlightened rule." (Id. at 288-289, emphasis here and in the following cites is mine).

Funny, but although the decision in Norwood gave the world a rule about enforcing illegal contracts, the case's subject contract "was not per se contrary to any statute. ... The illegality involved was the failure to comply with a technical formality--it was not founded on the agreement itself." (Id. at 290).

Fast forward to more recent times, the case Salazar v. Maradeaga, 10 Cal.App.4th Supp. 1 (Cal. App. Dep't Super. Ct. 1992), which was regarding an eviction of a tenant from an "illegal" unit, held that the agreement for renting an illegal unit is itself illegal and unenforceable. The unit was a "garage unit" on the ground level of the single family house (often referred to as an "in law" apartment). It was illegal, because it was never legally recognized as a dwelling unit. Consequently, the lease agreement for renting that "illegal" unit was also inherently "illegal," since it was entered into for an "illegal" purpose--to live in that in-law apartment.

Court in Salazar dealt with that lease agreement unapologetically, holding such contracts unenforceable: "A party who is not in pari delicto may be entitled to relief under certain circumstances, but the relief is limited to rescission and restitution; the party is not entitled to enforce the contract. (citations) This rule applies to the lease of real property. Where, as here, an occupancy violates a zoning or building code enacted for the benefit of the general public, the use itself is illegal, and the defect is thus unccorrectable, the lease agreement is held to be void and unenforceable by either party." (Id. at 4).

But in 2010, court in another case involving an "illegal" unit (a guesthouse built without building permits), Carter v. Cohen, 188 Cal.App.4th 1038 (Cal. App. 2d Dist. 2010), criticized Salazar, and held that "the rule barring the enforcement of unlawful contracts is not absolute." Court in Carter allowed one party to enforce the contract, based on the Norwood test.

The rule remains alive and sound, as we were reminded just a couple months ago, in Corrie v. Soloway, 216 Cal. App. 4th 436 (Cal. App. 1st Dist. 2013), a case involving an option in a purchase agreement. There, the original Norwood rule was again firmly reinstated and applied, analyzed by element. Corrie thus followed Carter and also allowed to enforce the subject agreement for one of the parties.

Reading those cases leads to a simple conclusion: first, avoid renting out "illegal" units; those leases may bring more problems then benefits. Second, if a lease of the "illegal" unit is unavoidable or is already existing, make sure you will be the less "delicto" party than the other. At a very least, landlords should take steps to ensure they have a documented proof of given notice to the tenant disclosing the unit's status. According with the Norwood test and the holdings in Salazar and Carter, any little detail of the parties' conduct under the lease or knowledge of the underlying facts may indicate one's greater or lesser degree of "fault" of being involved in the "illegal" activity. Your task is, if not to be a "good guy," to be a "better than the other" guy at least.

See this publication from the Rent Board (Topic No. 253). It hints that the in-law rental can apply both ways: tenants may complain about its condition to the Building Inspectors Department, while landlord may then comply with the noticed violations and will be allowed to evict the tenant.

If you are currently in, or anticipating to enter into, an unwarranted unit lease, your actual options and a strategy will depend on your case's particular facts. To learn more about your rights and obligations, make your first step toward taking control over the circumstances, and call my office at (415) 987-7000. I will be glad to assist in guiding you through the jungle. The only thing you can't afford is to stay put and uninformed. My office provides a confidential assessment of your particular scenario, free of charge, and I will share with you the results of the analysis along with my thoughts on available solutions.

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