Court Decision Upholding “Discriminatory” Rental Ban also Calms Industry Nerves

Published on: July 20, 2008

True or False: 1) Owner-occupants have more invested in the property and will be more concerned about maintaining it. 2) A large concentration of tenants in a common interest ownership community can threaten the value not only of the units they occupy but of the community as a whole.

You won’t find many owners or professionals in the common interest ownership world who would challenge either assertion. The assumption that owner-occupants are preferable to tenants is reflected both in secondary mortgage market policies that make a high owner-occupancy rate a condition for approving condominium loans and in the rental restrictions (or outright rental bans) that many communities have adopted.

But this conventional wisdom was challenged last year when an Indiana Appeals Court ruled that a rental ban in one condominium community violated the federal Fair Housing Act. Although the decision applied only in Indiana, it sent nervous ripples throughout the industry, because with a relatively small number of judicial precedents addressing condominium issues, it is not uncommon for courts in one jurisdiction to rely on the decisions of courts in others. Fortunately, at least in the view of most industry practitioners, the Indiana Supreme Court has reversed this unsettling decision.

Discriminatory Impact

The underlying dispute (in Villas West II of Willowridge v. Edna McGlothin) arose when the homeowners’ association sued an owner (McGlothin) for renting her residence, in violation of a covenant barring rentals in the community. McGlothin had moved into a nursing home after her husband’s death and needed the rental income to qualify for Medicaid and finance her care. The association sued her (and her estate after she died), arguing that the rental ban was needed to protect property values within the community and was consistent with the association’s obligation to do so. McGlothin countersued, arguing that the covenant violated the Fair Housing Act because it had a “disparate impact” on Blacks – that is, it prohibited more Blacks than whites from living in the community, and thus had a discriminatory effect, even if the policy’s intent was not itself discriminatory.

The question at issue was not the right of associations to enact restrictive covenants designed to protect property values, but whether this restrictive covenant in this community had an adverse and discriminatory impact on a protected class. The trial court and the appeals court both found that to be the case. Applying the disparate impact standard use in employment discrimination litigation, the courts set up the legal equivalent of a chess match. The plaintiff’s first move is to establish that a policy has a discriminatory effect. If that hurdle is cleared, the burden shifts to the defendant to demonstrate that the policy is justified by a legitimate purpose and is not a “pretext” for discriminating against a protected class. Then it’s back to the plaintiff to identify other less discriminatory policies that would achieve the defendant’s legitimate objectives.

In this case, the community association had cited its interest in barring rentals to tenants with little interest in maintaining property values. McGlothin contended that the community’s rules requiring appropriate attention to maintenance addressed that concern, and the lower courts agreed that the rules “more than adequately assured a neat, clean and visually attractive environment and a high degree of property maintenance.” As a result, the appeals court concluded, “plaintiff’s justification for the no-rent provision lacks a factual basis and is mere subterfuge, rendering said provision unnecessary and useless.”

The state Supreme Court reached a different conclusion, finding that the community’s rules did not, in fact, provide “an equally effective means of maintaining property values.” The lower courts erred, the Supreme Court said, by failing to consider adequately the distinction between ownership and occupancy.

Ownership vs. Occupancy

“Owners who occupy their property have an incentive to improve and update it,” the court said, “because they can both enjoy the improvements [while occupying the property] and reap the fruits of their labor upon selling the home.” Renters, on the other hand, “would only benefit from the current enjoyment, not from an increased market value,” the court noted. “Because covenants don’t address the [divided ownership and occupancy] issue, they are not an equally effective, less discriminatory alternative to excluding renters….It seems obvious,” the court continued, “that an owner-occupant is both psychologically and financially invested in the property to a greater extent than a renter. Personal motivation can surely achieve better results than contractual compulsion in many cases.”

In a footnote, the court noted another argument for upholding the rental restriction – the extent to which prospective buyers will base their purchase decisions in part on the expectation that their “owner-occupant neighbors are likely to make such investments” in maintaining the property.

Absent the existence of equally effective but less discriminatory alternatives for protecting property values, the court concluded, the community’s rental ban did not constitute a disparate impact violation under the FHA, “even if it has a disparate impact on a protected class.”

When the appeals court rejected the rental ban, many association attorneys in Massachusetts and other states began to advise association clients that their restrictive rental covenants might be subject to similar legal challenges. Exercising an abundance of caution, many attorneys will continue to note that possibility, pointing out that while a higher court has now upheld Indiana’s rental covenants and rejected the argument that they are discriminatory, courts in other jurisdictions could go the other way.

But that caution notwithstanding, it is probably safe to assume that those of us who were concerned about that prospect a few weeks ago are considerably less concerned now that the Indiana Supreme Court has made what we think is the right call.