Ridgewood Manor MHC, LLC v. Ridgewood Manor HOA

• Court: Superior Court of Delaware
• Decided: July 3, 2023
• Docket: K21A-10-002 RLG
• Status: Published

Opinion

IN THE SUPERIOR COURT OF THE STATE OF DELAWARE

RIDGEWOOD MANOR MHC, ) LLC, ) ) Appellant, ) ) v. ) C.A. No.: K21A-10-002 RLG ) RIDGEWOOD MANOR HOA, ) ) Appellee. )

MEMORANDUM OPINION AND ORDER

Submitted: March 8, 2023 Decided: July 3, 2023

Upon Appeal from a Final Decision and Order of the Arbitrator – REVERSED.

David C. Zerbato, Esquire, Morton, Valihura & Zerbato, LLC, Greenville, Delaware, Attorney for Appellant.

Anthony V. Panicola, Esquire; Olga K. Beskrone, Esquire; and Colten L. Fleu, Esquire, Community Legal Aid Society, Inc., Dover, Delaware, Attorneys for Appellee.

GREEN-STREETT, J. I. Introduction

The instant appeal stems from a dispute between the owner of a manufactured

home community, Ridgewood Manor MHC, LLC, (the “Landowner”) and an

association that represents the affected homeowners of that community, Ridgewood

Manor HOA (the “HOA”). Landowner sought an above-inflation rent increase for

the homeowners in Ridgewood Manor. The HOA objected to the above-inflation

rent increase, and, under Chapter 70 of Title 25 of the Delaware Code, invoked the

statutory arbitration process.

Following an arbitration hearing and submission of post-hearing briefing, the

Arbitrator issued her Arbitration Decision (the “Decision”) in favor of the HOA. 1

The Arbitrator found that the Landowner had not satisfied the requisite statutory

preconditions to support an above-inflation rent increase. Landowner appealed to

this Court, arguing that the Arbitrator committed legal error in rendering her

Decision. This Court agrees. For the reasons set forth below, the Decision of the

Arbitrator is REVERSED.

1 See generally, Decision, Sept. 29, 2021. 2 II. Factual and Procedural Background

A. The Rent Justification Act

The Delaware Manufactured Homeowners and Community Owners Act –

commonly referred to as the Rent Justification Act (the “Act”)2 – governs, among

other things, rent increases in manufactured housing communities.3 The Act allows

a manufactured home community landowner to increase rent by the rate of inflation

without showing more.4 In order to raise rent above the average annual increase in

the Consumer Price Index for All Urban Consumers in the Philadelphia-

Wilmington-Atlantic City area (“CPI-U”), the landowner must satisfy three

conditions as outlined in 25 Del. C. § 7052.5

First, the landowner must not have been found, in the preceding 12 months,

to be in violation of any provision that threatens the health or safety of its residents.6

Second, the landowner must show that the proposed rent increase is “directly related

2 25 Del. C. § 7050 et seq. 3 25 Del. C. § 7052. The Act has been revised, effective July 1, 2022. At the time of the Arbitrator’s Decision, an old version of the Act was in place. The Court will reference old sections from Title 25 of the Delaware Code that were effective until June 30, 2022. 25 Del. C. § 7052 et seq. 4 Bon Ayre Land, LLC v. Bon Ayre Cmty. Ass’n, 149 A.3d 227, 230 (Del. 2016) (hereinafter “Bon Ayre II”). When Bon Ayre II was decided, the Act, in relevant part, was codified as 25 Del. C. §§ 7040, 7042. 5 Id. 6 Id. (citing 25 Del. C. § 7052(a)(1)).

3 to operating, maintaining[,] or improving the manufactured home community.”7

Third, if the previous two requirements are met, the rent increase must be justified

by at least one of several factors enumerated in § 7052(c).8 The General Assembly

intended for the landowner to meet both the directly related test and justify the

increase with a factor under § 7052(c).9 Ensuring a landowner meets both of these

requirements is how the purpose of the Act is fulfilled.10

B. The Parties

Ridgewood Manor is a manufactured home community located in Kent

County, Delaware. Ridgewood Manor was purchased by Landowner in November

2020.11 Soon thereafter, Landowner undertook a number of community projects.

Specifically, Landowner spent $66,650.00 to renovate the property’s sales/rental

office; tear down a storage barn on the property; and fill an unused pool on the

property (“capital expenditures”).12

7 Id. (citing 25 Del. C. § 7052(a)(2)). 8 Id. (citing 25 Del. C. § 7052(c)). 9 Shady Park Homeowners’ Ass’n Inc. v. Shady Park MHC, LLC, 2023 WL 2366643 at *5 (Del. Super. Mar. 3, 2023) (citing Bon Ayre II, at 230). 10 Id. 11 Appellant’s Opening Br., 3. 12 Id. at 8.

4 On February 25, 2021, Landowner sent a letter to each homeowner within

Ridgewood Manor, notifying them of (1) a 1.504% rent increase, based on the CPI-

U 36-month average increase; and (2) an additional monthly rent increase based on

a “market rent” analysis.13 For most homeowners within the community, the

proposed rent increase equaled approximately $50 per month. 14 At the time of

Landowner’s proposed rent increase, it had owned Ridgewood Manor for

approximately three months.

At the statutorily required community meeting to address the proposed rent

increase, Landowner provided a presentation, through which it explained the basis

for its rent increase. The homeowners and HOA rejected Landowner’s asserted

justifications for the rent increase, and, as permitted by statute, filed a petition for

arbitration. An arbitrator was appointed to hear the case. On July 22, 2021, an

arbitration hearing was held.

C. The Arbitration Decision

As an initial matter, the parties agreed, and the Arbitrator concluded, that

Landowner satisfied the first requirement of Section 7052(a)(1): the landowner had

maintained a clean bill of health in terms of safety violations for the preceding 12

13 Id. at 4. 14 Appellee’s Answering Br., 3.

5 months.15 The Arbitrator then found that the three capital expenditures benefited the

homeowners, and were “directly related to [ ] operating, maintaining[,] or improving

the community.”16

The Arbitrator’s “directly related” analysis did not end there. The Arbitrator

performed an examination of Landowner’s acquisition costs, including capital

contribution, depreciation, and goodwill amortization (“Acquisition Costs”). The

Arbitrator noted that neither the Act, nor existing case law, contained language that

would permit the landowner to “use acquisition costs on the cost side of its ledger to

prove that its original expected return [had] declined.”17 The Arbitrator further

reasoned:

that to permit acquisition costs to offset any income in order to . . . justify a rent increase under the Act would put both the tenants and existing community owners at an unequitable disadvantage since the new owner would be unlikely to ever achieve its desired rate of return using six and seven figures for capital contribution and depreciation.18

The Arbitrator opined that, even if such acquisition costs were permitted to be

considered under the Act, Landowner had not met its burden in producing sufficient

15 Decision, 8. 16 Id. 17 Id. at 9. 18 Id. at 10.

6 documentary evidence to prove that it had incurred such costs and expenses. She

determined that the Acquisition Costs were not directly related to the operation,

maintenance, and improvement of the community.19 Given these conclusions, the

Arbitrator did not reach the issue of whether Landowner satisfied one or more of the

factors listed under 25 Del. C. § 7052(c). As a final matter, the Arbitrator granted

Landowner’s rent increase at CPI-U.

III. Standard of Review

When reviewing an arbitrator’s decision, the Court must independently

determine (1) whether the record created in the arbitration is sufficient justification

for the arbitrator’s decision, and (2) whether the arbitrator’s decisions are free from

legal error.20 The Delaware Supreme Court has interpreted this standard to mean

that a “substantial evidence review is the appropriate standard of review for the

arbitrator’s factual findings.”21 Under this deferential standard, the Court’s review

must be limited to determination of whether the arbitrator’s decision is supported by

substantial evidence and free from legal error. Substantial evidence means evidence

that is relevant and that a reasonable mind might accept as adequate to support a

19 Id. at 9. 20 25 Del. C. § 7054. 21 Sandhill Acres MHC, LLC v. Sandhill Acres Home Owners Ass’n, 210 A.3d 725, 731 n.37. (Del. 2019).

7 conclusion.22 However, issues of statutory construction and interpretation are

reviewed de novo.23

IV. Discussion

Since its passage in 2013, the Act imposed new requirements on landowners

who wished to increase rent above inflation in manufactured housing communities.

Unsurprisingly, given the relative newness of the Act and perceived nuances in the

statutory language, the Delaware Supreme Court was called upon to outline, with

specificity, what landowners must do to comply with the Act’s language and stated

purpose. At the heart of many of these appeals has been requested guidance on how

landowners fulfill the conditions of § 7052. That guidance exists in a trilogy of

pertinent cases: Bon Ayre Land, LLC v. Bon Ayre Community Association;24

Donovan Smith HOA v. Donovan Smith MHP, LLC;25 and Sandhill Acres MHC,

LLC v. Sandhill Acres Home Owners Association.26

22 December Corp v. Wild Meadows HOA, 2016 WL 3866272 at *4 (Del. Super. July 12, 2016). 23 Bon Ayre II, at 233. 24 Bon Ayre II. 25 190 A.3d 997 (Del. 2018) (TABLE). 26 210 A. 3d 725 (Del. 2019).

8 A. The Directly Related Standard: Bon Ayre II, Donovan Smith, and Sandhill

1. Bon Ayre II

In Bon Ayre II, the Delaware Supreme Court recognized that “the Act is

effectively a rent control statute.”27 “Its stated purpose is to ‘accommodate the

conflicting interests of protecting manufactured homeowners, residents, and tenants

from unreasonable and burdensome space rental increases[,] while simultaneously

providing for the need of manufactured home community owners to receive a just,

reasonable, and fair return on their property.’”28 “To accomplish this purpose, the

Act allows landowners to increase their rent by an inflation measure – CPI-U –

without any opportunity for homeowners to object.”29 To increase rent above the

CPI-U, a landowner must engage the test outlined in § 7052.30 Specifically, the Bon

Ayre II court held that the § 7052 test was conjunctive: a landowner wishing to

increase rent above the CPI-U must show that the proposed rent increase is both

directly related to operating, maintaining, or improving the manufactured home

27 149 A.3d at 234 (The Bon Ayre II decision references compliance with 25 Del. C. §§ 7040, 7042.). 28 Id. (citing 25 Del. C. § 7050). 29 Id. at 230. 30 Id.

9 community, and that the increase is justified by one or more of the eight factors listed

under subsection (c) of Section 7052.31

The Bon Ayre II court interpreted the “directly related” requirement to mean

that the landowner “must show that its original expected return has declined, because

the cost side of its ledger has grown.”32 This showing was deemed to be a “modest

one,” only requiring the landowner to produce evidence to suggest its return on its

property had declined.33 Very simply, “when a landowner [had invested] in

improving [its] community, it [could] reap the benefits of increasing the rent above

inflation rates.”34

2. Donovan Smith

The ultimate instructional takeaway from Donovan Smith concerned the

discovery of landowners’ books and records for homeowners to fairly test the

landowners’ cost and financial representations. Embedded in this holding, however,

was the Delaware Supreme Court’s affirmance of what satisfies a “directly related”

cost expenditure. Although affirmed on a case-specific, narrow basis, the Donovan

Smith court reconfirmed the relatively low threshold landowners needed to meet to

31 Id. at 233-34. 32 Id. at 234. 33 Id. at 235-36. 34 Shady Park Homeowners’ Ass’n, 2023 WL 2366643 at *5 (citing Bon Ayre II, at 234).

10 trigger an analysis of the § 7052(c) factors. The addition of a driveway to each unit

of a community and repainting a maintenance building were deemed sufficient “door

opener” costs to move to the last prong of § 7052’s test.35

3. Sandhill

This “directly related,” “door opener” threshold was further clarified in

Sandhill. In Sandhill, the Delaware Supreme Court expressly disavowed any

reading of the Act that required a landowner to offer evidence of its original costs

and expected return to satisfy the “directly related” test:

[t]here is no basis in the Act to infer such a requirement. Rather the proposed rent increase need only be “directly related to . . . improving the manufactured home community.” To make a prima facie case that a rent increase is directly related to improving the community – a requirement that we have previously described as “modest” – it suffices for the community owner to offer evidence that in making some capital improvement, the community owner has incurred costs that are likely to reduce its expected return.36

The Sandhill court then explained that some correlation between the cost

expenditure and proposed rent increase was required. Specifically, a landowner

could not expend minimal or nominal cost only to turn around and request a

disproportionate rent increase. “To satisfy [the directly related] requirement, there

35 Donovan Smith, 2018 WL 3360585 at *3 (Del. 2018) (TABLE). The Donovan Smith opinion references compliance with 25 Del. C. §§ 7040, 7042. 36 Sandhill, 210 A.3d at 729.

11 [needed to] be a material capital expenditure or increase in operational or

maintenance expenses that [had] a substantial relationship to the rent increase

sought.”37 “If a landowner [could] show that its costs [had] gone up, that [opened]

the door to a rent increase based on § 7052(c)’s factors, including market rent.”38

Those three cases – Bon Ayre II, Donovan Smith, and Sandhill – outlined an

analytical framework for what constitutes and satisfies “directly related.” In sum,

the directly related requirement is met if a landowner “offer[s] evidence that[,] in

making some capital improvement[,] [landowner] has incurred costs that are likely

to reduce its expected return.”39 The “justification” process outlined by the Act –

and clarified by the Delaware Supreme Court – was intended to be moderate,

equitable, and balanced.

B. The Arbitrator Committed Legal Error by Misinterpreting and Misapplying § 7052

As previously outlined, a landowner is permitted to raise a homeowner’s

rental rate above the average annual CPI-U increase if the landowner can justify the

conditions set forth in 25 Del. C. § 7052. There is no dispute here that Landowner

satisfied 25 Del. C. § 7052(a), and maintained the requisite clean bill of health in

37 Id. 38 Donovan Smith, 2018 WL 3360585 at *1 (emphasis added). 39 Sandhill, 210 A.3d at 729. 12 terms of safety violations. Accordingly, the Arbitrator found that Landowner

satisfied this initial qualifying condition.

With this first hurdle cleared, Landowner needed to demonstrate that the

proposed rent increase was “directly related to operating, maintaining, or improving

the manufactured home community.”40 The Arbitrator concluded that the three

capital expenditures, totaling $66,650.00, were directly related to operating,

maintaining, or improving the community:

Based on the testimony and evidence presented[,] there is no doubt that the removal of the barn and swimming pool and repairs and improvements to the sales office were related to the operation, maintenance, and improvement for the management of Ridgewood Manor . . . . these three (3) capital improvements benefited the homeowners in some manner however tenuous it may be. I, therefore, conclude that the three (3) capital improvements, totaling $66,650[.00] (amount claimed in PowerPoint presentation to homeowners) are directly related to operating, maintaining[,] or improving the community.41

With the Arbitrator’s finding that the “door opener” costs were related to the rent

increase, the next step of her review should have been to consider any relevant §

7052(c) factors – in this case, market rent. That review did not occur.

40 25 Del. C. § 7052 (a)(2). 41 Decision, 8.

13 Instead, the Arbitrator added an additional layer of “directly related” analysis

not required by the Act. She outlined the issue as one of first impression:

[t]he critical issue that I need to resolve is whether a landowner, regardless of whether they were or were not the purchaser of the mobile home community may claim costs of acquisition, including capital contribution, mortgage interest, depreciation[,] and goodwill amortization, as costs “directly related to operating, maintaining[,] or improving the manufactured home community” or, put another way, use such acquisition costs, on the cost side of its ledger, to prove that its expected rate of return has decreased or has not been met.42

The Arbitrator exceeded her authority with the addition of this “first

impression” layer of analysis. Contrary to the Supreme Court’s guidance, the

Arbitrator proceeded to hold Landowner to a markedly higher evidentiary standard

than required by the precedential “modest” burden outlined by Bon Ayre II and its

progeny. The Arbitrator expanded the “directly related” test to Landowner’s cost

and expense associated with the acquisition of Ridgewood Manor.

It is undisputed that Arbitrator found that Landowner met the first two

statutory requirements to raise rent above inflation: (1) it had no health or safety

violations in accordance with 25 Del. C. § 7052(a)(1); and (2) Landowner satisfied

25 Del. C. § 7052(a)(2), as it spent $66,650.00 to improve the community. The

Arbitrator, albeit with virtually no explanation, made this express finding about the

42 Decision, 9. 14 $66,650.00. This expense was a direct reduction of Landowner’s income by

$66,650.00. The next step of the established analytical and statutory framework

required the Arbitrator to analyze the § 7052(c) factors. Instead, after determining

the capital expenditures were directly related to the operation, maintenance, and

improvement of the community, she applied the same directly related standard to the

Acquisition Costs. The Arbitrator misapplied the § 7052 test – and this

misapplication constitutes legal error.

C. The Arbitrator Committed Legal Error by Creating an Analytical Schematic Inconsistent with the Statutory Framework

Much of the briefing and oral argument in this case outlined and discussed, at

great length, Landowner’s financials, Landowner’s return on its investment, and

discovery issues below. This Court finds much of this extended discussion

superfluous to the central issue of this appeal. Hyperfocus on accounting and

business principles here misses the mark.

According to the Delaware Supreme Court, neither this Court nor an

Arbitrator can “impos[e] a requirement on the community owner that the statute does

not contain.”43 Whether application of a two-tiered “directly related” standard or

insertion of an equitable standard,44 the Arbitrator cannot superimpose requirements

43 Sandhill, 210 A.3d at 729. 44 The Arbitrator hinted at, although did not directly apply, the following: “[T]o allow such acquisition costs to offset any income in order to create the “door opener” to justify a rent increase under the Act would put both the tenants and existing community owners at an unequitable 15 onto the Act that are not evident in the statutory language. In 2021, the Delaware

Supreme Court reiterated that “the role of the arbitrator under the Act is to render a

decision employing the standards under § 7052.”45 Here, the Arbitrator employed a

different standard.

By not following § 7052’s analytical framework, the Arbitrator diverted from

the standards set forth by the Act. This diversion resulted in conflation of the legal

issues – and the imposition of a heightened burden on Landowner not found in the

Act. The Arbitrator found the capital expenditures to be “door opener” costs directly

related to the rent increase. To meet its prima facie burden, a landowner must offer

evidence that, in making some capital improvement, the community owner incurred

costs that are likely to reduce its expected return.46 A homeowner then becomes

entitled to rebut that prima facie case by offering evidence that the expenditure does

not, in fact, reflect any increase in costs – for example, because the expenditure was

offset by reduced expenses in other areas.47

disadvantage since the new owner would be unlikely to ever achieve its desired rate of return using six and seven figures for capital contribution and depreciation.” Decision, 10. 45 Rehoboth Bay Homeowners’ Ass’n v. Hometown Rehoboth Bay, LLC, 252 A.3d 434, 442 (Del. 2021). 46 Sandhill, 210 A.3d at 729. 47 Id. 16 After finding that Landowner had demonstrated its prima facie case,

Arbitrator did not burden-shift appropriately – namely, require the HOA to show

that the capital expenditures were offset by reduced expenses in other areas. Rather,

the Arbitrator reutilized the “directly related” standard to analyze the Acquisition

Costs. This analysis resulted in the Acquisition Costs being carved out of

Landowner’s financials, which contributed to the Arbitrator’s finding that

Landowner could not meet its § 7052(a)(2) burden. By making this finding, the

Arbitrator recalibrated Landowner’s burden from “modest” to substantial. This

recalibration created a higher standard for Landowner to meet with no support in the

Act itself. The imposition of this burden constitutes legal error and cannot stand.

V. Conclusion

The case presented to this Court on appeal pivots around the Arbitrator’s

determination that Landowner failed to meet the statutory preconditions to seek an

above-inflation rent increase. Specifically, in denying Landowner’s proposed rent

increase, the Arbitrator concluded that it had failed to meet its burden under 25 Del.

C. § 7052(a)(2). Arbitrator substituted a legal standard and analysis inconsistent

with the current status of Delaware law. This substitution constitutes legal error.

Accordingly, the Arbitrator’s decision must be REVERSED.

17 IT IS SO ORDERED.