The California Supreme Court has ruled that an inclusionary housing requirement is an exaction rather than a land use regulation – a distinction that means inclusionary housing could be judged by the same nexus and proportionality requirements as other exactions.

In a unanimous ruling last Friday, the Supreme Court reversed an appellate court ruling and sided with developer Sterling Park in an ongoing dispute against the City of Palo Alto. Sterling Park had sought to fulfill its inclusionary housing commitment under protest, as permitted by the Mitigation Fee Act (Govt Code Section 66020). Palo Alto claimed that the inclusionary housing requirement was not an exaction under the Mitigation Fee Act but rather a land use regulation under the Subdivision Map Act (Govt Code Section 66499.37).

 Palo Alto's inclusionary housing program "is different from a land use regulation … (a limit on the number of units that can be built); instead, it is similar to a fee, dedication, or reservation under section 66020," wrote Justice Ming Chin for the unanimous court.

 The Supreme Court did not decide the merits of the case, in which Sterling Park challenged the inclusionary housing ordinance as an impermissible use of the city's power to impose exactions in exchange for land-use permits. Instead, it remanded the case to the Sixth District Court of Appeal for that decision.

 However, the Supreme Court's ruling certainly sets the stage for a possible ruling that would outlaw or significantly rein in  inclusionary housing ordinances. Under exaction law, a jurisdiction seeing to impose an inclusionary housing requirement on a developer would have to prove a strong nexus between the construction of the project and the need for affordable housing.

 In the 2009 case Palmer v. City of Los Angeles, 175 Cal.App.4th 1396 (2009), the Second District Court of Appeal called into question the legal validity of inclusionary housing requirements on rental housing projects. The court ruled uled that an inclusionary housing requirement on a rental development project near Downtown Los Angeles was effectively setting the rent on the housing units, thus violating the state's Coast-Hawkins Rental Housing Act.

 Just last week, Gov. Jerry Brown vetoed AB 1229, a bill designed to overturn the Palmer ruling, by saying he wanted to wait to see what the Supreme Court did in the Sterling Park case.

 The case began in 2006, when Sterling Park LLC sought approval of a proposal to demolish an existing commercial development on 6.5 acres of property on West Bayshore Drive and replace it with 96 residential condominiums. As a condition of approval, Sterling Park agreed, under the city's inclusionary housing ordinance, to set aside 10 units for affordable tenants and also pay the city a fee totaling approximately 5% of the actual sales value of the market-rate units.

 Three years later, however, Sterling Park filed a letter of protest as permitted under Government Code Section 66020, a part of the Mitigation Fee Act, claiming that the developer had agreed to the conditions under duress and claiming that the inclusionary housing requirements were invalid.

 The city did not respond and Sterling Park sued, seeking invalidation of the inclusionary housing requirement.

 In response, the city argued that the inclusionary housing requirements were not exactions imposed under the Mitigation Fee Act but, rather, conditions of approval imposed under the Subdivision Map Act . The Mitigation Fee Act contains the protest procedure that Sterling Park followed; the Subdivision Map Act has not such equivalent procedure.

Both the Superior Court and the Sixth District Court of Appeal ruled in favor of the city, but the Supreme Court reversed.

The appellate court had relied heavily on Trinity Park, L.P. v. City of Sunnyvale (2011) 193 Cal.App.4th 1014, which held that the Mitigation Fee Act covered only impact fees designed to defray the cost of infrastructure needed to serve the project.

By contrast, the Supreme Court relied heavily on Fogarty v. City of Chico (2007) 148 Cal.App.4th 537, which held that the phrase "or other exactions" contained in the Mitigation Fee Act should be interpreted broadly. The Fogarty case, in turn, depended in large part on an appellate court ruling in Williams Communications v. City of Riverside (2003) 114 Cal.App.4th 642.

Using the reasoning of Fogarty and Williams, rather than the ruling in Trinity, the Supreme Court so long as the number of units being constructed is not being challenged – in issue that would be covered by the Subdivision Map Act -- the conditions attached to how those units may be rented or sold can be litigated under the Mitigation Fee Act during or after construction of the project. 

"The procedure established in section 66020, which permits a developer to pay or otherwise ensure performance of the exactions, and then challenge the exactions while proceeding with the project, makes sense regarding monetary exactions.," wrote Justice Chin or the court. "By the nature of things, some conditions a local entity might impose on a developer, like a limit on the number of units … cannot be challenged while the project is being built. Obviously, one cannot build a project now and litigate later how many units the project can contain — or how large each unit can be, or the validity of other use restrictions a local entity might impose. But the validity of monetary exactions, or requirements that the developer later set aside a certain number of units to be sold below market value, can be litigated while the project is being built."

In the case of the Sterling Park development, Chin wrote, Palo Alto's inclusionary housing ordinance "offers developers two options, either of which, by itself, would constitute an exaction. The imposition of the in-lieu fees is certainly similar to a fee. Moreover, the requirement that the developer sell units below market rate, including the City's reservation of an option to purchase the below market rate units, is similar to a fee, dedication, or reservation."