Court Decides Whether Short-Term Rental Broker Requirement Is Constitutional

It is not uncommon for property owners to rent their vacation homes to short-term renters. Some individuals have made a business of marketing these short-term vacation rental properties on their own or through such internet sites as Airbnb and the like.

In Ladd v. Real Estate Commission, 2020 Pa. LEXIS 2764 (May 19, 2020) the Pennsylvania Supreme Court recently determined whether the requirements of a real estate “broker” under Pennsylvania’s Real State Licensing and Registration Act (RELRA), 63 P.S. Section 455.101 et seq. should be deemed unconstitutional as applied to a short-term vacation property manager.

Requirements of RELRA

As a preliminary matter, RELRA sets forth the statutory licensing requirements for real estate brokers in Pennsylvania.

Under Section 63 P.S. Section 455.201, a real estate ‘broker’ is defined as, among other things, a “person, who, for another and for a fee, commission or other valuable consideration … manages real estate” in Pennsylvania.

However, under Section 63 P.S. Section 455.304(10), RELRA specifically exempts from this statutory definition of a real estate “broker” “any person employed by an owner of real estate for the purpose of managing or maintaining multifamily residential property.”

RELRA requires a real estate broker to take an examination before becoming licensed to practice such real estate activities in Pennsylvania.

In order to be eligible to sit for the real estate ‘broker’ examination, a person, among other things, must “have completed 240 hours in real estate instruction in areas of study prescribed by the rules of the commission” and must “have been engaged as a licensed real estate salesperson for at least three years or possess educational or experience qualifications which the commission deems to be the equivalent thereof.”

In order to be eligible to take the examination to become a real estate salesperson that person must first, among other things, “complete 75 hours in real estate instruction in areas of study prescribed by the rules of the” Real Estate Commission.

Upon passing the examination to become a real estate broker, the person must thereafter “maintain a fixed office within this commonwealth.”

Failure to comply with these statutory licensing requirements can result in both civil and criminal sanctions under RELRA.

Ladd Manages Short-Term Vacation Rentals

Sara Ladd, a resident of the state of New Jersey, owned a couple of vacation properties near the Pocono Mountains, the opinion said.

Ladd soon used her digital marketing experience to establish an online system for booking her rental properties, the opinion said.

Other nearby property owners soon learned of Ladd’s success in managing to rent her properties and began hiring her to rent their properties, the opinion said.

Ladd eventually formed a limited liability company and launched a website to “take the hassle out of short-term vacation rentals by handling all of the marketing and logistics that property owners would otherwise have to coordinate themselves,” the opinion said.

According to Ladd, she entered into written agreements with her property owner clients to market their properties on the internet through her own website as well as listing them for rent on such websites as “Airbnb, HomeAway, Flip, Key and VRBO” and to oversee and manage the booking, billing and cleanliness of the short-term vacation rental properties.

Ladd solely owned the business and operated the majority of her business activities from her home in New Jersey, the opinion said.

Ladd’s Constitutional Challenge to Application of RELRA

After the commonwealth of Pennsylvania’s Bureau of Occupational and Professional Affairs called Ladd to inform her she had been reported for the alleged unlicensed practice of real estate, she shuttered her business to avoid any potential civil or criminal sanctions being levied against her.

She then filed a complaint with the Commonwealth Court of Pennsylvania, seeking declaratory judgment and a permanent injunction, in order to allow her to operate her business without the risk of incurring any civil and criminal sanctions as a matter of law.

In her complaint, Ladd alleged that the application of RELRA’s requirements for a real estate broker as to her violated her substantive due process rights pursuant to Article I, Section 1 of the Pennsylvania Constitution because it imposed unlawful burdens on her right to pursue her chosen occupation.

Article I, Section 1 of the Pennsylvania Constitution provides that “all men are born equally free and independent, and have certain inherent and indefeasible rights, among which are those of enjoying and defending life and liberty, of acquiring, possessing and protecting property and reputation, and of pursuing their own happiness.”

In Nixon v. Department of Public Welfare, 839 A.2d 277 (Pa. 2003), the Supreme Court found that included within the right to possess property under the cited section of the Pennsylvania Constitution is the right to pursue a chosen occupation.

However, the Nixon court stated that, unlike the rights to privacy, marry, or procreate, the right to choose a particular occupation should not be deemed fundamental.

Rather, according to the Nixon court, “the right is not absolute and its exercise remains subject to the General Assembly’s police powers, which it may exercise to preserve the public health, safety, and welfare,” … “but, the General Assembly’s police powers are also limited and subject to judicial review.”

According to the test enunciated by the Supreme Court in Gambone v. Commonwealth, 101 A.2d 634 (Pa. 1954), “a Pennsylvania statute that violates substantive due process is subject to a ‘means-end review’ where the court ‘weighs the rights infringed upon by the law against the interest sought to be achieved by it, and also scrutinizes the relationship between the law (the means) and that interest (the end).’”

In Gambone, the Supreme Court emphasized that “the level of scrutiny applied to that means-end review is dependent upon the nature of the right allegedly infringed.”

Since the right in Ladd was not fundamental, it was subject to rational basis review, which, under Pennsylvania law, is less deferential to the legislature than its federal counterpart, however.

Quoting the Gambone court, under heightened rational basis test:

“A law which purports to be an exercise of the police power must not be unreasonable, unduly oppressive or patently beyond the necessities of the case, and the means which it employs must have a real and substantial relation to the objects sought to be attained. Under the guise of protecting the public interests the legislature may not arbitrarily interfere with private business or impose unusual and unnecessary restrictions upon lawful occupations. The question whether any particular statutory provision is so related to the public good and so reasonable in the means it prescribes as to justify the exercise of the police power, is one for the judgment, in the first instance, of the law-making branch of the government, but its final determination is for the courts.”

The commonwealth filed preliminary objections in the nature of a demurrer, challenging the legal sufficiency of her constitutional claim.

The Commonwealth Court ultimately sustained the commonwealth’s demurrer and dismissed Ladd’s complaint, holding that RELRA’s broker requirements are constitutional as applied to her.

In doing so, the Commonwealth Court applied the heightened rational basis test announced in Gambone.

In Gambone, the Supreme Court held “a law restricting social and economic rights, like the right to pursue a lawful occupation, ‘must not be unreasonable, unduly oppressive or patently beyond the necessities of the case, and the means which it employs must have a real and substantial relation to the objects sought to be attained.””

Applying the heightened rational basis test set forth in Gambone to the factual circumstances set forth in Ladd, the Commonwealth Court concluded “RELRA bears a real and substantial relationship to the interest in protecting from abuse buyers and sellers of real estate and is similar to licensing requirements in other fields.”

In doing so, the Commonwealth Court did recognize that “RELRA’s requirements would likely be ‘unduly burdensome’ to Ladd due to the ‘small volume of real estate practice she conducted,’ but ’the Pennsylvania Constitution does not require the General Assembly to establish a tiered system for every profession that it regulates” to account for such disparities.”

Ladd filed a direct appeal to the Supreme Court and the Supreme Court granted permission to hear the merits of the appeal.

On appeal, the Supreme Court analyzed whether Ladd’s complaint raised a colorable claim that RELRA’s broker requirements are unconstitutional as they applied to her because they are, in that context, unreasonable, unduly oppressive and patently beyond the necessities of the case, thus outweighing the government’s legitimate policy objective.

Justice Kevin M. Dougherty wrote the opinion issued by the majority of the Supreme Court, reversing the Commonwealth Court’s order dismissing Ladd’s complaint and remanding the case for further proceedings consistent with their opinion.

The Supreme Court first addressed whether the statutory requirements of RELRA, as applied to Ladd, should be deemed unreasonable, unduly oppressive, or patently beyond the necessities of the case.

Acknowledging that the issue is one of first impression for the Supreme Court, it noted that decisions from other jurisdictions that have conducted a Gambone-like analysis in the context of occupational licensing requirements were instructive.

The Supreme Court in Ladd primarily relied upon the Texas Supreme Court’s ruling in Patel v. Texas Department of Licensing & Regulation, 469 S.W.3d 69 (Tex. 2015).

In Patel, the Texas Supreme Court struck down a statute that required eyebrow threaders to obtain a cosmetology license because it violated the due course of law provision of the Texas Constitution.

The Patel court applied a rational basis test, similar to the one set forth in Gambone, to determine the regulation was unconstitutional as applied to these individuals, who perform a very specific, limited cosmetology service.

The Patel court “considered how much of the hundreds of hours of coursework, including practical training, required for cosmetology licensure was completely unrelated to the specific service of eyebrow threading and determined the licensing requirement imposed a significant cost that was an unduly burdensome means to achieve the government’s health and sanitation end.”

In comparison, the Supreme Court in Ladd pointed out that Ladd “similarly faced with 315 hours of coursework (75 hours for her salesperson license and 240 for her broker license) in various topical areas that pertain to the work of traditional real estate brokers, but not to the services contemplated by her unique business model.”

The Supreme Court in Ladd emphasized that “[t]he only topics listed that are arguably related to her services are the general two-credit “Commission-developed or approved law course” and maximum four-credit “Real Estate Law” and “Residential Property Management” courses that satisfy at most 150 hours of the 315 hour requirement.”

Furthermore, the Supreme Court in Ladd stated that, “because the broker coursework cannot be completed until the salesperson coursework and apprenticeship are satisfied, Ladd’s burden is substantially increased because she would have to forego her own profits for three years while she completes the licensure requirements.”

“Considering both the quantity of nonrelevant hours and the cost of completing those hours, the three- year apprenticeship requirement, adding to the equation the lost opportunity cost of shuttering her business during the apprenticeship”, the Supreme Court in Ladd concluded that she “stated a claim that the broker license requirements are unreasonable, unduly oppressive and patently beyond the necessities of the case.”

Moreover, the Supreme Court in Ladd also reasoned that “the brick and mortar office requirement, as applied to Ladd’s self-described business model, appears to be disproportionate to the government’s interest in safeguarding the public from fraudulent practices by those who ‘trade in real estate,” in that such a requirement to obtain a physical office space in Pennsylvania would be tantamount to an excessive fee for entry into a profession since her business model was only sustainable because she was able to provide quality services with limited overhead, and requiring additional overhead, including rental or mortgage, taxes, insurance, and maintenance of a property would not further the statutory objectives of RELRA.

The Supreme Court in Ladd was further persuaded that the application of RELRA to Ladd is unconstitutional when considering that person who manage and facilitate rentals of lodging in apartment complexes and duplexes situated in on behalf of their property owners are completely exempt from the RELRA’s broker licensing requirements.

While the Supreme Court in Ladd believed that she technically fell within the statutory definition of a real estate “broker”, it concluded that her business model—as described in her complaint—was more closely analogous to the services provided by these exempt individuals than to those of a real estate “broker.”

Furthermore, the Supreme Court in Ladd noted that her business would not operate without regulation and oversight in the absence of a broker license since the services her business provided would, in its estimation, fall under Pennsylvania’s Unfair Trade Practices and Consumer Protection Law (UTPCPL), 73 P.S. Section 201-1 et seq., the state consumer fraud statute which prohibits unfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce.

The Supreme Court in Ladd then briefly discussed whether the commonwealth’s police power was being exercised in a manner that bears a real and substantial relation to the purported policy objective.

In a conclusory statement, the Supreme Court stated that “it is not clear and ‘without a doubt’ those requirements bear a real and substantial relation to the statutory goal of protecting the public from fraud.”

Reprinted with permission from the June 9, 2020 edition of The Legal Intelligencer © 2020 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382, reprints@alm.com or visit www.almreprints.com.