Proposed Revision to the Lease Protection Act That Would Further Disadvantage Tenants

- June 28, 2004. Bill No. 170088, proposed by Representative Kwon Younggil:

Partial Amendment to the Commercial Building Lease Protection Act and

June 28, 2004. Bill No. 170090, proposed by Representative Cho Seungsu:

Partial Amendment to the Housing Lease Protection Act -

1. The Purpose of the Amendment Bills and Criticism of Them

Democratic Labor Party Representatives Cho Seungsu (“Rep. Cho”) and Kwon Younggil (“Rep. Kwon”) respectively introduced a bill to amend the Housing Lease Protection Act (hereinafter, the “Housing Lease Amendment Bill”) and a bill to partially amend the Commercial Building Lease Protection Act (hereinafter, the “Commercial Lease Amendment Bill”). Rep. Cho states that the reason for proposing the Housing Lease Amendment Bill is that “therefore, this amendment bill aims to promote housing stability and rent stability for tenants by establishing or supplementing relevant provisions necessary for the adjustment of lease disputes, thereby promoting stable housing and rent conditions for tenants, who are economically and socially disadvantaged in residential building leases.” Rep. Kwon states that the reason for proposing the Commercial Lease Amendment Bill is that “there are problems such as the proviso clause relating to the scope of application under Article 2 of the Act, the excessively high rate of rent increases, the absence of a mediation body to resolve lease disputes, and the absence of a competent administrative department with authority to take corrective measures against clearly illegal or improper acts, and the purpose is to supplement these shortcomings.”

However, there remains a strong doubt as to whether these two amendment bills can truly achieve their intended purposes. Most of the provisions in both amendment bills are various forms of government regulation that are likely to produce many side effects. Legislators or those in power often find it easy to think that they can achieve their intended objectives by suppressing or controlling the workings of the market through law or political power. Such thinking or attitudes, together with the justification of protecting the “socially disadvantaged,” seem to have led to the submission of regulation-oriented bills such as these two amendment bills. Yet regulations are not only created for the benefit of interest groups, but also, because of many unforeseen side effects, end up harming in the long run the very groups the law is intended to protect. In addition, as such regulations increase, the economy as a whole also becomes less efficient and loses vitality. Therefore, when legislators or those in power seek to solve social problems through regulation, they need deep study and thorough understanding of the side effects of regulation.

2. Review of the Amendment Bills

(1) Review of the Housing Lease Amendment Bill

Let us analyze in detail the expected effects of the major changes in the Housing Lease Amendment Bill. First, the amendment bill extends the renewable lease period to 10 years and prohibits the lessor from refusing the lessee’s request for renewal without just cause (Article 10 of the amendment bill). This provision greatly extends the lease term from the current 2 years to 10 years. Since this provision significantly restricts the rights of the lessor over the long term, the supply of rental housing will decline. Of course, the law lists cases in which renewal may be refused, but because of the complexity of economic life and the various situations that can arise in human life, that alone is insufficient. Even in cases where renewal can be refused, if the lessor must compensate the lessee or bear costs that the lessor otherwise would not have had to bear, the incentive to lease will decline. In addition, in order to prevent anticipated lease disputes in advance, it is highly likely that lessors will frequently become more exacting and discriminatory in scrutinizing tenants’ character, financial condition, and so forth. Along with the extension of the renewable lease period, the provision requiring the lease contract—apart from rent and deposit—to be concluded on the same terms as the previous lease ignores the principle of changed circumstances and compels the lessor to sacrifice for the sake of the lessee. In particular, as will be seen below, this provision could have even more pronounced effects because it would be implemented simultaneously with price controls. For example, if inflation makes it necessary to raise the deposit substantially, price controls that suppress such an increase, combined with a long renewable lease period, will place lessors at a disadvantage and are likely to result in a decline in rental housing. Viewed overall, the extension of the renewal period under this amended provision will reduce rental housing, and such a reduction will cause jeonse deposits or monthly rents to rise above what they would have been without such a provision.

Second, the Housing Lease Amendment Bill limits rent increases to 5% per year and, in the case of monthly rent, regulates the conversion rate so that it may not exceed 10% per year (Articles 11 and 12 of the amendment bill).1)

These two rates not only make explicit in statutory provisions what had previously been set by Presidential Decree under the current Housing Lease Protection Act, but at present the upper limit on the conversion rate for monthly rent is 14% per year. However, the rent increase rate is the same at 5% per year. In other words, this provision of the amendment bill regulates rent prices (or, in the case of monthly rent, the conversion rate) and codifies that regulation in law. A price set below the level determined in the market is called a “price ceiling.” When the government sets the price of a good or service below the market price, the supply of that good or service decreases and demand increases compared with what would have occurred without government intervention. Because a price ceiling is lower than the price that would be freely determined in the market, suppliers do not provide enough of the good or service to satisfy what consumers want in the market. This is because suppliers who believe they cannot earn an appropriate profit at the low ceiling price do not supply the good or service. Consumers, because the regulated price is lower than the market-determined price, demand more than they would at the free-market price. Under a price ceiling, demand always exceeds supply. This is called “excess demand.” The specific size of excess demand depends on the elasticity of the demand and supply curves. If prices are freely determined in the market, the existence of excess demand leads to a rise in price. But under a price-ceiling system, prices are regulated by the government, so supply no longer increases. As a result, the price actually paid by consumers becomes higher than the price they would have freely paid in the market. In many cases, the difference between the regulated price and the actual price paid by consumers appears in non-monetary forms. For example, consumers may have to wait longer to obtain the rental housing they want, or the quality of the housing may be lower, so that the effective monetary price of housing services is actually higher than the regulated price. Or, because an adequate quantity of housing services cannot be obtained, people may evade government enforcement and enter into illegal contracts. In that case, the rental housing market becomes a black market, and consumers have to pay a very high price in cash. In short, the price ceiling that the sponsors of the amendment bill seek to introduce is harmful in every respect and beneficial in none.

Third, where the agreed rent or deposit is deemed unfair, the amendment bill allows the head of the relevant agency to take necessary measures such as recommending mediation, and where this is violated, a fine for negligence of up to 5 million won may be imposed (Articles 19, 20, 22, and 23 of the amendment bill). This provision would allow the government to regulate individual prices, rather than having rent or deposit amounts determined by free contract between lessor and lessee. It means that if problems arise that cannot be resolved even through price regulation, the government will directly intervene in individual contracts to control prices, making it a more powerful form of price control than general price regulation. The standard for government intervention in individual contracts is the rent or deposit of nearby similar housing. If the rent or deposit in question differs markedly from that price, it may be regarded as an “unfair” price and the necessary measures may be taken. Although implicitly, this amendment bill presupposes the concept of an “average price.” But because all prices are subjective, it is mistaken to apply the concept of an average price in judging whether a price is unfair. In addition, even if one were to concede the concept of an average price a hundred times over, how much difference constitutes a marked difference will vary from person to person. At that point, the judgment of the contracting parties as to whether the transaction is beneficial disappears, and the judgment of an outsider enters in its place. Then one party gains at the expense of the other. Because this kind of price regulation of individual contracts is worse than the general price regulation described above, its harmful effects will likewise be proportionately greater.

(2) Review of the Commercial Building Lease Amendment Bill

Among the review of the Housing Lease Amendment Bill, the second and third points apply equally to the Commercial Lease Amendment Bill. The economic principles are the same. Here, only those matters unique to the Commercial Lease Amendment Bill will be examined.

First, with respect to the scope of application to commercial buildings, the existing law contained a proviso excluding large buildings with high deposits, whereas the amendment bill deletes that proviso so that the law would apply to all commercial buildings (Article 2 of the amendment bill).2)

To understand the significance of deleting the proviso, it is necessary to consider why the proviso itself was created. The proviso to Article 2 of the Commercial Building Lease Protection Act can be viewed as a provision intended to protect tenants where rent or deposits are small in amount. The proviso itself, albeit indirectly, suggests that the Commercial Building Lease Protection Act was enacted to look after the interests of tenants rather than lessors. It appears that large buildings were excluded from the scope of the Act based on the judgment that tenants do not need protection when rent or deposits are large. In cases where rent or deposits are large, the tenant was regarded as not being the weaker party. It is consistent with market principles to regard lessor and lessee as equals. Even if the tenant is economically weaker than the lessor, because each party seeks its own interest in a transaction, what the government should do is protect the transaction itself, so long as it is not an “unfair” case in which the lessor imposes oppression on the tenant in forming the contract—that is, so long as it is a free contract. In that respect, in order to ensure free transactions between lessors and lessees, it is right to keep the scope of application of the Commercial Building Lease Protection Act as narrow as possible. The broader the scope of application to commercial buildings, the greater the number of tenants who benefit at the expense of lessors, and the greater those benefits become. Therefore, the amendment bill expanding the scope of application to commercial buildings is a worsening, not an improvement, of the current law.

Second, the amendment bill includes a provision establishing compensation standards in order to prevent lessors from refusing contract renewal by “abusing” the provisions on demolition and reconstruction (Article 10(6) of the amendment bill). Article 10 of the current Commercial Building Lease Protection Act provides that contract renewal may not be refused without just cause. It recognizes demolition and reconstruction of the building as one of the forms of just cause. Article 10 of the Commercial Building Lease Protection Act excessively protects tenants and infringes on the rights of lessors. When the lease term expires, the lessor should be able to refuse renewal even without any special reason. However, the current law lists the grounds on which renewal may be refused. The amendment bill adds an even worse provision to an already flawed statutory provision that infringes on the rights of lessors. By requiring a certain amount of compensation where renewal is refused because of demolition or reconstruction of the building, the amendment bill in effect blocks the lessor from refusing renewal on the grounds of demolition or reconstruction, except where such matters were agreed upon in advance by contract. One must not be deceived by the expression “abuse” used by the sponsors of the amendment bill. This provision of the amendment bill excessively protects tenants and infringes on the legitimate rights of lessors.

Third, in order to prevent the abuse by building owners of restoration clauses in lease contracts, the amendment bill would make mandatory the right to claim reimbursement for “necessary expenses” and “useful expenses” guaranteed under Article 626 of the Civil Act (Article 15(2) of the amendment bill). Article 626 of the Civil Act contains two points. One is that when the lessee has expended necessary expenses for the preservation of the leased object, the lessee may claim reimbursement from the lessor. The other is that when the lessee has expended useful expenses, the lessor must reimburse them at the end of the lease if the increase in value still exists. However, making these two provisions mandatory especially disadvantages the lessor. The law treats lessor and lessee fairly when it allows necessary expenses and useful expenses to be excluded by contract. Of course, necessary expenses and useful expenses may also be recognized by contract. Whether to recognize such expenses is a matter for lessor and lessee to settle by contract. But by completely blocking the lessor from excluding necessary expenses and useful expenses by contract, this provision of the amendment bill disadvantages the lessor and benefits the lessee. Naturally, this provision will increase disputes between lessor and lessee, and the supply of commercial buildings will decline.

Fourth, the amendment bill proposes that the beneficiaries of commercial building lease protection should also include nonprofit corporations, political parties registered under the Political Parties Act, and nonprofit private organizations, among others (proviso to Article 3(1) of the amendment bill). On the premise that the proviso to Article 2(1) of the Commercial Building Lease Protection Act remains valid, expanding the protected parties in this way may not present any major problem. However, if the amendment bill deleting the proviso to Article 2(1) were to take effect, this could become a problematic provision. Nevertheless, even when nonprofit corporations and similar entities lease commercial buildings, from the standpoint of the nature of the service, it is closer to a residential lease. In other words, although in outward form it is a lease of a commercial building, in substance it is a lease of housing. Therefore, from the standpoint of the nature of the service, whether to include this provision requires careful review.

3. Summary and Conclusion

The Housing Lease Amendment Bill and the Commercial Building Lease Amendment Bill introduced by Democratic Labor Party lawmakers contain many toxic provisions. In the long run, such provisions will increase the costs borne by tenants rather than protect them. In other words, it may be expected that the two amendment bills, proposed with the aim of protecting tenants, will in the long run instead harm them. This is because all the contents of the amendment bills run counter to economic principles. Of course, in the short term, tenants may benefit at the expense of lessors. But that is only temporary. In the long run, because the negative effects of regulation are greater than the positive effects, both lessors and lessees will become victims. If one seeks through power or law to suppress human action aimed at pursuing self-interest, that power or law will not help humanity as a whole, but rather harm it.

Although not addressed directly in this article, laws and policies must be made with the issue of enforcement in mind. Only when laws or policies are fair will citizens or interested parties comply with them most faithfully, and in that case the costs associated with enforcement will be minimized. If a law or policy protects one side at the expense of the other, it will be regarded as unfair, and some citizens or interested parties will not comply with it. In such cases, increases in conflict, disputes, and crime are a natural consequence. The provisions proposed in these two amendment bills are unequal in the extreme.

Yongdeok Jeon (Professor of Economics, Daegu University)

1)

This part of the analysis can be applied equally to the Commercial Lease Amendment Bill. However, under the Enforcement Decree of the Commercial Building Lease Protection Act, the upper limit on claims for rent increases is 5% per year, while the conversion rate for monthly rent is 14% per year. Therefore, in the Commercial Lease Amendment Bill, only the upper limit on the conversion rate for monthly rent is lowered from the current 14% to 10%.

2)

The Enforcement Decree of the Commercial Building Lease Protection Act provides deposit thresholds of 240 million won for Seoul, 190 million won for the Seoul metropolitan overconcentration control region, 150 million won for metropolitan cities, and 140 million won for other areas.

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Original title: 임차인을 더 불리하게 만들 임대차보호법개정법률안

Author: Yong-deok Jeon

Date: 2004-08-27

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=bill&pn=3&idx=25833