When a Foreclosure Sale Fizzles, Expect Fireworks

This is a story about what happens when a foreclosure sale fizzles. In Louis Zazzarino vs. 13-21 East 22nd Street Residence Corp., a shareholder defaulted on a loan made by her bank. The bank held a non-judicial auction of the shares, as was its right under its loan documents, and Zazzarino was the successful bidder. Any final sale, however, was subject to the board’s approval, and the board decided not to approve Zazzarino. It seems that Zazzarino was an investor who purchased and flipped apartments. He would not make the apartment his residence, and the board did not want an investor purchasing an apartment.

The original shareholder wound up paying the lender what was owed and was able to keep the apartment. The jilted buyer sued. Among other things, Zazzarino pointed to a provision in the proprietary lease: “If purchase by the Lessee [the shareholder] of the shares allocated to the apartment was financed by a loan made by a bank . . . and a default shall have occurred under the terms of the security agreement, an individual designated by the secured party [the lender] . . . shall become entitled to become the owner of the shares [subject to] the consent of the Lessor’s then-managing agent, which shall not be unreasonably withheld.” 

Thus, Zazzarino argued, whoever purchased at auction would be permitted to purchase the shares with approval by the managing agent but not the board, and it could not be “unreasonably withheld.” Zazzarino made a number of other arguments, claiming the board had: breached its contract with him; interfered with his contract with the lender when it refused to allow him to purchase; failed to act in good faith; breached its fiduciary duty to Zazzarino by engaging in fraud and self-dealing; and discriminated against him because he is of Italian-American ancestry. 

The court contended that Zazzarino was, at best, a potential purchaser. The loan that was foreclosed was a home-equity loan taken years after the shareholder bought the apartment – not a loan used to finance the purchase of the apartment. Therefore, it was not subject to the lease provision upon which Zazzarino relied. 

The board’s duty to act in good faith is premised on the existence of a contract. The court found that there was no contractual obligation on the part of the co-op and thus no contract for the co-op to breach. As to interference with Zazzarino’s contract with the lender, the board had the absolute right to accept or reject Zazzarino’s application. Therefore there was no interference; the board was merely exercising a right. As to breach of fiduciary duty, there was no fiduciary relationship. As to discrimination, Zazzarino didn’t allege any facts that showed even an inference of discrimination based upon his national origin. In fact, there was no evidence that the board was aware he was Italian-American. The court dismissed the complaint against the co-op. 

When faced with a foreclosure, it’s important for boards to review their documents to determine the corporation’s responsibilities to both the shareholder and the potential purchaser. As there is likely a recognition agreement (a contract entered into by the shareholder, co-op, and lender), the board should also review its responsibilities to the lender. Boards should be proactive in dealing with the lender to make sure, among other things, that the terms of sale in the foreclosure include a provision that any purchaser at auction is subject to board approval.

Dale J. Degenshein is special counsel at law firm Stroock & Stroock & Lavan.