Mitchell A. Dix, attorney with Mitchell A. Dix & Associates, is on his way to a meeting that didn't have to happen with a director the board didn't want to seat, concerning an issue the co-op shouldn't have had to face.
The 242-unit Bronx cooperative in question encountered a disturbing scenario. A shareholder in litigation for non-payment of maintenance had been elected to the board. Although he had been fighting the co-op in the courts at the time of his election, he squeaked into office because of five proxies from other unhappy shareholders. Surprisingly, there was no requirement that directors be current on their maintenance.
"He was elected even though he was in deep arrears," Dix recalls. "To this day, he has not paid that back maintenance and has not even shown up to many board meetings. And when he does show, he is an obstructionist." Now Dix and the other board members want to amend the bylaws to prevent such a scenario from occurring again in the future.
The Bronx case is not unique, and it points up a lesson most cooperatives and condominiums should seriously consider: modernizing the bylaws. Without a doubt, it is a crucial area of concern. "We recommend that every building look at its bylaws and proprietary lease," says attorney Stuart Saft, a partner in Wolf Haldenstein Alder Freeman & Herz. If you don't, you could get into more trouble than the issue is worth.
Bylaws, Your Laws
The bylaws outline the power of the board. Yet many co-ops and condos actually do things without having the power to do them. Take something as simple as the number of seats on the board. "Typically, the maximum number of members is seven," notes attorney Richard Siegler, a partner in Stroock & Stroock & Lavan. "But over the years, the board may have expanded to nine. So you have de facto nine directors, but two are not really directors." That could cause problems if a disgruntled shareholder questions or tries to invalidate a board's decisions. He could conceivably claim that the board acted without proper representation.
The first step in modernization is to review your bylaws (if you haven't had a periodic check already, then your lawyer hasn't been on the ball) and also the proprietary lease. "The bylaws deal with the operation of the corporation and not the individual apartment," explains Saft. "The proprietary lease deals with the relations between landlord and tenant." Most were drafted by the original sponsor and therefore usually have language favoring him (he is usually listed as the "holder of unsold shares").
"We like to review the bylaws periodically for changes, and also look at the proprietary lease to be sure both are current with laws that have come down and changes that have come down," says Stanley B. Dreyer, a partner in Gallet Dreyer & Berkey.
"Bylaws were frequently written by the sponsor's attorney and were generally not in the co-op's best interest," Saft adds. "Since 1985, there has been a lot of legislation and court cases that have to be considered. We have found some pre-1980 buildings in which the board believes it has the power to control sales, financing, subletting, and then, on reviewing bylaws and the lease, are surprised to find they don't."
Many bylaws have simply been adapted from corporate documents and may not deal with problems that typical cooperatives encounter. "Most have evolved from standardized bylaws from business corporations," says Robert Tierman, a partner in Litwin & Tierman. "It is often not a question of modernizing but of customizing them. Now that the dust has cleared and the sponsor is gone, you should try to conform bylaws to your needs. Unlike other business corporations, every decision made in a co-op can have an effect on the lives of shareholders. In that case, democracy has to be enforced better than it is. In that regard, the standard form of corporate bylaws is a little weak. It usually perpetuates existing boards at the expense of shareholders."
If you don't review, you could be in for a surprise. At one Queens co-op, for instance, a rebellious, non-resident shareholder took advantage of sponsor-drafted language allowing non-resident owners to run for office. He was on the verge of being voted in when the building's attorney, Mitchell Dix, found a loophole to prevent the election from taking place.
"This guy had bought a home on Long Island but couldn't sell his apartment," Dix recalls. "He was on the board when he was a resident, but gave the impression that at the next election [after he had moved out], he would resign. But when the annual meeting came around, he arrived with proxies from the sponsor to get back on the board. The bylaws had never been amended to prevent a non-resident from serving. I found a provision that enabled us to adjourn without an election. Then the board amended the bylaws so that a person had to be a shareholder and resident to serve."
Areas to Update
Modernization is important for legal reasons. If you have not updated your bylaws, they may not take into account recent changes in the law. In 1987, for example, the state legislature allowed the elimination of corporate directors' personal liability to the corporation and its shareholders. "There are much wider provisions for indemnification of officers and directors," says Edward T. Braverman, a senior partner in Braverman & Associates. "Most of my co-ops have been amended to give additional protection for indemnification should they be sued and to be in line with changes in the Business Corporation Law." The legislature also permitted corporations to facilitate how board members are reimbursed for personal judgment and litigation expenses.
Many co-ops, however, have not taken advantage of these changes by incorporating them into their bylaws. "All co-ops and condos should make sure they avail themselves of additional protections enacted into law for officers and directors in the mid-'80s," says Steve Wagner, a partner in Wagner Davis & Gold. "The funny thing is that the language contained in most stock bylaws says that officers and directors are provided with the maximum insurance protection provided by law. But that language does not give the maximum protection. Unless you amend your bylaws to conform with the changes, you do not have that."
Updating bylaws can also help take advantage of changes in technology that could ease a board's operations. For instance, some cooperative or condominium bylaws do not permit board members to participate in meetings via conference call or recognize the validity of proxies delivered by fax machine. Most proprietary leases and bylaws also require notices of annual meetings to be supplied by registered, certified, or first class mail. They could often be more easily delivered by fax. "We occasionally get an amendment to allow telephonic board meetings," says an attorney at Schwarzfeld Ganfer & Shore. "That is a time when you need to modernize."
Attorneys also say that procedures for removing board members should be reviewed. "Some bylaws say that directors can be removed with or without cause," says Tierman. "Some require cause. On the one hand, it has always struck me as a little bit unfair that once a director is elected, he is not allowed to serve out his term and could be prevented from serving for no good reason. The first time people disagree with him, they can throw him out. That goes against the theory that board members once elected should exercise their best judgment, doing what is right as opposed to constantly being concerned about violating the wishes of the electorate. On the other hand, by having provisions about showing cause, you have to get into a whole debate about what cause is, which in itself is complex."
"I would review the bylaws at least every five years," observes Howard Schechter, a partner in Schechter & Brucker. "Of course, board members should always stay up to date with changes in the law. There are provisions adopted by the state legislature. If there is change beneficial to the corporation, the board should take steps to update."
Some areas to watch for amendment include:
Mandatory Insurance Provisions:
"The board may want to mandate liability insurance on all contents of apartments," says attorney Douglas P. Heller, a partner in Friedman Krauss & Zlotolow. "It's a way for the building to protect its liability insurance. If you are a board member, you want to make sure insurance is there for every eventuality."
"I find that bylaws frequently provide for annual meetings to be held on a specific day, say the third Wednesday in April, but that may be Passover," Siegler notes. "So you might want to change the language to be less precise — we provide that meetings should be held on a date decided on by the board. That gives boards more flexibility in management."
Changes in Board Election Procedures:
Tierman says that one item that often comes up is the issue of cumulative voting, as set forth in the bylaws and certificate of incorporation. In most cases, such voting was inserted to ensure that the sponsor could elect a certain number of people to the board even when his ownership dropped below 50 percent. "A lot of co-ops have cumulative voting in the bylaws," notes Tierman. "Some feel that such voting skews the results of elections in a way that is unfair."
Decreasing Quorum Requirements for Shareholder Meetings:
Most co-op and condo bylaws require the presence (in person or by proxy) of holders of a majority of shares or common interests in order to obtain a quorum at an annual meeting. Without that quorum, there is no meeting. "Associations which habitually encounter this problem may want to consider a bylaw amendment reducing the quorum requirement to one-third of the outstanding shares or common interests," observes Bruce Cholst, a partner in Rosen & Livingston.
The Proprietary Lease
While amending bylaws, it may also be necessary to alter the proprietary lease, since some of the controlling power for one can come from the other. Notes Braverman: "When you amend the bylaws, the changes must correspond to the language in the proprietary lease. Some buildings have changes that appear in the proprietary lease but not in the bylaws. You want to make them in the mirror image. One example is the flip tax. It has to be provided for in the proprietary lease."
Subletting policy is also dealt with primarily in the proprietary lease, although there are provisions dealing with sublet fees in most bylaws. You should inspect those very carefully. The consequences of not doing so can be severe: in a recent case involving the Hotel Des Artistes, a Manhattan co-op, the board's subletting fees were struck down partly because of contradictions between the board's actions and the requirements of its governing documents.
"Your attorney periodically should review your bylaws and your lease to incorporate the various changes in the law that have evolved over the years," says attorney Arthur I. Weinstein. "There have been a variety of court cases concerning sublet fees, which in several cases have resulted in substantial rulings against co-ops because of inadequate bylaw provisions concerning a board's right to impose fees. Similarly, they should review policies and procedures concerning move-in, move-out deposits, or modifications to previously enacted flip taxes."
Late fee provisions, also in the proprietary lease, are often vulnerable to legal challenge, either because of how they were implemented or because they are excessive. "Sometimes you find that bylaws have language on fees that courts have zeroed in on," says David Tane, a partner in Deutsch Tane Waterman & Wurtzel.
According to Weinstein, the proprietary lease contains at least two areas that are non-amendable without the consent of the sponsor: "Typically, paragraph 38 of the lease defines the holder of unsold shares — the sponsor or the successor to the sponsor — and then gives special rights to that holder. Those include the ability to sublet without board approval, the right to sell apartments without board approval, limitations on the co-op's ability to make certain modifications of the co-op's budget for a five-year period without sponsor approval, and lastly, provides extra rights for the sponsor to control the board. Those restrictions, contained in the lease, are usually not amendable without the sponsor's consent."
How to Do It
The process for amending bylaws varies from building to building. Sometimes, a simple board majority is enough. There are some cases, however, where two-thirds of the shareholders must agree to make the changes. According to Tierman, "certain bylaw provisions cannot be amended by a simple board majority. Those usually involve questions of maintenance and share allocation. Also, board members cannot amend bylaw provisions adopted by all the shareholders."
"If the board feels that politically an issue is so controversial that it wants to put it to the shareholders, then they can use the two-thirds shareholder procedure," Weinstein notes. "Conversely, if some shareholders wish to amend the bylaws — to put in term limits, for instance — and the board is against it, then 25 percent of the shareholders could call a meeting and propose an amendment to the bylaws."
But be careful on how you amend. "If you're going to make changes, be sure it is properly drafted and properly adopted," says Schechter. "Consult your lawyer."
The cost of changes is what might stop some from altering their bylaws. Don't worry: a good lawyer can keep fees from getting too high. "Any attorney with experience can review and make recommendations in an hour," Saft says. "He's looking for certain things, and does not have to read every document. The cost could be a couple of hundred dollars to have this kind of corporate inventory done, depending on the hourly rate."
Reviews can be simple or complex. For example, Howard Schechter, a partner in Schechter & Brucker, is reviewing bylaws for one of his boards. He is giving the directors a breakdown of what potential changes might be, along with a one-line description of the suggested variations in language and why. "That way, the board can discuss the changes over time," he says. "Then they can get back to us and say, 'This sounds interesting, this does not.' "
Some attorneys like to involve at least one board member every step of the way. "When I amend these things, I try to find someone on the board who is really into this stuff," observes Heller. "Then we go over it, word for word, and read over sections and draft ideas together, and rip it apart together. The two of us will write a new draft. It helps to have someone with technical interest on the board. He lives there and knows the issues. If the lawyer is leading the charge, he may not be where the board wants to go. It helps if you really have someone who wants to get involved."
Whatever you do, the prudent course is to keep on top of the bylaws. Otherwise, you could be in for an unpleasant surprise. Concludes Wagner: "The bylaws often involve issues that nobody regularly pays much attention to. But when something controversial arises, any number of people can become incensed and start digging. Then, watch out. It's better to be prepared."