New York's Cooperative and Condominium Community
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Checks and balances to prevent sponsor fraud
In many buildings where the sponsor still has a substantial investment, he may also have retained management. Boards are urged to institute a system of checks and balances that will safeguard shareholder assets.
In many buildings where the sponsor still has a substantial investment, he may also have retained management. This is not to say that it is necessarily bad to have the sponsor as management. Remember, that if a sponsor still holds investments in a cooperative housing corporation, it is in the sponsor’s best interest that the property be well-maintained, maintenance charges be kept under control, and improvements (both structural and aesthetic) be made. The sponsor still has an interest in the rental value and future resale value of his units.
However, there is no getting around the fact that a sponsor in a cooperative housing corporation is a former landlord, and a developer in a condominium is a former owner. They held the title to the property and ran it for profit. Decisions were made by them and for them, and there was no one to account for these decisions except the Internal Revenue Service. After conversion, the typical sponsor retains management of the building, and suddenly finds himself in a position of having to answer to a board of directors. This is comprised of the new shareholders who make decisions about what expenses get allocated to the sponsors’ rental units, and what expenses are allocated to the cooperative housing corporation.
At conversion, all shareholders sign a proprietary lease, which, among other things, lays out what responsibility the cooperative housing corporation has for expenses and which must be borne by the tenant-shareholder. In almost all plans, the cooperative housing corporation is responsible for such common elements as lobbies, halls, compactor rooms, roofs, and boilers. The tenant-shareholders’ responsibility most often begins and ends with the walls, floor, and ceiling in their unit. Anything inside (kitchen cabinets, toilets, home furnishings, and painting) is their responsibility and anything outside (electrical wiring, certain plumbing, windows, and doors) is the cooperative housing corporation’s.
In addition, once conversion takes place, it is no longer the building staff’s job to repair individual units. They just repair and maintain the common elements. The tenant-shareholder does not call the super when the toilet is stuffed, nor is he entitled to a paint job in his unit every two years when the lease in a rental would be renewed. These distinctions are why it is important in a sponsor-managed building that particular care be taken by the board of directors in monitoring expenses.
After conversion, the sponsor still owns the shares in all the unsold units and rents them to outsiders. The sponsor is a shareholder with special privileges, but none of them relate to the maintenance of his units. The sponsor rents out these units to third parties and is still a landlord who must bear the expenses of the maintenance of his units, but not with the cooperative housing corporation’s funds. The sponsor pays maintenance to the cooperative housing corporation, as do the other shareholders, and then collects rent from his tenants. That money goes into a separate bank account he maintains. All expenses for the maintenance and repair of these units are paid out of these funds.
Checks and balances must be put into place by the board to ensure that expenses are being properly allocated between the sponsor and the cooperative housing corporation. The board should receive a monthly management report that includes:
• A copy of all bank accounts under management control.
• Bank reconciliations on all these accounts.
• A list of all checks written for the month.
• Copies of all paid bills.
• A list of each unit, the maintenance and other income charged, collections and arrears.
• A list of all unpaid bills.
•A list of income from other sources such as laundry.
The treasurer should compare the checks paid for the month against copies of bills to make certain that the bills being paid are proper cooperative housing corporation expenses, using the guidelines laid out above. For example, if there were expenses in the sponsor units for the kitchen appliances, painting of apartments, window blinds, or flooring, typically, these would be the sponsor’s responsibility.
Another set of checks and balances that must be maintained is the use of staff time. The staff should be given a list of job responsibilities for the common elements. Any shareholder complaints must be filled out in the form of a work order, and there should be a work log so the staff’s time is accounted for. Any work done for the sponsor on his units by the staff should be done after working hours.
There should be a management contract in place, just as there would be for a third party manager that outlines the responsibilities of management. There is always a dollar limit that the manager can spend without board approval, unless it is on a recurring item, such as fuel or an emergency repair. This amount is usually in the range of $500 to $1,000. Many boards retain management oversight by requiring two signatures on all checks over these limits (one, a director’s signature, and the other, a manager’s). In addition, the board typically retains control over reserve funds.
At all times, there should be a separate bank account for the cooperative housing corporation and the sponsor, and funds should not be commingled. There should not be loans back and forth between the two. The sponsor should pay his maintenance on a timely basis, and if there is a mortgage due the sponsor, a check should be cut for this.
(During the recession of the late 1980s, sponsors found themselves in cash-flow shortages and unable to make their maintenance payments. Many boards had to make application to the courts to have the tenants in sponsor-held units pay rent directly to the cooperative housing corporation and bypass the sponsor. In many cases, the cooperative housing corporation had to cancel the sponsor’s proprietary lease and take title of the units. In today’s market place, however, rents received on unsold shares typically far exceed the maintenance being charged unless it is for a rent-controlled tenant. Therefore, we are not seeing these problems often in today’s economic times.)
Sponsors are entitled to Senior Citizen Rent Increase Exemption, which is a reduction the cooperative housing corporation receives on its real estate taxes for eligible senior citizens renting in the building. When the real estate tax expense and payments are calculated each year, a liability should be set up for this amount due the sponsor. Too often, this is not done and the board is shocked when large sums are ultimately owed the sponsor.
Almost all cooperative housing corporation plans require that the books and records be audited annually. The outside auditor should be made aware of any relationship between the sponsor and management, and should specifically be aware of expenses that could be management’s responsibility. The expenses should be properly allocated between the parties and reimbursement made if necessary.
Similar rules should be followed in the case of a new condominium development. The distinction here would be in construction costs, punch list items, and warranty items. After the condominium plan is in effect, the developer should not be paying for these items out of condo funds.
In the last analysis, if your sponsor is your managing agent, do not feel that this is immediate grounds for dismissal. Instead, make sure that a system of internal controls is put in place to safeguard your assets.
Mindy Eisenberg Stark, CPA, CFE, is a certified public accountant and certified fraud examiner.
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