Loyalty Oath

One of the most significant rulings affecting the operation of cooperatives and condominiums in New York was the decision by the Appellate Division of the Supreme Court for the Second Department in Board of Managers of the Fairways at North Hills Condominium, etc. v. Fairways at North Hills, et al. In that case, the court held that the individual members of a condominium’s board of managers, who were appointed by the sponsor, owed a fiduciary obligation to the other purchasers of the condo units to act in the best interests of the condominium as a whole, rather than in the sponsor’s interest. This was the first time the courts had dealt with this issue.

The facts of the North Hills case involved the development and construction of the Fairways at North Hills Condominium, which is located in the Village of North Hills in Nassau County. The defendants were the sponsors of the condo and also three individuals who were appointed by the sponsor to serve on the first board of managers. The original complaint cited numerous causes of action arising from the alleged negligent construction of the units, negligent design and construction of common areas, and undervaluation of maintenance costs, inadequate contingency reserves, and incorrect projections of required common charges.

The appeal stemmed from the supreme court’s refusal to dismiss the portion of the complaint claiming that issues of fact existed as to whether the defendants breached their fiduciary duty to the condominium. The sponsor’s appointees to the condo argued that they owed no fiduciary duty to the condominium and the unit-owners because all of their loyalty was owed to the sponsor who had appointed them.

The appellate division disagreed, noting that “a fiduciary duty on the part of the initial board of managers vis a vis the condominium and its unit-owners came into being at the time of the sale of the first condominium unit...a condominium’s first board of managers is subject to a great potential for conflicts of interest such that a very high standard of duty must be imposed upon it to ensure that its members do not gear their decisions to the benefit of the sponsor at the expense of the association or its members…. The imposition of such a duty is particularly warranted where the sponsor or developer retains essentially total control over the planned community for a substantial period of time during its developmental stages… In so ruling, we recognize the practical concern that unit-owners damaged by bad faith depredations of unscrupulous boards may find themselves without any legal recourse in the event the sponsor’s assets become unavailable or dispersed due to voluntary corporate dissolution or involuntary liquidation.”

The North Hills decision sent a clear message to sponsors and members of boards of cooperatives and condominiums appointed by the sponsor: the actions of the board members would be carefully scrutinized by the courts and, if the members failed to act in the best interests of the cooperative or condominium, they could be found to be personally liable for the consequence of their actions or their failure to act if an action was required. Moreover, in such a situation, the sponsor-appointed members would not be indemnified by the cooperative or condominium.

The decision provides a limited recourse for purchasers of cooperative apartments and condominium units who believe that the sponsor has not met the requirements of the Martin Act (New York’s securities law) and terms of the offering plan for the property. Unfortunately, the purchasers of condominium units and their boards are unable to pursue Martin Act claims directly because New York law states that there is no private right of action under the Martin Act. So, if the sponsor disposes of its assets, the purchasers would be without any recourse against the sponsor or other course of action.

In North Hills, the court established that the purchasers of the condo units and the boards they elect can proceed against the personal assets of the sponsor’s representatives on the board if the sponsor’s representatives failed to act in a prudent and business-like fashion. The ability to have access to a board member’s personal assets provides one of the few instances where the courts permit someone acting on behalf of an entity to be personally liable for his or her actions as a member of the board of that entity.

The question remains as to whether a sponsor’s designees on the board who are appointed after the units have been sold would also have personal liability for actions they take as board members that interfere with the board’s attempt to learn whether the sponsor violated the Martin Act, the offering plan, or the board’s attempt to pursue the sponsor for such actions. It seems reasonable to assume that the board members’ fiduciary duty is irrelevant to when they are appointed, but rather that they owe a duty to all of the owners and not just one.

The decision does not speak directly to that point, however. Nevertheless, in the decade since the North Hills decision, attorneys for cooperative and condominium boards and the purchasers of the units in those buildings have used the threat of proceeding against the sponsors’ members to get them to act in the best interests of the corporation or condominium. Many sponsor-appointed board members have resigned rather than risk personal liability.

It is indeed unfortunate that neither the Martin Act nor the attorney general’s office provide a remedy for cooperative and condominium boards and purchasers to get the building completed the way it was described in the offering plan or the sales brochures without being required to start a time-consuming and expensive lawsuit against the sponsor.

As helpful as North Hills has been in getting sponsor board members to act properly and to get them to recognize their fiduciary duty, it does not provide assistance in those situations where the sponsor does not appoint members to the board and still ignores the requests of the purchasers and the boards to correct the construction and financial deficiencies that the sponsor caused or did not prevent. There is also no recourse where a sponsor fails to complete the building properly, but shields personal assets by using layers of entities between the sponsor entities and its principals.

Before the North Hills decision, the sponsor representatives on boards disregarded the complaints made by the purchasers of the cooperative and condominium units. Meanwhile, the sponsor maintained complete control of the board and ignored the conditions of the buildings that were converted or constructed by the sponsor. North Hills has not ended that indifference entirely, but it has provided the purchasers with a remedy and course of action.