First Refusal Denied
Can a laundry room operator in co-op buildings grant itself a right of first refusal to a renewal of the lease for the laundry room space after the original term of the lease expires? The answer was “no” in Inwood Park Apartments Inc. vs. Coinmach Industries Co. , where the court held the right to be an unreasonable restraint on alienation that was unenforceable.
The plaintiff was a co-op apartment building at 585 West 214th Street in the Inwood section of Manhattan. Coinmach was engaged in operating laundry facilities. Under a lease agreement dated September 12, 1994, the co-op leased to Coinmach a laundry room in the building for a term of eight years from the date Coinmach installed laundry equipment in the premises. The lease provided that Coinmach would be responsible for installing laundry equipment and operating a coin laundry on the premises for the benefit of the residents of the building. The parties agreed that the initial term of the lease expired May 31, 2003. The second paragraph of the lease said: “This lease shall continue for like successive terms after the expiration of the original term unless either party shall give notice of its intention not to renew, sent by certified mail, return receipt requested, to the other party, no less than (90) days and no more than one hundred and twenty (120) days prior to the expiration of the original term or any successive term thereafter.”
The co-op alleged that on February 11, 2003, it notified Coinmach of its intention not to renew the lease and that in April 2003 it entered into an agreement with another party to operate the laundry room on the date the co-op delivered possession of the laundry room to the other party. The complaint also alleged that, on May 13, 2003, Coinmach wrote to the co-op attempting to exercise its right of first refusal in Paragraph 12(c) of the lease, but that Coinmach never forwarded any agreement documents to the co-op in that correspondence. Coinmach argued that the co-op failed to validly terminate the lease and that the lease therefore renewed automatically.
In addition, Coinmach submitted evidence – that was not refuted – that the co-op had sent Coinmach a copy of a lease dated April 2003 that it had executed with a new laundry operator and had sought Coinmach’s decision to match the offer. Coinmach observed that it was only after Coinmach communicated to the co-op on May 13, 2003, its choice to meet the offer that the co-op rejected Coinmach’s acceptance.
The complaint set forth four causes of action. The first sought a declaration that the lease had not renewed automatically. The second sought a declaration that Coinmach had not exercised the right of first refusal in Paragraph 12(c) of the lease because Coinmach did not provide the co-op with a signed agreement nor did it inform the co-op of the rent it deemed commercially reasonable. The third cause of action sought a declaration that the right of first refusal in Paragraph 12(c) of the lease was null and void under the rule against perpetuities because it could be exercised only after the initial term of the lease expired. The fourth cause of action sought a declaration that the right of first refusal in Paragraph 12(c) of the lease was null and void because it constituted an unreasonable restraint on alienation of property.
The merits of the co-op’s motion for summary judgment on its third and fourth causes of action involved a determination of the validity of Paragraph 12(c) of the lease. That section stated: “At the expiration or termination of this lease or any renewal, Lessee shall be provided with, and thereupon, shall have the right of first refusal to meet any bona fide bid or offer to lease the laundry room(s) and/or provide coin-metered laundry equipment services to the Premises on terms which are substantially equivalent to the terms of this Lease except that the Lessor may charge any new rent so long as it is commercially reasonable. Should Lessor not receive any bona fide bid or offer to take effect at the expiration or termination of this Lease or any renewal, then the terms of this Lease shall continue in effect until such time as Lessor has received a bona fide bid or offer and Lessee has been afforded its right of first refusal.”
The co-op argued that this clause violated the rule against perpetuities and the rule against unreasonable restraints on alienation. It also argued that Paragraph 12(c) of the lease created an option in favor of the defendant. The court disagreed and held that Paragraph 12(c) of the lease did not create an option, but instead creates a preemptive right. It cited a prior case which held: “An option grants to the holder the power to compel the owner of property to sell it whether the owner is willing to part with ownership or not. A preemptive right, or right of first refusal, does not give its holder the power to compel an unwilling owner to sell; it merely requires the owner, when and if he decides to sell, to offer the property first to the party holding the preemptive right so that he may meet a third-party offer or buy the property at some other price set by a previously stipulated method. Once the owner decides to sell the property, the holder of the preemptive right may choose to buy it or not, but the choice exists only after he receives an offer from the owner. If the holder decides not to buy, then the owner may sell to anyone.”
The lease at issue here was between a co-op and a commercial partnership and involved the provision of coin-operated laundry services to a building owned by the co-op. The lease was executed by people acting in their capacity as officers, not individuals, and concerned a laundry room, which was apparently outside of the residential area of the building. These factors weighed in favor of finding that the rule against remote vesting did not apply in this case because the lease came within the commercial exception.
Furthermore, the court said that an appellate court had held that, based upon the holding of an earlier case, “because the management of condominium developments has a valid interest not only in securing the occupancy of the units but also in protecting the ownership of the common areas and the underlying fee, its preemptive rights to repurchase units before sale to third parties should be excepted from the operation of the rule.”
In this entire case, the court had upheld the application of the commercial exception to the rule against perpetuities where the preemptive rights were lodged in the condominium because the policies underlying the exception – the encouragement and development of property – were supported by such application. The court in the earlier case had further stated: “In light of the comparatively recent emergence and widespread use of new and creative ownership arrangements of property, such as condominiums and cooperatives, that were uncontemplated in the postfeudal agrarian period in which the then progressive Rule Against Perpetuities had its rise, this modem trend of holding the ‘right of first refusal’ not to be subject to that rule appears to be more consistent with the realities of contemporary commerce and economics than [do] the authorities holding to the contrary.”
Thus, the court held that the preemptive right embodied in Paragraph 12(c) of the lease here was not subject to the rule against remote vesting as it came within the commercial exception to the rule cited; therefore, the co-op’s motion for summary judgment on the third cause of action was denied.
Finally, the court had to determine whether, as asserted in the co-op’s fourth cause of action, Paragraph 12(c) of the lease violated the common law prohibition against unreasonable restraints on alienation. It cited a prior case which said: “The test to be used in determining the validity of a preemptive right under the common-law prohibiting unreasonable restraints on alienation was the reasonableness of the restraint, judged by its duration, price and purpose. Significantly, the duration of the restraint is not measured by the life of the preemptive right, but rather by the period during which the right can be exercised once the owner decides to sell.”
In this case, the co-op argued that Paragraph 12(c) of the lease violated the rule against unreasonable restraints on alienation because it could be exercised at any time after the term of the lease was concluded. Furthermore, the court found, based on the express terms of the lease and Coinmach’s arguments, that the purpose of the preemptive right also violated the rule against unreasonable restraints on alienation. The express purpose of the lease clause was to ensure that Coinmach remained in possession of the premises as long as Coinmach matched any bona fide offer. While the requirement that Coinmach match any bona fide offer rendered the preemptive right reasonable as to price, no beneficial purpose has been demonstrated. In this lease transaction as opposed to a sale, the mere receipt by the co-op from Coinmach of equivalent consideration as would be available from a third party did not render the transaction beneficial. The proper exercise of the preemptive right by Coinmach compelled the co-op to lease the premises to a lessee whose leasehold it had terminated. Therefore, in the court’s view the preemptive right served no beneficial purpose and was thus null and void.
Comment: The trial court decision discussed above was recently upheld by an appellate court which reasoned that the right of first refusal did not save the right upon which Coinmach relied, since that right under the subject lease, if not exercised by Coinmach before the lease’s expiration, could be exercised indefinitely thereafter and without limitation as to the time within which the exercise was accomplished. Permitting Coinmach a temporally unrestricted right would constitute an unreasonable restraint upon the alienation of property. The appellate court perceived no beneficial purpose to be served by effectively requiring the residential co-op to retain Coinmach’s laundry room services indefinitely, regardless of their quality.
No Abatement for Inconvenience
Were co-op shareholders entitled to an abatement of maintenance charges on the theory of breach of the warranty of habitability for the inconvenience caused by the renovations of their cooperative apartments, which was done with the approval of the co-op’s board? The answer was a clear “no” in 315-321 Eastern Parkway Development Fund Corp. vs. Wint-Howell.
In this case, the co-op petitioner moved the court for summary judgment in nonpayment proceedings seeking maintenance charges for certain co-op apartments at 315 and 321 Eastern Parkway, in Brooklyn. The respondent co-op shareholders opposed the motion on the grounds of breach of the warranty of habitability and each sought a full abatement for the months of September through December 2004 and for one-half of January 2005.
The petitioner was a not-for-profit corporation organized under Article XI of the Private Housing Law to provide housing for persons of low income. In 2002, the board of directors agreed to apply to the Department of Housing Preservation and Development (HPD) to restructure its then-existing loan with the city of New York in order to retire the balance on the mortgage and to borrow additional sums of money to repair defective conditions in the buildings.
Thereafter, HPD approved a secured loan in the amount of $1 million on the condition that the maintenance would be raised to cover the cost of the loan. The shareholders were then informed of the loan application procedure, the renovations contemplated, and the fact that their maintenance would have to be increased accordingly.
On August 22, 2002, all the tenants and shareholders received written notification, by ordinary mail, that if the loan was granted there would be “rehabilitation work throughout the building” and that “[i]t is anticipated that this work will take 6-9 months to complete…requiring access to each apartment.” The petitioner’s application for a loan was approved by HPD and closed on June 18, 2004 and the work contracted for on July 1, 2004 with Novalex Contracting, LLC for $917,019.
The respondents argued that, during the extensive renovations, adequate kitchen and bathroom facilities were not provided to accommodate them; causing great inconvenience. While the co-op did not dispute the fact that the respondents, as well as all the other tenants in the two buildings, were inconvenienced during the renovation process, it noted that, of the 24 shareholders involved, only the two respondents in this case were not paying their maintenance and were seeking an abatement under these circumstances.
In analyzing the law applicable to the case, the court said that the seminal case regarding the authority and autonomy of a cooperative’s board of directors to make decisions for the benefit of the cooperative was Levandusky vs. One Fifth Ave. Apt. Corp. , decided in 1990. In Levandusky, the Court of Appeals was faced with “the legal question of what standard of review should apply when a board of directors of a cooperative corporation seeks to enforce a matter of building policy against a tenant shareholder. [It] conclude[d] that the Business Judgment Rule furnishes the correct standard of review.”
Developed in the context of commercial enterprises, the Business Judgment Rule prohibits judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. So long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board’s.
The court’s holding in Levandusky regarding the Business Judgment Rule was further reiterated and reinforced in its decision in 40 W. 67th Street vs. Pullman, in 2003, stating that “the Business Judgment Rule best balances the individual and collective interests at stake in the residential cooperative setting.”
The co-op cited a 1992 case, a nonpayment proceeding seeking maintenance charges, in which both parties moved for summary judgment. The respondent sought abatement on the ground of breach of the warranty of habitability, alleging that work done by the petitioner cooperative “wrongfully rendered [his] terrace uninhabitable.”
Ironically, the court noted that the respondents in the case at bar were relying on that same case for the proposition that the warranty of habitability applies to co-op apartments and, therefore, they were entitled to monetary relief in the form of an abatement.
Although the court there stated “as a matter of law, the warranty of habitability as set forth in Real Property Law Section 235-b applies to co-op apartments and buildings, regardless of any clauses to the contrary in the proprietary lease,” it did not award any abatement to the respondent-shareholder. In fact, the court citing Levandusky, noted that it “cannot disturb” the business judgment of the cooperative regarding the work done on the terrace and the inconvenience it caused the shareholder.
While this work no doubt caused great inconvenience to the respondent and affected the appearance of the terrace, the court there found that there was not a breach of the warranty of habitability. The co-op was properly exercising its right to work on the terrace to repair roof leaks. No evidence had been presented to show that the work was unnecessary or improper. Similarly, the court said that the work undertaken by the co-op was necessary to fulfill its obligations pursuant to the proprietary lease to maintain the premises. The board approved the work contracted for and all the tenants were given notification of the proposed work.
While all the parties and the court concurred that the warranty of habitability applied to co-ops, it was necessary to examine the circumstances on a case-by-case basis to determine whether it was an appropriate relief for the conditions in tenant’s apartment. Moreover, there was a clear distinction between being a rental tenant and a co-op shareholder who was, in effect, an owner of the building itself. In the court’s view, it was well settled that conditions within the co-op apartment that are not caused by external factors for which the co-op can be held accountable are the sole responsibility of the shareholder. Here, while the conditions within the respondents’ apartments were a direct result of a building-wide renovation project that the board of directors voted on and approved, it did not fall within the purview of a breach of the warranty of habitability, especially where the renovations would inure to the benefit of the shareholders by protecting their investments in a properly maintained building.
The respondents’ position – that the board and the contracting company did not provide appropriate alternative facilities (i.e., sufficient and accessible kitchens and bathrooms), resulting in major inconvenience and disruption during the renovation period – did not require a finding by the court that an abatement was warranted. Regardless of the fact that the co-op’s attempts to alleviate any disruption of the tenants’ use of their respective premises were inadequate, there had been no proof forthcoming that these inadequacies were anything other than poor planning. The court said that the respondents had not demonstrated that the board’s conduct was willful or outside of its scope of authority.
Were the court to grant the respondents an abatement, the respondents would, in effect, be seeking damages against themselves, as they, along with all the other shareholders who have not sought any abatement, would have to vote an assessment against themselves to cover the cost of any recovery. This would result in a zero gain for the respondents and an unnecessary out-of-pocket expenditure for all the other shareholders. The court cited an earlier case, which held that, “an owner cannot be given financial compensation against himself and fellow owners for necessary maintenance.”
The court said that the respondents’ disenchantment with the renovation process had to be weighed against the greater good that had been bestowed upon the co-op as a whole. Neither the court, nor any other court, could substitute the judgment of the co-op board unless it could show that the board had acted in bad faith or without authority. Such was not the case here.
A co-op or condo is by nature a myriad of often competing views regarding personal living space, and decisions taken to benefit the collective interest may be unpalatable to one resident or another, creating the prospect that board decisions will be subjected to undue court involvement and judicial second-guessing. Allowing an owner who is simply dissatisfied with a particular board action a second opportunity to reopen the matter completely before a court, which generally may or may not agree with the reasonableness of the board’s determination, threatens the stability of the common living arrangement.
Therefore, the court held that the respondents were not entitled to any abatement for breach of the warranty of habitability for the conditions in their apartments during the renovation process. Accordingly, the co-op’s motions for summary judgment were granted as to each respondent. The co-op was awarded a final judgment in the amount of $5,6921.11 against one respondent and a final judgment in the amount of $3,468.40 against another respondent.
Comment: The statutory warranty of habitability was enacted by the state legislature in 1975 to insure that all tenants, including co-op owners, could enjoy safe and comfortable housing and has been a potent weapon for tenants ever since by providing rent abatements when the statutory standard was not provided by landlord. Here, the co-op embarked on needed renovations to its property for the benefit of all unit owners. Since the work was necessary, under the Business Judgment Rule applied by the court, great deference was given to the decision of the board to undertake the repairs without requiring some sort of rent abatement for the inconvenience of a few unit-owners caused by the renovations.
Richard Siegler is a partner in the New York City law firm of Stroock & Stroock & Lavan, and a member of the Committee on Condominiums and Cooperatives of the Real Property Section of the New York State Bar Association. He is also an adjunct professor at New York Law School, where he teaches a course on cooperative and condominium law.