New York's Cooperative and Condominium Community
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How the Business Judgment Rule applies to condos and the regulating of selling/l
Our attorney explains how the Business Judgment Rule applies to condo board decision-making and board regulation of unit-owner sales and leasing of units.
I am the president of a medium-sized-unit Tribeca condominium. An attorney on the board told us that our board decisions are protected from unit-owner challenge by the Business Judgment Rule, the same way that co-op boards are protected. But he also said that we couldn’t regulate selling or leasing of units. He also said that unit-owners could sometimes use the condominium law to attack board decisions. I’m totally confused. Can you give us some guidance on this?
One point of clarity established long ago is that the Business Judgment Rule applies to condo board decision-making. That means courts will not question condo board decisions unless there is a finding of discrimination, bad faith, or self-dealing. However, condo boards also must act in compliance with their governing documents, any contract with unit-owners, and the Condominium Act (Real Property Law, Section 9-B) and other applicable laws. As will be seen from some recent appellate court decisions, it is not always clear or predictable just what that means.
Also reasonably clear is that condo governing documents usually substantially limit or eliminate board regulation of unit-owner sales or leasing of units. However, some believe that a recent appellate court decision enhances board power in this area.
Ironically, condo boards sometimes respond to conflicts with unit-owners by arguing in favor of board power to act unilaterally (i.e., without unit-owner consent) and other times by arguing that unit-owner consent is required. While somewhat complex, a review of some recent disputes provides a framework for establishing general parameters for condo board decision-making. This is especially crucial because condo boards at least seem more particularly prone than co-op boards to taking extreme actions, perhaps an attempt to compensate for the usual freedom of unit-owners to sell and rent without board regulation. And condo owners (who are often investors in multiple units or commercial unit-owners) seem more willing and able to challenge condo board actions.
In Borress & Borress LLC vs. CSJ LLC (decided March 2006), the Appellate Division, First Department, faced condominium unit-owners challenging a (presumably board-initiated or board-sanctioned) conversion of certain commercial condominium units to residential status. The court concluded that neither the declaration of the condominium nor the bylaws contained “any restriction…warranting a modification, addition or deletion by 66 2/3 percent of the unit-owners in order to effect the conversion of the subject units, so long as for a lawful purpose and not in violation of the Certificate of Occupancy.”
The court apparently rejected the unit-owner plaintiffs’ argument that an offering plan designation of the units as commercial dictated that unit-owner approval was necessary to change them to residential. The court noted: “They don’t point to any document requiring a 66 2/3 percent vote to amend the Offering Plan.” But that seems a cavalier dismissal of a document (the offering plan) on which purchasing unit-owners are expected to rely.
The court also rejected the plaintiffs’ attempted reliance on Real Property Law Section 339-k, which requires “consent of all unit-owners affected” for, in the words of the court, “renovation work that would jeopardize the structural integrity or reduce the value of one’s property, or impose an easement thereon.” But, presumably, the challenging unit-owners did feel that the conversion would diminish the value of their units.
This short decision appears straightforward enough, but is worth a bit of reflection, which will be somewhat speculative because (as usual) the decision left some key facts unstated. It appears that the offering plan and certificate of occupancy indicated that the units in controversy would be residential. It also can be surmised that, for some reason, the declaration of the condominium and bylaws said nothing about the use or conversion of these units, because if the declaration or bylaws expressly designated them one way or the other, or allowed or precluded conversion of units from commercial to residential use, then, in all likelihood, no litigation would have ensued.
So, unless there are designations or restrictions in the declaration or bylaws and as long as there is compliance with applicable law (e.g., amendment of the certification of occupancy), the courts will probably defer to a condo board and allow the conversion of a unit from commercial to residential status in spite of the unit-owners’ expectations to the contrary. I am not precisely sure why the challenging Borress unit-owner plaintiffs found the conversion objectionable. But whatever the reason, it is a bit disquieting that the unilateral action of a condo board could so readily cause such a profound change in the commercial versus residential composition of the units of a condominium.
A condo board lost a recent battle with a unit-owner over power and authority in Board of Managers of the Europa Condominium vs. Orenstein (decided March 2001). There, the Appellate Division, First Department, rejected a condo board’s attempt to prevent an alteration by a commercial unit-owner. Ironically, the board there found itself arguing that unit-owner approval was necessary for the alteration, although usually boards find themselves arguing against the necessity for unit-owner approval, and thus for the sufficiency of board approval, as in the Borress case. Of particular interest here was the appellate division’s interpretation of the Condominium Act provisions with broad potential application elsewhere, and a widely respected justice’s noteworthy dissent regarding this interpretation.
The Europa majority first noted that the unit-owner’s intended extension of the concrete slab comprising the mezzanine level of a restaurant was “located wholly within the defendant’s commercial unit and forms no part of the common elements of the Condominium.” The court thus concluded that the condo’s governing documents permitted the slab without board or unit-owner approval. The much more difficult question was whether “excavation” into the cellar floor, presumably to support the mezzanine level extension, required unit-owner consent because it could encroach on common areas.
The court first concluded that the board had “failed to demonstrate” that the excavation violated conditions in the condo’s declaration otherwise permitting this common area incursion. The court next tackled the Condominium Act implications with an analysis having broad implications for other condo disputes.
For certain categories of condo alterations, including, among others, those affecting “the soundness or safety of the property” or that “add any material structure or excavate any additional basement or cellar” – Real Property Law Section 339-k requires the unit-owner to secure “consent of all unit-owners affected…” The court interpreted the phrase “unit-owners affected” to not, at least in the situation there, require consent of all unit-owners, but only of those unit-owners “appurtenant” to the common interest (i.e., cellar floor) in question, which conveniently did not include any unit-owners. In other words, even though the alteration plainly invoked RPL Section 339-k, the consent of not even one unit-owner was deemed necessary because no unit-owner was deemed “affected” by the alteration.
The court did feel compelled to at least attempt to deflect the predictable shock of its sanctioning, without board or unit-owner consent (or review), of a unit-owner’s drilling into the structural components of a New York City high-rise building. The court noted that “the Buildings Department may be relied upon to exercise the requisite oversight to see that structural integrity remains unimpaired.”
To reach its decision, regarding the applicability of RPL Section 339-k, the Europa court analyzed similar language in RPL Section 339-i(2) and contrasting language in RPL Section 339-1(1). The former provision – dealing with matters that might be construed to have “altered” the “permanent character” of common elements – also requires “the consent of all unit-owners affected” [emphasis added], while the latter – dealing with a third party’s placing of a lien on common elements – requires “the unanimous consent [of] the unit-owners.”
In other words, the court concluded that, in drafting the Condominium Act, the New York State legislature intended to distinguish situations in which consent of all, rather than just “affected,” unit-owners is required. The court’s decision stands for the proposition that the legislature did not intend an overly broad interpertation of the term “affected” and the corresponding need to secure approval of many or all unit-owners in many situations.
The Europa court dissenter rejected the majority’s claim that his broader interpretation of the “affected” language of RPL Section 339-k was “in effect rendering the qualification…mere surplusage.” Dissenting Justice David B. Saxe stated: “I do not suggest that Section 339-k necessarily requires the consent of all unit-owners before excavation may proceed.” So, he agreed that there was a relevant language distinction between RPL Sections339-k and 339-i(2) on the one hand, and RPL 339 (1)(1) on the other.
But Justice Saxe did indicate that he would interpret the “affected” language more broadly than covering only “appurtenant” unit-owners; and, in the situation there, direct a trial on the issue of whether certain unit-owners might be “affected” by the construction project. Those, in turn, apparently would have veto power over the project.
As a practical matter, both the majority and dissenter seemed to realize that the requirement of seeking the consent of even a small number of “affected” unit-owners might seal the fate of the project, whether or not it had board support. That is why the majority felt the need to conclude that none were “affected” as a matter of law, and the dissenter was content to conclude that the consent of all was not “necessarily” required, although both the majority and dissenter could not deny that (in the words of the majority) “any alteration that threatens the integrity of the structure is a common concern to all unit-owners.”
A condo board recently prevailed over a unit-owner in another case adopting a narrow interpretation of the “affected” language of the Condominium Act. In Cohen vs. Board of Managers of the 22 Perry Street Condominium (decided December 2000), the Appellate Division, First Department, approved a board’s grant of a “one-year license” retroactively allowing certain unit-owners to construct a wall to incorporate “14 square feet of [hallway] space” into their two adjacent units, which they had physically combined. The court rejected another unit-owner’s claim that this grant somehow violated Real Property Law Section 339-i. In doing so, the appellate division once again applied a practical reading of the Condominium Act to limit the need for unit-owner approval for a unit-owner’s action, this time (unlike in Europa) sanctioned by the board.
The Cohen court discounted, subsection by subsection of RPL Section 339-i, the concerns of other unit-owners. Somewhat less controversial: the court termed the grant a “revocable license” and thus said that it “did not affect the common interest appurtenant to each unit, or contravene the method for calculating common interest,” and added that “the common interest.. has retained its permanent character,” and that the suing unit-owner (and, presumably, all others) still enjoys the same percentage of ownership of the common elements as he did prior to the erection of the wall.” The court was impressed that the license was “terminable by either party” although constructing walls and doors in common areas seems at least somewhat permanent.
More debatable was the Cohen court’s finding that the “common interest…has not been altered by construction of the wall” and that “construction of the wall area…did not affect or compromise plaintiff’s use of the subject hallway.” One could, of course, argue that enclosing any area of hallway, even unused by other unit-owners, certainly limits the potential use of that hallway, especially by nearby apartment owners. For example, elderly residents are known to exercise during the cold weather months by walking the hallways of their apartment buildings. So, any hallway-taking has the potential to shorten their track. And the common interest also arguably had been “altered,” at least for a time, by the enclosure of 14 square feet of the hallway into two units.
However, as with the Borress situation, the court seems to be advocating a practical approach, in which the need for unit-owner approval cannot so easily override board action by way of broad interpretation of the limitations of the Condominium Act. In effect, this reflects the realization that a condo cannot adapt to certain unpredictable or inevitable situations if approval of all unit-owners, or even of those broadly affected, is too often required. Unless there is a blatant violation, the courts will let condo boards do their jobs, aided by governmental oversight where applicable.
So, in the three decisions just discussed, the condo board’s position prevailed twice (in Borress and Cohen). The condo board lost only when (in Europa) it aligned itself with the side promoting the need for approval of unit-owners. The one common theme was that the side promoting the need for unit-owner approval lost all three times. And in Brasseur vs. Speranza (decided August 2005), the Appellate Division, First Department, also ruled in favor of a condo board. That case involved a unit-owner challenge to the board-imposed requirement that unit-owners execute a standard alteration agreement before conducting alterations in their units.
Unit-owners did prevail in two recent examples of condo board excess. In Kwiecinski vs. Sea Breeze II Condominium Association (decided September 2005), the Appellate Division, Second Department, denied a board summary judgment against unit-owners challenging the board’s borrowing of $52,296 in plain violation of a bylaw prohibition banning borrowing of over $50,000 without unit-owner approval. And in Zack vs. 3000 East Ave. Condominium Assoc. (decided June 2003), the Appellate Division, Fourth Department, granted summary judgment to unit-owners challenging a board’s “‘split’ or ‘hybrid’ method of allocating common expenses to the various units” the “express intent of [which]…was to shift a portion of the financial burden from the owners of the larger units to the owners of the small units on the theory that it was ‘unfair’ to the owners of the larger units to have common expenses in strict proportion to the square footage of their units.” The Business Judgment Rule thus does not give condo boards carte blanche to violate their governing documents or applicable law.
The collective power of unit-owners also prevailed, in a sense, in another recent hard fought battle in which the board, as in Europa, promoted, or at least accepted, the necessity for unit-owner approval of board action. In Demchick v. 90 East End Avenue Condominium (decided May 2005), the Appellate Division, First Department, confronted unit-owners challenging a bylaw amendment that allowed only the owners of larger units to lease or purchase certain smaller units at the condo’s premises. While the condo’s governing documents contained no such restriction on the leasing or sale of the smaller units, the appellate division approved the bylaw amendment because it concluded that Real Property Law Section 339-v(2)(a) allows such a bylaw amendment to be adopted by unit-owners.
The court also rejected the challengers’ argument that the restriction constituted an unreasonable restraint on alienation of the units. The court concluded that owners of the larger units were told when purchasing that only they would be allowed to lease or purchase the smaller units. So, the restriction was consistent with their expectations. It is striking, however, that in Borress, the court did not seem as concerned as it was in Demchick about upholding the expectations of unit-owners who purchased units based on offering plan provisions that indicated the mix of commercial and residential units.
More importantly, in both cases, the court seems cavalier about preserving the essential nature of the condominiums in which unit-owners had purchased. The Borress court let the board change units from commercial to residential without unit-owner approval. The Demchick court did note the need for unit-owner approval of the restrictions on leasing and selling, although I have some question about whether the “majority” approval the court cites constituted the “not less than sixty-six and two-thirds percent” approval required, under RPL Section 339-v(1)(j), for a bylaw amendment. However, such unit-owner approval is small comfort to the minority of the unit-owners who saw the value of their units substantially plummet by severe restriction on the universe of potential renters or purchasers of their units.
Thus, under Borress, unit-owner consent is not required for the board to change the character of units from commercial to residential unless there is a restriction in the governing documents, but, under Demchick, it is necessary (and sufficient) to change (i.e., reduce) the ability to lease or sell a unit. To me, logically, this spectrum should be moved to the right, if you will. Changes of unit usage are important enough to require unit-owner consent, and imposing leasing or selling restrictions (which, if extended, could essentially change a condo into a co-op) should be extremely hard (80 percent, plus unit-owner approval) or virtually impossible (100 percent unit-owner approval) to accomplish. On the other hand, I am quite comfortable (under Europa and Cohen) with leaving approval of alterations to the board, to truly affected unit-owners, and (with fingers crossed) the New York City Department of Buildings.
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