Sponsor Good, Sponsor Bad

In the course of doing its job, every co-op.condo board must develop a complex web of relationships with numerous individuals and institutions – shareholders, residents, professionals, staff, contractors, and banks, to name a few. None has the potential to turn more devastatingly toxic than the board’s relationship with the sponsor.

Here are portraits of two buildings that experienced the extremes: a condo that developed a smooth working relationship with its sponsor; and a co-op that fought with its sponsor until it got dragged into a swamp of lawsuits, ill will, and bad blood.

When a sparkling new 212-unit high-rise condominium opened its doors in White Plains in the fall of 2005, the sponsor’s offering plan projected an annual operating budget of about $2 million. It sounded good on paper to potential buyers.

A little too good. The trouble, as the condo’s first board of managers quickly learned, was that the money was about half what it would take to run the building properly.

“We ran a deficit the first year,” says Frank Palazzolo, treasurer of the seven-member board. (Six seats are held by residents, one by the sponsor.) “We realized invoices were not getting paid and services were not getting performed. We spoke to the managing agent and the sponsor. Fortunately for us, the sponsor was amenable to making changes.”

The operative word here is “fortunately.” A little good luck never hurts in these affairs. After the board instituted an annual energy surcharge of $670,000, the sponsor offered to do three things: give the condo a cash infusion; pay off some outstanding invoices; and cover any budget deficits for 18 months if the energy surcharge were removed.

The board agreed to the first two steps but, on the advice of its attorney, rejected the third. “We didn’t want to do that,” Palazzolo says of the sponsor’s offer of a temporary subsidy. “We wanted to make this a pay-as-you-go building.”

And so the condo accepted a $570,000 cash infusion from the sponsor while the sponsor picked up $200,000 of unpaid bills. With the energy surcharge still in place, the board was able to turn the finances around. Today, all bills are paid promptly, the $3.9 million budget is balanced, and the condo has a reserve fund of $370,000.

“As a result,” says Palazzolo with evident pride, “we’re in a position where the 2009 budget won’t have a maintenance increase. That’s unheard of in this day and age.”

“What’s amazing is how quickly they turned around the finances,” adds the board’s attorney, James Glatthaar, a partner at Bleakley, Platt & Schmidt. “I think the key was good leadership and having financially savvy people on the board.”

Palazzolo agrees, adding that another key was the board’s willingness to attack problems head-on and not let them linger. “If you’re opening a new building,” he advises, “the board has to be proactive with the managing agent and the sponsor. If you try to mask the problems, they can drag on for five or six years. All you’re doing is putting off the day of reckoning.”

Now we shift to the Upper West Side of Manhattan, where a toxic legal battle between the board and the sponsor in an established co-op led one observer to remark: “There’s a big difference between what you can work out in new construction and a building where the sponsor has owned shares for 30 years.”

The problem, it is widely agreed, is twofold: the sponsor of this 250-unit high-rise co-op also served as the managing agent. After the building converted to a co-op in 1984, he retained ownership of about one-third of the shares. As a result, the sponsor held a majority of the seats on the seven-member board until the late 1990s.

“When shareholders finally took control of the board, we started asking a lot of questions of each other and the sponsor,” says a former board member, who spoke on condition of anonymity. “We wanted better financial statements and set agendas for meetings. We asked about repairing the elevator. Any time the sponsor was going to have to spend money, we had issues.”

A major bone of contention was a commercial space that was rented to a fitness club. The board wanted to have the space appraised, with an eye toward raising the rent. The sponsor, who controlled the commercial lease, balked. “At that point we really started digging,” says the former board member.

The board replaced its professionals (a new managing agent was brought in to handle the finances while the sponsor continued to handle the staff and physical plant). It also hired an appraiser to ascertain the value of the commercial space. Eventually, the rent on the commercial space was raised. The board also replaced the co-op’s accountant and attorney. When the board voted in January of 2001 to cut out the sponsor as a co-manager, the lawsuits finally started to fly. It wasn’t a flurry of paper. It was a blizzard. The board sued the sponsor for financial malfeasance and for refusing to sell off his shares. The sponsor countersued, claiming the board’s actions were not taken at regular board meetings.

In June of 2005, the state Supreme Court ruled that the board was protected by the Business Judgment Rule, and that there was insufficient evidence to support the sponsor’s counter-claims of breach of fiduciary duties and self-dealing. The court ruling stated: “Mere speculation was insufficient to demonstrate that the [board] breached its fudiciary duties in hiring a new accounting firm, a new managing agent, a new law firm, and a real-estate appraisal firm to ascertain the market value of a commercial lease held by the sponsor’s principal, and in adjusting that lease.”

Good news for the co-op board? Yes and no. The lawsuits didn’t stop there, and eventually the courts determined that a new election had to be held. The sponsor wound up regaining control of the board. All four of the former majority board members have since moved from the building. Says one: “I’ve talked with veteran lawyers who say this is the most egregious situation they’ve ever seen. It’s very important to know what the sponsor is up to and also to make sure that he sells off his apartments.”