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Can a house rule apply to only one owner?
A board’s fiduciary duty requires that all shareholders are treated equally – but what happens when the unit in question is listed for professional use instead of residential?
May a co-op board adopt house rules that, without question, apply solely to one shareholder?
In the Matter of the Application of Barrie Aguirre, as executrix of the Estate of Florence Weinbaum v. 260 Apartments Corp. raised that question when the estate attempted to sell Weinbaum’s co-op apartment at 260 West End Avenue. It contracted with a third party and, as is typical in co-ops, the sale was conditioned on the board’s approval. Two months after the estate and its purchaser signed the contract, the board promulgated house rules directly addressed to this unit and the buyer refused to close.
The Back Story
To provide context, the court explained the historic use of the apartment. In 1947, the unit was leased to Weinbaum’s father, a doctor, as a professional office. The unit is accessed through the lobby of the building and is a few steps up from the main lobby – it is on the “mezzanine” level of the building.
When the building converted to cooperative ownership in 1980, Dr. and Mrs. Weinbaum purchased the shares and he continued to use the unit as his medical office until his retirement in 1981. There was a factual dispute as to whether another family member used the unit as a medical office for several years or whether it was used intermittently as a residence and/or for storage. There is no dispute that it is the only professional unit in the building.
What the Documents Show
The offering plan et al. The circa-1980 offering plan described the unit at the mezzanine level as a “doctor’s office.” The proprietary lease, in the “use of premises” paragraph, states that apartments shall be used as a private dwelling “and for such other purposes as may be permitted under applicable zoning laws and are otherwise legal.” Sublets are not permitted unless the board or a supermajority of shareholders consents. Also applicable – leases may not be modified without a supermajority vote of the shareholders. Finally, the bylaws state that reasonable fees to cover actual expenses may be charged on an assignment or sublet.
House rules and certificate of occupancy. Notwithstanding the above provisions, the board promulgated house rules (again, two months after the contract was signed) as follows – all with the predicate “for professional space”: (i) the board will only grant subleases in one-year terms; (ii) there can be a maximum of three concurrent subleases; (iii) a lessee can only sublease if she conducts her professional activities in the building; (iv) a percentage of the sublessee’s rent shall be paid to the co-op; (v) no medical equipment, lab instruments, or heavy industrial devices can be brought into the space without the board’s approval; (vi) business may only be conducted Monday through Friday from 8 A.M. until 8 P.M.; and (vii) clients awaiting appointments shall not loiter in the lobby.
The board then went further, advising the purchaser that he would have to amend the building’s certificate of occupancy (C of O) to reflect the commercial use of the unit as the board believed that the only use permitted was as a residence. According to the estate, this demand caused the purchaser to rescind the contract. The estate demanded an order annulling the house rules and money damages in at least the sum of $850,000.
The court began its ruling by discussing the Business Judgment Rule – that courts will defer to a board’s determination, provided the action taken is for the purpose of the co-op, within the scope of the board’s authority, and in good faith. In looking at whether the rule applies, the court must consider if the co-op met its fiduciary duty, which requires that all shareholders should be treated equally. The court also discussed a statute applicable to business corporations as well as co-ops. The statute states that a corporation cannot impose different conditions on shareholders who hold the same class of shares (all shares in a co-op are of the same class).
Based on the statute, even if the board had the right to promulgate the house rules and impose conditions on subletting, including a sublet fee, it could not do so against a single shareholder. Accordingly, the court vacated the house rules and enjoined the co-op from enforcing them.
Questions Regarding Money
As to the estate’s demand for $850,000, the court said that the amount would be excessive as the estate still owns the shares. But the court also questioned whether the C of O had to be amended and, if so, whether by the shareholder of the professional unit or by the co-op itself. This, in part, because the extant 1940 C of O does not reflect the current building composition, having nothing to do with the professional unit – there have been combinations and reconfigurations of units.
In fact, the court explicitly noted that the affidavit submitted by the co-op’s expert was “curious” – he stated that the unit cannot be legally used as a professional office unless there were a change to the C of O; however, he never addressed the undisputed fact that the unit was used as a doctor’s office from at least 1947 through 1981. Moreover, the offering plan identified the unit as a professional office. The court quickly concluded that the answer to the question of whether a co-op board can adopt house rules that, without question, apply solely to one shareholder was “no,” and left open whether the board’s promulgation of these rules would require it to pay its shareholder any money damages.
This decision raises a number of recurring issues. The first is whether a board can impose obligations on one shareholder and not on others on the theory that the one shareholder is not similarly situated. Some of the house rules this board promulgated (e.g., people cannot loiter in the lobby, subleases of no more than one-year terms) could have been made applicable to all shareholders and, in that circumstance, would likely have been less suspect. Others – such as the “no equipment” rule and the hours of business – could only have been designed to affect the professional unit.
The C of O issue is tricky. There are many buildings in New York where the C of O for the professional unit must be changed, although more often the C of O has the unit listed for professional use and a shareholder wants to use it for residential purposes. In some cases, the addition of residential space may violate zoning limits on a building’s permitted residential space density. In any event, it is important that the shareholder and the co-op board retain professionals who are conversant with the then-current Department of Buildings requirements for change of use.
Rosenberg & Estis
Wolf Haldenstein Adler
Freeman & Herz
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