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Board members don’t have to disclose why they rejected a buyer – until they’re sued.
Take a look at the many issues raised when the board members’ reasons for rejection just don’t make sense, as was the case in Berkowitz v. 29 Woodmere Blvd. Owners Inc.
A long-standing mantra has it that boards of cooperative housing corporations, if they are not discriminating, can accept or reject a purchaser for any reason or no reason. And board members need not disclose their reasons – at least until they are sued. So let’s look at the many issues raised when the board members’ reasons just don’t make sense, as was the case in Berkowitz v. 29 Woodmere Blvd. Owners Inc.
Twenty-nine Woodmere Boulevard Owners is a cooperative apartment building in Woodmere, New York. Martin and Sylvia Berkowitz purchased Apartment 4J in 2000, and sought to sell it 10 years later. Jeffrey Lax tried to purchase the apartment for $200,000. The board reportedly concluded that the price was too low. Lax subsequently agreed to increase his offer, but the board did not respond. The board’s minutes offer very little, merely that Lax’s package should be reviewed by all board members and a decision about interviewing him should be made “soon.” One month after that, Lax was rejected. The corporation’s lawyer advised Lax that the decision not to approve his application “was based solely on the negotiated price.” Lax sued in federal court for discrimination, claiming that the board was biased against him because he was an unmarried man. In New York, single men and women are considered a protected class. The action was discontinued when the co-op paid Lax an undisclosed sum.
After the Lax purchase was rejected, the Berkowitzes found another potential buyer, Lisa Manginelli, who offered to pay $202,500 for the apartment. Following a review of her paperwork, Manginelli was rejected as well. Some time after these rejections, the apartment was sold for $160,000, which would seem to have validated Lax’s claim.
The Berkowitzes subsequently sued the co-op corporation and all individual directors for monetary damages. The court first considered the charges of breach of fiduciary duty. The co-op and its board moved for summary judgment (i.e., that the lawsuit be dismissed before trial), claiming that each board member considered the applications of both Lax and Manginelli and had decided – based solely on the application and without an interview – to reject the proposed purchasers. The board stuck to the argument that Lax was rejected because of the low price. The board claimed that Manginelli was rejected because her finances were inadequate.
Saying that a corporation owes no fiduciary duty to its shareholders, the court dismissed the claim against 29 Woodmere Boulevard Owners Corp. The claims against the individuals fared differently. A board member, unlike a corporation, owes a fiduciary duty “to act solely in the best interest of all shareholders.” Individual board members can be liable for breach of fiduciary duty if their decision is tainted by discriminatory considerations. The court cited the oft-quoted tenet that discrimination rarely announces itself – generally, a plaintiff must ask the fact-finder to infer the defendant’s intent from circumstantial evidence.
The court discussed the fact that while the majority of the board members claimed they had rejected Lax because of his purchase price, they ultimately accepted a purchaser who paid 20 percent less than Lax had been willing to pay. And, the court noted, Lax offered to increase his offer if price was indeed an issue for the board. In addition, the evidence showed that the board never actually met to consider Lax’s application. As to the board members, the court found that they failed to identify documents, statistics, or any fact they relied on when they decided Lax’s purchase price was too low. In sum, according to the court, the board of directors argued that “they have explained their rationale and that should be enough.”
The court concluded that the conduct of the board and the board members must be measured by the principles of the Business Judgment Rule – i.e., were they acting in good faith, in the exercise of honest judgment, and in the lawful and legitimate furtherance of corporate purposes?
As to Manginelli, the court dismissed the Berkowitzes’ claims because her finances were insufficient to permit her to purchase; indeed, the maintenance was nearly half her monthly income. As for Lax, however, the question remained: was he rejected because he was an unmarried man? The court concluded that this question had to be addressed.
The Berkowitzes had also sued for breach of contract – namely, the proprietary lease – which in this case prohibits the board from “unreasonably” withholding its consent. Implied in every contract is a covenant to act in good faith and to deal fairly.
Finally, the court discussed the issue of whether the Berkowitzes could be awarded attorneys’ fees if they were successful. The co-op’s lease says that the co-op could obtain attorneys’ fees against the Berkowitzes (or any shareholder) if that shareholder were in default. Under New York law, a residential lease that allows a landlord to obtain attorneys’ fees is reciprocal, so that the shareholder can recover fees if he or she prevails in the litigation. Here, even though it was clear that the defendant co-op could not recover fees – the Berkowitzes were never in default – the court ruled that the provision was reciprocal; it was not necessary that the board be in “default” under the lease. Accordingly, if the Berkowitzes prevailed in the litigation, they could pursue their claim for attorneys’ fees.
This case can be used as a teaching tool – because many of the issues and arguments involve practical, real-world acts that boards come across regularly. First, it is important to remember that, in the context of discrimination, there are two ways people may sue. The person who was allegedly the victim of discrimination may assert a claim against a board directly. Or the shareholder could have claims for breach of contract against the corporation or breach of duty against the individual board members, or even charges of discrimination. In its ruling, the court spends very little time discussing the action Lax brought against the co-op; however, it does note that Berkowitz was a party to the action. We are not certain why the board agreed to settle with Lax, yet there was no settlement at that time with Berkowitz.
While it is true that boards do not need to set forth their reasons for rejecting a proposed purchaser, this does not mean that boards have carte blanche. Once a person raises an arguable basis for rejection that, if proven, would be actionable, the board cannot simply rely on the Business Judgment Rule to say that the person was rejected and that’s that.
Boards, on occasion, believe they are safe from legal harm when rejecting a purchaser, particularly if there has been no interview – the theory being that board members would not know the rejected applicant was of a protected class because they had not met. That, of course, was not the case here, and the board’s apparent reliance on the fact that Lax had not been interviewed was irrelevant.
The court’s decision to dismiss Manginelli’s claims is consistent with general court principles. If there is an objective reason to reject a purchaser, then there will be no viable claim. However, the rationale is suspect when an applicant is a member of a protected class, and the board rejects, citing a lowball price – then allows the sale to go forward for 20 percent less. In such a situation, the court will not simply dismiss the decision as a legitimate exercise of business judgment.
Finally, boards must remember that even though the attorney-fees lease provision says the co-op can recover fees, the provision is reciprocal but not precisely parallel. Therefore, while a default by the shareholder is required to allow the corporation to recover fees, a default by the corporation is not necessary for a shareholder to seek fees against the corporation.
As a best practice, if a board is going to reject a prospective purchaser – particularly if it is not for obvious financial reasons – it may be prudent for the board members to step back, take a breath, and call the board’s lawyer to ascertain what courts will consider when deciding whether the board and its individual members acted within their rights.
For plaintiff: Mildred J. Michalczyk
For defendant (co-op): Schneider Mitola
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