I spent the better part of five years litigating Braun vs. 941 Park Avenue. This case was the ultimate in vanity litigation. The two parties’ egos and expenditures far outweighed their common sense. Nonetheless, the case generated several important giveaways to the board.
A familiarity with the building’s unique interior layout is crucial to understanding the case. This is an elite building, consisting only of duplex units. With one exception, each duplex apartment alternates the main entrance from floor to floor. The main entrance always opens on the living quarters of one of the apartments. So Apt. 3A, for instance, has its main entrance on the third floor, and 3B has its main entrance on the fourth floor. The exception is the second floor, which has both of the living quarters on that floor. There is no main entrance on the first floor. It had probably been designed that way to accommodate professional space that had previously existed there. Consequently, there was a very small area on the second floor that receives a lot of use because they have two families. In any event, because they are shared main entrances, called vestibules, historically there have been disputes because both families had unrestricted access.
The board decided to address the issue in 1983 with a house rule. It said that when the downstairs rooms front onto the main entrance (the vestibule), the owner of that apartment has dominant rights and can receive guests there, receive mail there, and decorate that hallway. That rule seemed to work fine because, throughout the building, everyone had two vestibules and one of them was a vestibule they could decorate and the other one they agreed not to use. The problem with that house rule is that it ignores the unique situation of the second-floor vestibule, shared by two owners. And that problem remained under the radar for 14 years because the parties got along, sharing the vestibule comfortably.
But then, in 1997 and in 1998, the two second-floor owners moved out. There were now two new owners whose personalities mixed like oil and water. They immediately started fighting over the use of that one crowded vestibule. It became a real crusade, and it just didn’t let up.
Both parties came to 30 board meetings, complaining. It was tying up the entire building’s operation. So the board tried to mediate. When that failed because of the two egos involved, they decided to impose a new house rule thatspecifically targeted the two owners of the second-floor vestibule, and no one else. Under the amended house rule, the second- and third-floor apartment owner (2A) got to treat the second-floor vestibule as his front door. He got to decorate it. He got exclusive privileges to bring guests in that way, to have guests up there. The other unit-owner (Apt. 2B) was told that his guests required an escort and the building had the staff provide an escort. So that was the house rule, which governed the second floor-vestibule. Both parties sued, claiming that they were the target of discrimination.
The trial lasted three and half weeks. It was appealed, and the appeals were monumental. But the co-op won, and the rule was upheld in all respects, except for one minor exception: the escort rule. That was appealed, raising two questions. Is it a rule that specifically targets one or two isolated shareholders? Is it discriminatory, because it doesn’t apply building-wide and therefore constitutes unequal treatment?
I argued that this was a situation where the second-floor vestibule was unique in its layout, and the whole idea behind discrimination is that you’re taking similarly situated people and treating them differently. This was not a similar situation, because the vestibule was one of a kind. The court’s decision said that you can have a house rule that is specifically targeted when the situation that’s being addressed is unique, because you’re not treating similarly situated people differently.
Another issue was the claim that this was an arbitrary and capricious house rule, and therefore unreasonable. The bylaws enabled the board to enact “reasonable” house rules. Had that word reasonable not been in there, the board would have been able to claim protection under the Business Judgment Rule (BJR). Since there was no bad faith here, the court having decided that there was no discrimination, the rule would have been upheld under the BJR. But the use of the word “reasonable” eradicated the BJR, and we had to demonstrate to the court that our rule was reasonable. That was no easy task.
You should look at your house rules and especially at the provision regarding the board’s power to enact house rules. If there is a restriction that any rule be reasonable, you should consider amending that word out of existence so that you can claim the protection of the Business Judgment Rule.
The final issue is that the owner of one of the units claimed that he had never received notice of the amended house rule that applied to his unit. And that gave me a few gray hairs because it was a valid argument. The board never notified him, but the amended rule was in the board minutes. Fortunately, the court bought my argument that he could have and should have discovered that through due diligence and a review of the minutes.
The takeaway for boards is that they ought to provide a copy of the house rules to everyone and require all prospective purchasers to fill out an acknowledgment that they have read the house rules and understand them.
Bruce Cholst is a shareholder at Anderson Kill.