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Business Corporation Law, Section 713
AUTHORDavid Berkey, Gallet, Dreyer & Berkey
PAGE #pp. 44-45
Board members should disclose all material facts of their interest in a company if their board is considering a transaction with such company.
An “interested director” is defined in Section 713 of New York’s Business Corporation Law (BCL) as a person who is a director or officer or who has a substantial financial interest in an entity that is seeking to do business with that board member’s cooperative or condominium. And if the interested member wants to steer business to his related entity or to a person who has a relationship with him so he can gain some financial advantage from the transaction, he and the board have to follow the dictates of Section 713.
Transactions that are approved by a co-op or condo board can be set aside if the interested member votes in favor of the transaction without telling fellow board members about his interest in the entity with which his co-op or condo is seeking to do business. So to prevent that situation from occurring, members should disclose all the material facts of their interest in the related entity, whether or not they have a financial interest in a transaction that’s being considered by the board. If full disclosure is made and the majority of disinterested members votes to approve the contract or transaction, then it cannot be attacked. And if you can’t get all of the disinterested members to approve, then you have to go to the disinterested shareholders or unit-owners and get a majority of them to approve the transaction.
Now if the transaction was improperly approved – for example, the president has a relationship with the company that is now being contracted with to paint the building – the board can set aside that contract. And there are many situations, unfortunately, where a board member steers business to a friend or to a company in which he has an interest. If the contract wasn’t reasonable or if the cost was above the market price for the same products or services, those contracts need to be set aside.
The New York State Legislature decided this was becoming a problem and so it passed a new law, Section 727 of the BCL, that now requires disclosure of all transactions where there are interested members on the board. Two things have to happen: first, all board members have to be given a copy of Section 713 so they understand what it is to be an interested member; second, the board has to submit an annual report to the shareholders or unit-owners, signed by each member and containing information on every contract that was voted on by the board where one or more member was interested. The reports have to list the name of the contract recipient, the contract amount, the purpose of the contract, the date on which the vote occurred, and how each member voted; and also state when the contract will be valid and how long it will last.
If by chance there were no contracts that year in which an interested member was involved, the co-op or condo still has to render a report stating no actions were taken.
If a board member’s law firm or accounting firm is being hired by the co-op or condo, these are clearly transactions on which the interested board member should not be voting, and they require approval by a majority of disinterested board members. Slightly more complex are situations where real estate brokers sit on the board. The perception shareholders or unit-owners have is that the broker is controlling the application process and is going to make sure that this contract is approved, so the broker gets his or her commission. You need to remove that perception. You do so by having the real estate broker recuse himself or herself from the vote on that sale, lease, or sublease.
Another troublesome situation arises when a board member’s relative controls the company seeking to contract with the board member’s co-op or condo. There you need full disclosure of the facts. You need to know whether or not the board member has any financial interest in his family member’s company. If he’s not getting any money from the transaction and it’s just a familial relationship, technically the member is not an interested member. But some co-ops and condos decide that the conflict still exists because of the family relationship, and they adopt codes of conduct which require the board member to recuse himself or herself from the deliberation and the vote.
Hopefully, board members with questions will consult their lawyers and then comply with the conflict-of-interest laws so that contracts are properly approved and sunshine is shed on the board’s transactions – and shareholders can be confident that their board has been acting properly.
David Berkey is a partner at Gallet, Dreyer & Berkey.