July 21, 2011 — A shareholder asks: My board is thinking of raising our co-op's flip tax to the higher of 10 percent of the profit or 2 percent of the sales price. We feel that is the best way to maximize the amount that we receive from both longtime owners selling for big profits and newer owners just hoping to break even or minimize their losses. Our current flip tax has been in effect for many years and is just $20 per share. Is there any problem with this new flip tax, and can we do it with a board vote at the next meeting?
This is the type of question that gets co-op attorneys' blood flowing. The answer seemingly should be so simple, and in certain respects it is. But there are many traps along the way to adopting or modifying a flip tax (more accurately, a "transfer fee"), and the consequences are great if the co-op gets it wrong. An improperly implemented flip tax might remain in effect for many years, and then one successful challenge could require the co-op to refund the amounts collected on scores of sales, amounting to many hundreds of thousands of dollars of losses.
Flip taxes channel two distinct legal streams. The common source is that co-ops are corporations governed by the Business Corporation Law (BCL). The first stream is BCL 501(c), which provides that "each share shall be equal to every other share of the same class." Co-ops have one class of stock, and each "apartment owner" actually owns just some of that stock, and also gets a proprietary lease.
So, if a co-op charges a flip tax other than on a strict "per share" basis, it could run afoul of this law, as New York's highest court found for in the landmark 1985 case Fe Bland v. Two Trees Mgt Co. However, your flip tax may qualify for the exception to BCL 501(c) that was adopted in 1986 to allow co-ops to treat shareholders disproportionately to their stockholdings with regard to flip taxes, so long as it is allowed in the "proprietary leases, occupancy agreements or offering plans, or properly approved amendments" to them.
The second stream contains the principles of corporate governance that are found in a co-op's bylaws and, to a lesser extent, proprietary lease, as well as the BCL.
After its original formation by a sponsor, a co-op is governed by its board of directors, except when the governing documents or law deems an action important enough to require shareholder approval.
So, for example, a co-op's proprietary lease — your Constitution, as it were — usually can be amended only by a supermajority vote of shareholders, typically two-thirds or three-quarters. Co-ops' bylaws, however, typically provide that, on transfers (the legal term for sales and similar transactions), co-ops are entitled to reimbursement for related expenses. Bylaws also are a logical place for co-ops to provide for flip taxes. Bylaws typically can be amended by a supermajority vote of the board of directors alone, as well as by the shareholders alone.
When these streams merge into the flip-tax river, things become murky. One might conclude that co-ops can use the just-discussed BCL 501(c) to impose flip taxes on shareholders in whatever ways you want (short of unlawful discrimination, bad faith, and self-dealing); and can do so simply by amending your bylaws instead of the proprietary leases, thus being able to do it with board action alone.
But two fairly recent cases highlight that this is far from clear.
In Weigel v. 30 West 15th St. Owners Corp., shareholders voted to amend a co-op's bylaws to impose a flip tax equal to 1 percent of the sales price, and then 20 years later the board unanimously approved an amendment to the bylaws increasing the charge to 2 percent. Since the shareholders determined that a 1 percent fee was appropriate, shareholders arguably should have been allowed to decide that twice that fee was later appropriate. But the court concluded that co-ops can adopt flip taxes in their bylaws, which could be amended by board vote alone, and thus upheld the flip tax there.
(Most co-op bylaws state that provisions adopted by shareholders must be amended by shareholders. In Weigel, such a provision apparently was not present, or was overlooked or ignored for some reason.)
In Pello v. 425 E. 50 Owners Corp., a co-op board claimed to have adopted a flip tax equal to two months' maintenance, and a year later to have increased it to 2.5 percent of the sales price. The court noted first that, "Imposition of a flip tax may be effected by amendment to the co-op bylaws, and it is not necessary that the proprietary lease also be amended." The court found, however, insufficient evidence of proper board or shareholder approval for the initial flip tax, and only marginally adequate evidence of board approval alone for the amended flip tax.
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