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CASCADING CONFLICTS FINALLY BROUGHT HER DOWN

Cascading Conflicts Finally Brought Her Down

James Woods, Woods Lonergan

 

Conflicts between boards and the building’s shareholders or unit-owners are nothing new in New York City. But once in a long while, these disputes wind up going to trial. You’re familiar with a recent case. What was the nature of the beef? 

The essence of the complaint was that the sponsor controlled the board. In 1986 the building submitted an offering plan to become a condominium, and the sponsor had control of the building for five years or so. She wound up putting family members on the board and giving out contracts to family members to be the management company. It was self-dealing.

 

What did the unit-owners do?

They filed a lawsuit, a derivative action, on behalf of the condominium. They wanted to hold the sponsor and the board to task for what was going on. The case has an interesting procedural history. Initially, the New York Supreme Court wound up dismissing the complaint. The amended complaint then went up to the Appellate Division, which said: “The lower court erred. We’re going to send this back. We’re not going to allow the business judgment rule to bar the court from examining whether or not these self-dealings were breaches of fiduciary duty, or if they were breaches of contract.”

 

So the business Judgment rule is not impenetrable armor if there’s self-dealing or if the board is acting in bad faith. Now the case is back on track to go to trial. Were there any financial improprieties?

Yes, there was a host of complaints, but the key was that under the offering plan, the sponsor would have control either for five years or until 75% of the units had been sold. But the sponsor continued to control the board well past those five years. There was also another prohibition in the offering plan that the sponsor would not vote for a majority of the board seats after those triggering events — either the five years or the sale of the 75% of the units — but the sponsor kept control. She transferred one of the units to her daughter, another one to her husband. 

 

As it turns out, the husband owned a management company, and he was the one who was managing the building. So not only was the sponsor voting for a majority of the seats, but she failed to obey the offering plan and sell all of her units. She was permitted to retain one or more, but she needed to amend the offering plan, and she chose not to do that. In addition, they didn’t hold elections for a few years.

 

How did the court rule in the case?

There was a three-day non-jury trial. The court found that the sponsor had breached her fiduciary duty and had breached a contract in the offering plan, by voting for the majority of seats and by failing to amend the offering plan. The court also decided that, yes, there was in fact self-dealing here. Both the sponsor and her family directly and indirectly benefited from this contract with the management company. In addition, when the management company needed to have work done, guess who it hired? A construction company owned by the husband.

 

What a shock!

You see a pattern forming here. One of the things the unit-owners were seeking was monetary damages. While the court found that they had not met the burden of demonstrating that they were somehow damaged by this management company, it gave them everything else they were looking for. It ordered new board elections and then went even further. To remedy the prior abuses, the court limited the family’s seats on the board for the next six years to no more than two. I thought it was interesting that the court went to those lengths to ensure, going forward, that the condominium would be protected.

 

In addition, the condominium had not had proper financial statements. The court ordered that they have verified financial statements by a certified accountant. And the final thing, the court ordered that the individual defendants had to pay their attorney’s fees for the trial, pretrial motions and post-trial motions.

 

Is there a lesson to be learned from this intriguing, odd case?

I think the lesson is that boards have to follow the procedures when it comes to elections very, very closely, and they have to disclose to all unit-owners or shareholders if there’s any potential conflict of interest. They also need to recuse themselves in the event there’s even the appearance of a conflict. As this case shows, the courts will act. And this court gave the plaintiffs almost everything they were looking for.

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