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SPONSOR OBLIGATIONS

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Sponsor Obligations

Oct 03, 2018

Matthew Leeds, Partner, Ganfer Shore Leeds & Zauderer

In a co-op where the sponsor still owns a very large number of units, it’s possible that independent shareholders will never have effective voting control. In an undersold building, lenders are sometimes unwilling to provide loans to co-ops to raise money with a mortgage or to refinance an existing mortgage. This issue can also affect loans on individual apartments, which  affects salability and values.

 

There might also be a thought that people renting the sponsor’s apartments cannot comport themselves in a manner conducive to the kind of cooperative living when most of the apartments are owner-occupied. The two more tangible complaints – about board control and that financing was stymied – were the foundation of a 2002 Court of Appeals decision in 511 West 232nd Owners vs Jennifer Realty.

 

Sponsor Obligations 

The Board of an Upper East Side cooperative, together with several of its shareholders, filed a lawsuit against the Co-op’s Sponsor, seeking to force the Sponsor to sell the remaining apartments (constituting just under 30% of the total shares of the Co-op) it still owned in the building.  The Sponsor filed counterclaims asserting that it had no express or implied obligation under the offering plan to sell all of its shares.  The parties ultimately settled the case by the Sponsor agreeing to sell a significant portion of its remaining holdings in exchange for certain financial incentives from the Co-op. (Frost Equities v. Frost Owners Corp.)

 

The board in that case complained that the co-op could not function as an independent purchaser might expect. They said that the co-op was not “viable.” The tactical approach in this case was to assert that the original offering plan said that the sponsor intended to sell apartments and that therefore there was an actual obligation for the sponsor to do that and not keep apartments as profitable rentals.

 

The sponsor asserted that this claim was extrapolating language into a promise that wasn’t there. The sponsor also asserted that in any event the offering plan and corporate documents explicitly had provisions that pointed out that, as in most buildings, the sponsor could rent apartments without any right of approval.

 

The Court of Appeals ruled in 2002 that there is not per se a promise to sell in an offering plan. All the court said was that it is possible that, in some circumstances, there might be a promise to sell. To figure that out in a given instance would require the determination of a fact at a trial.

 

(Incidentally, that matter was settled without trial, and I am not aware of any trial going to a conclusion on this issue, including in the Jennifer case. Those lawsuits that have been brought subsequently, were settled.)

 

One other change to the landscape since the Jennifer decision is that it has become customary for offering plans to include additional explicit disclosure that the sponsor reserves the right to rent rather than sell units. The offering plans also discuss the repercussions of that fact on corporate governance. Because of that fact, it would be more difficult to mount the Jennifer type challenge based on an offering plan like that.

 

On the other hand, you have to look at a particular offering plan, because some do in fact have specific representations that the sponsor would agree to sell. Those would have been negotiated by a sponsor, or might have been inserted at the time of the review of the offering plan at the Attorney General’s office. We have certainly seen instances like that.

 

There is a recent recorded document that might give insight to a typical post-Jennifer sensibility.  There is a case called Frost Owners vs Frost Equities, settled in 2015. What is distinctive is that the case led to a settlement that is on the public record because it was ordered by the court. (Full disclosure: my firm represented the sponsor in this matter.)

 

According to the Frost settlement, the sponsor owned about 30 percent of the apartments – 49 of 163 apartments in the building. In the settlement, the sponsor agreed to sell 15 of its 49 apartments over time as vacancies occurred. At the same time, the co-op paid an incentive fee to the sponsor of $125,000 in connection with the settlement. In addition, the corporation agreed to pay an incentive fee of 19 percent of the sales price of each apartment, so that the sponsor got a bonus of 119 percent of the sales proceeds when an apartment was sold. In exchange, the co-op did get a requirement that at least 15 of the sponsor’s apartment would be sold to independent purchasers.

 

Briefly, some lessons to be learned from the corporate governance point of view. (1) In a low-sold situation, determine if there is an actual problem that is worth addressing. (2) Make sure there are real damages, such as an inability to finance or corporate governance issues. (3) Check the corporate documents and the offering plan as to whether there might in fact be a promise by the sponsor to sell. (4) Also, check the corporate documents if there are in fact provisions that enable the sponsor to continue leasing out apartments without consent of the board. (5) There is always the opportunity to try to negotiate. A political solution is always best and certainly usually less expensive. (6) At the same time, if too many rentals is an issue, discuss a limitation on all owners, not just the sponsor, to continue leasing out apartments. (7) You can ask if the Attorney General’s office could lend its support to the cause. I do not know if they would respond positively.

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