Flip-Tax Blowback: The Dangers of Implementing with No Shareholder Vote

"There is definitely an increase in litigation," says attorney Jeff Reich, a partner at Wolf Haldenstein Adler Freeman & Herz, who has handled several cases involving disputed flip taxes. "Potentially, there is a personal liability for individual board members if they've acted in bad faith or exceeded their authority."

That's what happened at 425 East 50th Street in Manhattan, where State Supreme Court Judge Walter Tolub ruled that the co-op board had imposed a 2.5 percent flip tax improperly because it had failed to obtain approval of two-thirds of the shareholders for an amendment to the proprietary lease. The board also failed to send a required written notice to shareholders that the board would hold a meeting at which a proposed flip tax would be discussed.

When Bylaws Aren't By Law

The case involved a former board member, Joanne Pello, who, in December 2007, had found a buyer willing to pay $955,000 for her two-bedroom apartment. However, she refused to pay the $23,875 flip tax, which the board had recently raised from two months' worth of maintenance to 2.5 percent of the sale price. In changing the flip tax, the board had merely amended the bylaws, not the proprietary lease. (The board members at are "seriously considering" an appeal, according to their attorney, Richard Marin, of Marin Goodman, and declined to comment.) In a coda that's sure to chill many board members, Judge Tolub added that boards and corporations are also "answerable for any damages the plaintiff can prove to have sustained."

Such damages could be "a big chunk of money," says Steven Sladkus, another partner at Wolf Haldenstein. "Most bylaws state that board members will be legally covered by the corporation for regular damages, but a board member cannot seek indemnity for punitive damages."

As Judge Tolub's ruling spells out, the main thing co-op boards need to remember is that if they wish to alter or introduce a flip tax, sublet fee or late fee, they must spell out the changes in the proprietary lease.

"Boards make this mistake all the time," notes James Samson, a partner at Samson Fink & Dubow. "They think they can impose a late fee and don't realize they need to get shareholder approval to amend the proprietary lease. They sometimes get challenged and have to give the fees back."

How Not to Flop a Flip

To make the change, the board must give shareholders written notice of a meeting to discuss the issue. It can be either a special session or the regular annual meeting. At that time, owners of at least two-thirds of the shares must approve the changes. Some leases require an even larger majority.

There is sometimes wiggle room. "They can do something broad and say the board can levy a flip tax or sublet fee in an amount to be determined," says Sladkus. "Or it can be narrower: a specific percentage or charge." In setting fees for late payment of maintenance, the board can charge a specific percentage of the amount due or set a flat fee.

Regardless of the course a board chooses to pursue, getting proposed changes approved means educating your shareholders and showing them what other buildings in the neighborhood are charging. "You've got to do these things before [calling for] a vote," says Sladkus. "Talk about it in the lobby, in the laundry room."

Despite such a vocal publicity campaign, a proposed two percent flip tax was shot down last year at 2 East End Avenue, a 55-unit co-op on Manhattan's Upper East Side. Supporters of the tax pointed out it would generate between $50,000 and $100,000 a year. Opponents were not impressed, and in the end, owners of fewer than 50 percent of the shares voted in favor of the flip tax — far below the required two-thirds.

"It was a heated issue," recalls Brad Blumenfeld, vice president and an opponent of the proposal. "It met with mixed reviews, and it even split the board — three in favor, two opposed. People in favor said it would generate money for the reserve fund, while people who were against it felt it was an inequitable tax on their neighbors. The feeling was that the tax would be eating into their profits if they decided to sell."

The lesson is, don't assume. Because if you impose a flip tax or other fee without taking the legal steps, your shareholders may flip out.

 

Adapted from Habitat June 2008 . For the complete article and more, join our Archive >>

Illustration by Danny Hellman