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Sponsor & Conversion Issues

Published: Summer 2002

Sponsors' Obligation to Sell Apartments:
The Jennifer Realty Case


By far the most interesting case of 2001 was 511 W 232nd Owners Corp. v. Jennifer Realty Co. Typical of many buildings converted to co-op Status in the late 1980s under a non-evict plan, the sponsor initially sold 15-25% of the units. After the building became a cooperative, the sponsor sold a few more units, but stopped selling in 1989. At this point, the sponsor still owned 40-75% of the building. Ten years went by and the sponsor did not sell another unit. As rental tenants left, freeing units from rent stabilization, the sponsor was running a free market rental business and was not selling.

There is nothing in the business corporation law or in a typical offering plan which clearly says the sponsor must continue selling apartments until they are all sold – although CNYC and others have always contended that apartments in a co-op or condo offering should be sold, not rented.

In 511 West 232nd Owners Corp. v Sponsor. Jennifer Realty Co., 729 NYS2d 34 (1st Dept. 8/9/01), the Appellate Division found that the sponsor did have an implied duty to continue to sell all the apartments to persons who intend to reside in the building. This is in accord with earlier decisions in Washington State and Montana, holding that a promoter of a cooperative venture had an implied obligation to continue to sell all the apartments for residential uses. The Jennifer case was appealed by the sponsor to the Court of Appeals. CNYC and the NY State Attorney General each wrote friend-of-the-court briefs in support of the cooperative.

On June 11, 2002, the Court of Appeals issued its much-awaited decision in this important case. The court held that the allegations by the plaintiffs that the offering plan constituted a contract that contained an obligation on the part of the sponsor to act in good faith to timely sell so many shares as necessary to create a “fully viable cooperative,” and that by keeping a majority of shares of the cooperative, the sponsor defeated the purpose of the contract, creating a legally sufficient pleading for a cause of action for breach of contract.

The ruling, however, was a narrow one. The court did not address the issues of whether the complaint stated a valid cause of action for fraud, or whether the cooperative and the purchasing shareholders had standing to prosecute such claims. It left in place the dismissal of those claims by the appellate division, and the court expressly declined to rule on the merits of the contract cause of action – that is, whether there was sufficient proof in the record to show that the plaintiff had proved its case. The court was very careful to limit its decision to the claim that the offering plan included an implied covenant to sell apartments beyond the 15% minimum within a reasonable period of time in order to create a viable cooperative.

While the decision is a substantial step forward on behalf of cooperatives and tenant shareholders who have been victimized by the failure of the sponsors to carry out their offering plans, it does not completely resolve all issues. The court expressly did not address the issue of whether the sponsor implied a promise to sell all of its unsold shares, holding that “at the very least … the plaintiff's complaint sufficiently alleged, at a minimum, that the sponsor undertook a duty in good faith to timely sell so many shares in the building as necessary to create a fully viable cooperative.”

Thus, while affirming that the door is open for the cooperative to require the sponsor to sell shares, it leaves the extent to which the shares must be sold, and in what time frame (to be determined by the lower courts). There is no statute or court decision which defines a “fully viable cooperative,” and the Court of Appeals did not undertake to do so. Accordingly, the court has laid out a road map for substantial further litigation in this case. The lower court will have to wrestle with the concept of what constitutes a fully viable cooperative – whether the facts in this case show this cooperative is not – and how many apartments will have to be sold in a certain time frame until that standard is reached. Since the Court of Appeals did not reach the merits of the lawsuit, the burden remains on the plaintiff cooperative to prove all of the allegations of its complaint. The case also did not deal with the applicability to “holders of unsold shares” of the sponsor's obligation to create a “viable cooperative.”

On the other hand, the court dismissed the other sponsor contentions by stating that they were all without merit. The dismissed sponsor contentions include the claim that this issue is a legislative question and only the legislature could determine the scope of the sponsor's obligations under an offering plan; that all of the causes of action in the complaint were barred by the statute of limitations; that the plaintiffs lack standing to raise contract claims which in substance were or should be governed by the Martin Act; and that the remedy of injunctive relief be dismissed because it would impermissibly create two classes of stock. In conclusion, to paraphrase Winston Churchill, while this is not the end of the battle over sponsors failing to carry out their offering plans, it is certainly the beginning of the end of that battle.

 
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