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Legal Issues

Published: Spring 1996

The following article appeared in the Spring 1996 issue of CNYC's quarterly Newsletter. You must be a member of CNYC to receive the complete Newsletter, which features timely articles on issues of importance to cooperative shareholders and condominium unit owners.


RECENT SIGNIFICANT LEGAL DECISIONS

Not only do court decisions resolve issues for those who are directly involved, they also provide instruction for others who may find themselves in similar situations. To help cooperatives and condominiums keep track of new and important legal decisions, attorney Marc Luxemburg, president of CNYC, presents an annual seminar at the Cooperative Housing Conference reviewing the significant decisions handed down in that year.

CNYC frequently takes advocacy positions on key legal issues in briefs of amicus curiae. If your building is involved in a legal action that you think is significant to other buildings, please send an e-mail message to info@cnyc.coop and be sure to keep CNYC informed of the status of the case.

CNYC thanks Mr. Luxemburg for the following article, which highlights recent cases addressing matters of importance to cooperatives and condominiums. CNYC also thanks Stuart M. Saft, chairman of CNYC, who provided the summary and commentary on the Freddie Mac case regarding post-deconversion rents. Mr. Saft also wrote the briefs of amicus curiae, which CNYC presented in support of the DHCR position on this case.


COURT ALLOWS HIGH INTEREST ON UNPAID MAINTENANCE

A court has recently authorized a cooperative to collect interest on unpaid maintenance from a defaulting shareholder at a rate of up to 24% per year. Most proprietary leases provide that if the shareholder fails to pay maintenance promptly, the cooperative may collect interest "at the maximum legal rate". The question has arisen many times as to what the maximum legal rate is. General Obligations Law §5-501(l) and Banking Law §14-a provide that for any loan or forbearance of any money or "things in action", the maximum rate of interest is 16% per year.

However, in 815 Park Avenue Owners Inc. v. Lapidus, Supreme Court, New York County, IAS Part 6, Index No. 30618/91, decision of November 2, 1995, Justice Wilk found that an interest rate of 19.56% on unpaid maintenance was legal. The court said that the 16% limit was inapplicable because the failure to pay maintenance did not constitute a loan or forbearance of any money. The court also rejected the limit of 9% set forth in the Civil Practice Law and Rules, since that only applies to post-judgment interest and is not applicable to arrears. The court's decision seems to be based upon the theory that if there is no agreement to delay legal action, the mere passage of time is not a forbearance, and therefore the 16% rate would not apply.

SPONSOR MUST DISCLOSE TAX INCREASE
IN PLAN OR AMENDMENTS

The saga of co-op versus sponsor continues. In 61 West 62nd Owners Corp. v. Harkness Apartment Owners Corp., NYLJ, 1/2/96, p.26, C5 (1st Dept.), the cooperative sued the sponsors for breach of warranty for not disclosing an assessed valuation increase in the offering plan or any amendments.

The co-op claimed that the assessed valuation for real estate tax purposes presented in the original plan was $15,125,000, whereas in fact the sponsors knew, or are alleged to have known, that there had been an increase in assessed valuation to a sum of $19,600,000 to be phased in over a five-year period. The cooperative sought damages as a result of the nondisclosure, arguing that the warranty concerning the amount of the taxes contained in the offering plan was renewed by the filing of amendments, which stated that there had been no material changes in the plan.

The court held, as a matter of law, that the amendments did constitute renewals of the express warranties in the original plan regarding the financial aspects of the conversion. The court said that the express warranty constituted a continuing promise to indemnify if the facts were untrue. Although the original plan was promulgated more than six years before the lawsuit was brought, the suit was held timely because amendments that did not disclose or correct the misstatements were issued within the six-year period.

The court found that there were triable issues of fact concerning the parties' understanding of the facts and the common practice of representation in the offering plan. The matter was remanded for trial.

COURT USURPS BOARD'S RIGHT TO SET POLICY

In Johard v. 82-04 Lefferts Tenants Corp., NYLJ, 1/3/96, p.28, C2 (Sup. Ct. Queens Co.), a prior decision had held that the plaintiff, a non-resident tenant-shareholder, could be nominated as a member of the board in a "non-sponsor" seat. After the decision was rendered, but before it became effective, the board of directors held a special meeting to amend the bylaws to provide that only those who reside in the building and do not sublet their apartments are eligible to sit in the non-sponsor seats on the board.

The shareholder challenged this action. In its defense, the board noted that it was protected by the business judgment rule since it was acting in good faith for the purposes of the cooperative and within the scope of its authority.

The court, however, held that the action was a "blatant bad faith attempt to circumvent" the court's prior determination, and to prevent the plaintiff from being nominated. The bylaws amendment was vacated and the cooperative was enjoined from preventing the shareholder from running for a non-sponsor seat.

This decision appears to be improper. The fact that a prior court held that the bylaws, as they then existed, permitted a non-resident to run for a seat on the board of directors does not stand as a reason why the board may not thereafter amend the bylaws to require residency in the building as a condition of serving on the board. The fact that the court determined eligibility by its reading of the corporate documents does not give it a continuing right to control future eligibility. It appears that the court overstepped its bounds. This is the kind of decision that should be taken up on appeal.

NARROW COURT DECISION UNFAIRLY PROTECTS SPONSOR

In ALH Properties Ten, Inc., v 306-100th Street Owners Corp., 86 N.Y. 2d 643, 658 N.E. 2d 1034, 635 N.Y.S. 2d 161 (1995), the Court of Appeals held that a cooperative's lien on the shares and proprietary lease of a sponsor took priority, with respect to maintenance obligations, over a security interest held by a lender to the sponsor. However, the lender had priority over non-maintenance obligations -- i.e., to make repairs not incorporated in the proprietary lease.

The court's ruling was based on a very narrow technicality: that in order to enforce a lien against the sponsor's lender, the stock certificate would have to specifically notify a lender of the existence of the prior lien on behalf of the cooperative. The court found that the notice contained on the stock certificate was sufficient to notify the lender of the maintenance obligations, but did not sufficiently notify the lender of the non-maintenance obligations.

Unfortunately, there was nothing in the court's decision that indicated that it paid any attention to the larger issues involved. The fact is that the sponsor, by the simple expedient of cashing out on its unsold shares, had been enabled to avoid its obligations to the cooperative pursuant to the offering plan. The court did not seem to pay any attention to this aspect of the case.

The transaction involved a loan of $12,750,000 from a German bank based on the security of 12 apartments in this building, as well as cooperative apartments in 16 other buildings. The court did not discuss whether the lender engaged in the usual "due diligence", whereby before parting with $12,750,000 it should have examined all of the underlying cooperative documentation regarding the sponsor's obligations. If the lender had been so grossly negligent as to make a $12,750,000 loan without examining in detail the underlying documentation, the court should not make the cooperative pay for its negligence. One can only be dismayed that the Court of Appeals focused on minute details without paying attention to the broader picture.

DHCR RETAINS JURISDICTION OVER DECONVERTED COOPERATIVES

The courts have at last answered a question that has been vexing to the cooperative and lending industries, as well as the New York State Department of Housing and Community Renewal (DHCR), for almost six years: After a cooperative apartment building is foreclosed by a mortgagee and reverts to rental status, are the former shareholders again protected by the Rent Stabilization Law (RSL)? This question has been answered in the affirmative by the recent decision in Federal Home Loan Mortgage Corporation v. New York State Division of Housing and Community Renewal. The Federal Home Loan Mortgage Corporation is known as Freddie Mac.

Freddie Mac v. DHCR, decided by the United States Court of Appeals for the Second Circuit on May 2, 1996, was a result of Freddie Mac's foreclosure of the mortgage it held on the cooperative apartment building at 101 Lincoln Road in Brooklyn. After foreclosing the mortgage and thereby wiping out the cooperative shareholders' equity in their apartments, which accelerated the loans that the shareholders had taken to purchase their apartments, Freddie Mac brought a Declaratory Judgment action in the United States District Court seeking a judicial determination that the DHCR had no authority after a building was deconverted.

Freddie Mac's primary argument was that since buildings owned by cooperatives are exempt from the Rent Stabilization Law, which the DHCR administers, and since the RSL does not specifically provide that after deconversion a building reverts to stabilization, the foreclosure not only ended the cooperative ownership of the building but also allowed the lender to acquire it free of the RSL and DHCR regulations. Freddie Mac argued that applying the RSL would be a unconstitutional "taking" of its property. After the District Court found in favor of the DHCR, Freddie Mac appealed to the Second Circuit Court of Appeals. The Circuit Court requested that the New York State Court of Appeals rule on the issue of the DHCR's post-deconversion authority.

The New York State Court of Appeals rejected Freddie Mac's argument and found that while the cooperative conversion temporarily removed the building from DHCR jurisdiction DHCR's authority was reasserted after the foreclosure because the RSL was enacted "to ameliorate the dislocations and risk of widespread lack of suitable dwellings." The court determined that these were the very tenants the legislature intended to protect when it gave the DHCR this broad mandate. The court also denied Freddie Mac's argument that this was a "taking", since Freddie Mac was being treated the same way as every other rental landlord and there was "no reason to penalize tenants because of their prior status as shareholders of a failed cooperative." Interestingly, all of this could have been averted if Freddie Mac would have objected to the conversion in the first place. Freddie Mac made the mortgage loan on 101 Lincoln Road prior to the conversion, at a time when the tenants were protected by the RSL and Freddie Mac had the power to prevent the conversion from occurring by withholding its consent to the sponsor.

The good news is the former tenants are protected; the news that is possibly bad is that we don't yet know all of the ramifications of this decision. Freddie Mac claimed during the litigation that, if the RSL applied after deconversion, then solvent cooperatives would not be able to obtain mortgage financing because the appraisals would have to be based on the building's value (after a theoretical deconversion) as a rent-stabilized building, rather than as a market-rent building. Only time will tell if Freddie Mac's concern was just hyperbole or a harbinger of a bigger problem.

 
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