| Published:
Winter 2003
WHAT IS A "VIABLE"
CO-OP OR CONDO?
The Court of Appeals of the State of New York has ruled
that sponsors have an obligation to create a "viable"
cooperative or condominium when they convert a building
to cooperative or condominium ownership. The Court did not
define the term "viable".
The Council of New York Cooperatives & Condominiums
fully supports the proposition that the goal of a conversion
to cooperative or condominium status of an existing residential
building is to achieve 100% owner occupancy within a reasonable
time. This proposition was adopted by the Appellate Division,
1st Department, in its decision of the Jennifer case (285
AD2d 244, 729 NYS2d 34 1991) discussed on page 7 of this
Newsletter.
The Court of Appeals stated that it was not deciding that
issue at this stage of the case, thus leaving the door open
to adopting this position in a subsequent appeal.
Accordingly, at this time, it is essential to identify
the criteria for determining when a cooperative is "viable".
Viability
The Council of New York Cooperatives offers the following
criteria to be met in order for a building to be defined
as a "Viable" Cooperative or Condominium: Viability
involves both the financial and the operational aspects
of the cooperative/condominium, which are impacted by the
number of "unsold" units.
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At a minimum, the number of units sold
to bona fide purchasers, each of whom occupies a unit
as a residence, must give the purchasing shareholders/unit
owners complete corporate control. This means that at
least enough units must be sold so that the purchasers
can amend the organic documents without a veto by the
sponsor/holders of unsold shares. In most instances this
will mean that either 66 2/3% or 75 % of the units must
be sold, or that the sponsor is otherwise unable to prevent
amendments of the organic documents
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There can be no Sponsor control, either
directly or indirectly, of building operations, including
no ability to elect more than a minority of the directors.
The sponsor does not control the managing agent, and there
are no long-term contracts with the Sponsor that control
any important facilities or services to the shareholders/unit
owners.
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Unit owners must be able to market their
units at a price and on terms that are not compromised
or hindered by the number of unsold units, and must be
able to refinance end loans on individual units. There
must be no "red-line" determinations from institutional
lenders for shareholder/unit owner end-loans.
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The cooperative must be able to refinance
its mortgage on a commercially reasonable basis. There
must be no "red-line" determinations from institutional
lenders for refinancing of existing building mortgage
or new building mortgages.
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The purchasing shareholders/unit owners
should be able to control the number of transient tenants,
so as to reduce unusual wear and tear on the building
and to maintain a stable residential community.
Analysis
A cooperative or condominium may be viable when less
than all five criteria are met. The negative impact of failure
to meet one or more of these tests may be reduced by corrective
actions. Some of the considerations to determine whether
viability exists when all conditions are not met follow:
1. Minimum Number of Sales.
If non-purchasing tenants constitute a substantial number
of the units in a building the Sponsor may be unable to
meet the minimum level of bona fide sales. A sponsor agreement
or consistent practice to sell units as they become vacant
is an acceptable component of viability.
In the event that the Sponsor demonstrates to the satisfaction
of an independent Board of Directors or Managers that a
need exists for "fair market" rental income to
cover shortfalls of maintenance over rent, an agreement
between the Sponsor and co-op to the effect that future
sales will be made when the shortfall is covered may be
sufficient to establish viability.
Similarly, if there are numerous free market apartments
held by the Sponsor, appropriate agreements between the
co-op/condominium and the Sponsor to avoid "flooding"
the market by spacing sales at a negotiated rate over a
given period of time could satisfy a viability test, as
could an agreement that deals with spacing sales in a depressed
market.
When sponsor sublets are to be permitted, the Sponsor should
accept some level of control by an independent Board with
respect to approval of sublet tenants. Sponsor protection
with respect to permitted sublets (sublets after an agreed
threshold or sublets permitted on a need basis) should be
limited to sublets consented to by an independent Board,
such consent not to be unreasonably withheld.
2. Sponsor Control.
Where the Sponsor owns a sufficient number of units because
of the high number of non-purchasing tenants to enable the
Sponsor to maintain control of the Board, the Sponsor should
agree to refrain from voting in any election of Directors
for more than a minority of directors.
In buildings with sponsor control irrespective of the number
of units owned by it, the Sponsor should be required to
take the following actions:
a. Waive any remaining "anti-rape" sponsor control
provisions concerning the operating budget or capital expenditures.
b. Waive the right to vote for directors when the Sponsor
has a continuing right to appoint any board members.
c. Amend any "100% of shareholder" requirements
for amendments to co-op or condominium documents or board
actions such as terminating management or other contracts.
3. Red-lining making end-loans
unavailable.
The Sponsor should cooperate in obtaining institutional
financing for individual units on rates and terms comparable
to fully viable cooperatives, or at least agree to provide
reasonable sponsor financing to purchasers of Sponsor units.
But the Sponsor should not attempt to perpetuate control
through foreclosures of financed units.
4. Red-lining affecting
ability to refinance building mortgage.
The Sponsor should participate in the lending process by
helping to arrange institutional financing, and agreeing
to bank conditions such as "negative pledges";
the Sponsor should extend existing sponsor mortgage at competitive
rates and terms; and, where large numbers of non-purchasing
tenants exist, the Sponsor should guaranty or subsidize
the building debt so that it is commercially reasonable.
5. Unit Values.
If unit values are negatively affected solely because of
the existence of non-purchasing rent regulated tenants,
the Sponsor may not be able to correct this situation and
the cooperative would not be viable until sufficient units
have been sold to allow unit sales at fair market prices.
6. "Sweetheart"
Contracts.
The Sponsor should agree to permit an independent Board
of Directors or Managers to terminate, at its sole election,
any contracts between the building and the Sponsor, including
any management contract with the Sponsor or any Sponsor
affiliate.
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