Aspects of a Lease

When the cooperative form of housing was first created in the early part of the 20th century, there was no model for the lawyers to use in order to structure the relationship between the cooperative and its tenant-shareholders, so lawyers had to create a document. Not surprisingly, they started with a form of residential lease, adapted it to the co-op mode by putting in clauses relating to the operation and management of the cooperative, and then called it a "proprietary lease."

In 1977, the court of appeals expressly noted, in State Tax Commission v. Shor, that since ownership of shares in a cooperative entitled the shareholder to a long-term proprietary lease, the lease contains "a mixed concept and terminology, superficially resembling the traditional rental apartment lease, except, for example, that the lessee pays monthly maintenance charges and is subject to assessments instead of rent. For some purposes it is a lease; for others it is a compact between cooperative corporation and cooperative tenant. In any case the rights of the tenant are initiated by the capital investment made in the shares in the co-operative corporation." (emphasis added).

A second relevant appeals court decision is Levandusky v. One Fifth Avenue Apartment Corp. (1990). The court pointed out that cooperative shareholders consent to be governed by the decisions of the board of directors, and the board is responsible for running the day-to-day affairs of the cooperative. To that end, the court noted, the board's powers cover areas that range from financial decision-making to promulgating regulations regarding the use of the property.

The agreement by shareholders to submit to the decision-making authority of a cooperative board is voluntary, and the board takes on the burden of managing the property for the benefit of the shareholders. The court concluded that courts "should not undermine the purposes for which the residential community and its governing structure were formed: protection of the interest of the entire community of residents in an environment managed by the board for the common benefit." Accordingly, the courts should not be judging the "reasonableness" of the conduct of a cooperative board, but, in most instances, the inquiry of the court should be limited to whether the directors acted in good faith.

SETTING THE STANDARD

In the early 1970s, a standardized form of proprietary lease was created, and subsequently adopted by the attorney general's office as a model for use in connection with cooperative conversions, and virtually all cooperatives created after the early 1970s have utilized this standard form as the basis for the proprietary lease. Whether there was logic to the order in which the various paragraphs in that lease were placed is not readily ascertainable from an examination of the existing form.

Three years ago, under the auspices of the Council of New York Cooperatives and Condominiums, a new form of agreement between the cooperative and its shareholders was created. One of the major underlying themes of the new form is to identify those aspects of the agreement that relate to the "compact" between shareholder and cooperative with respect to the management of the corporation, and to identify those aspects strictly relating to the physical operation of the building. The new form has been revised several times; the current edition is called 2.02.

The first significant change in the form is that it is called a "Shareholder's Agreement and Proprietary Lease," to be certain that both branches of the analysis of the court of appeals are properly emphasized in the document. Another major change in the new form is a re-ordering and restructuring so that all clauses relating to a common topic are found in one article. The new lease contains eight articles:

(1) The Demised Premises

(2) Payments to the Apartment Corporation

(3) Physical Maintenance of the Building and

Alterations to the Building

(4) Management of the Corporation

(5) Ownership Occupancy and Use of the Apartments

(6) Defaults

(7) Termination

(8) General Legal Clauses

Based on the Levandusky case, a second major theme underlying the structure of the new form is that the principal function of the shareholder body is to elect the board of directors; the principal function of the board of directors is to have the necessary power and authority to manage and operate the building. Because the board's right to manage the operations of the corporation is subject to the political control of the shareholders, the cooperative documents should seek to minimize the extent to which a court may step in and attempt to dictate how a cooperative should be managed.

ANALYZE THIS

What does it all mean? In Article 2, covering payments to the apartment corporation, the payment of maintenance based on a proportionate share of the operating expenses ("cash requirements") of the apartment corporation remains the fundamental bedrock of the cooperative, that is, that the shareholders share the operating expenses in proportion to their ownership. However, two new concepts have been introduced. For the first time, in paragraphs 2.3.1 and 2.3.2, the cash requirements to be allocated among the shareholders proportionately are divided into (i) ownership expenses and (ii) operating expenses.

The ownership expenses are those expenses that arise from the ownership of the property which do not strictly relate to the operations of the real estate. These include, among other things, real estate tax and assessments, interest on mortgage indebtedness, capital improvements, corporate taxes, professional fees, and the creation of reserve or surplus funds. The operating expenses are those things that go to operating and maintaining the building including salaries, utilities, and repairs.

The significance of this distinction is twofold: one is that in the event that there is damage to the building and a shareholder becomes entitled to an abatement of maintenance because of the uninhabitability of the apartment, the ownership expenses should not be abated since they relate to the investment in the apartment, rather than its use. Similarly, in the event that the cooperative should be terminated for whatever reason, the ownership expenses will continue until the corporation is wound up and its operations are terminated. The operation of the building may cease, but the operation of the corporation will not cease, and the corporation will require funds to continue its ability to own the property until it is sold or otherwise disposed of.

The second new concept with respect to financial obligations of the shareholder is the introduction of the concept of user charges. These are charges for use of services, facilities, or utilities, consumption of which is discretionary on the part of the shareholder, or which are appropriately charged on a use, rather than on a pro-rata basis. This would include use of utilities such as water or electricity, receipt of electronic signals such as the providing of cable services, and would extend also to more traditional items such as laundry facilities, health clubs, exercise rooms and parking facilities, which have not customarily been charged on a pro-rata basis, although there has been no specific recognition in the standard form of proprietary lease of the distinction.

With respect to Article 3, concerning the operation, repair, and alteration of the building and the apartments, the basic division of responsibility in the existing form of lease - the apartment corporation being responsible for the building and the common structure and facilities, and the shareholder being obligated to maintain the interior of the apartment - has not been changed, but the new form clarifies and further delineates the responsibility for repair of the interior of the apartment when it has been damaged by an external cause.

Paragraphs 3.6.1 and 3.6.2 expressly provide that it is the shareholder's responsibility to repair damaged areas of the apartment, which are allocated to the shareholder under the terms of the agreement, regardless of the cause of the damage. This is not intended to relieve the apartment corporation of its liability for negligence or breach of the agreement, however it is intended to clarify that the cooperative is not responsible for restoring the interior of a damaged apartment.

Article 4 consolidates the various portions of the prior lease, which relate to the management of the cooperative. The principal new concept is in Paragraph 4.4, which itemizes the purposes for which the house rules may be enacted. The new concept allows the imposition of charges and fees to be levied against shareholders who violate the agreement or the house rules.

In simple terms, this allows the board to levy fines. Some people may consider the ability to fine to be inappropriate and heavy-handed. However, upon reflection, fining somebody $25 because his or her dog did something that it shouldn't have done in a place that it should not have done it, is obviously far less heavy-handed than attempting to evict the shareholder from the building, which is essentially the only remedy allowed under the previous form of a proprietary lease. In addition, the amount of the fine may be limited by the concept that a fine cannot be purely punitive, but must be related to the actual losses or costs imposed on the corporation by the breach of the rules by the shareholder.

Article 5, involving ownership, occupancy, and use of the apartments, includes a substantially updated concept of what constitutes a family. As a result of changing social and moral attitudes, the concept of a "family" has undergone a significant change over the course of the last generation. It is no longer sufficient to define a "family" as solely including relatives by blood or marriage. Accordingly, in Paragraph 5.1 the definition of a family is expanded to include the shareholder's spouse, or one additional adult, the shareholder's children and blood relatives, the children of a spouse, or the children of an additional adult. Thus, it includes unmarried couples and same sex relationships, children of former marriages, and other similar aspects of current social mores.

In addition, Paragraph 5.1.1 clarifies that no person other than a spouse or other adult (married or unmarried) may occupy the apartment unless the shareholder is residing in the apartment, and Paragraph 5.2 further clarifies that a sublet includes any occupancy of the apartment not authorized by the agreement regardless of whether any rent is paid to the shareholder.

In Paragraph 5.2.1, the standard by which discretionary board decisions shall be measured is spelled out - specifically that the board may grant or withhold consent for any reason or no reason, or may attach to its consent such conditions, including charging fees, as the board in its discretion may impose. The purpose of this is to clearly carry out the dictate of the court of appeals that the courts should not undermine the management of the cooperative by the board of directors by, in effect, second-guessing the decisions of the board so long as they are made in good faith. This concept is applied to essentially all of the discretionary determinations of the board, particularly with respect to transfers of apartments, sublets, and alterations - the terrible trilogy of transactions where the board has the power to say "no" to a shareholder.

Article 6, concerning defaults, also introduces a new concept intended to deal with changing times, namely the clause prohibiting undesirable conduct. The current lease form is based on the notion that undesirable conduct would be continually repeated. The ability to evict a shareholder by reason of undesirable conduct requires that the undesirable conduct be repeated after notice from the cooperative to cease the wrongful conduct.

It was never thought that a shareholder would commit such an objectionable act that he should be evicted without a second chance. The board should not have to wait for a repetition of this, or any other similar conduct before having an ability to evict such a shareholder, and, accordingly the commission of the felony has been made the basis for evicting a shareholder regardless of repetition.

The final new concept of significance is in Article 8. Paragraph 8.5.3 authorizes the resolution of any disputes between the corporation and any shareholder, or between shareholders, to be by either arbitration or mediation, rather than a court proceeding, at the corporation's option.

These are the significant new concepts introduced by the Shareholder Agreement and Proprietary Lease for the New Millennium - Form 2.02. It is a document that deserves serious study and consideration by all cooperatives to determine the extent to which these concepts are relevant and significant to each particular body of shareholders, and the extent to which these new concepts should be incorporated into the organic documents of each building.