Change is Good

If the shareholders do not enact the document, the years of experience and drafting that went into the preparation of the new form of proprietary lease and shareholders' agreement would be meaningless. As much as we would like to say that the board of directors can vote to change the form of lease, that is not the case. This document will require the approval of the holders of two-thirds of all the shares (not just two-thirds of those who vote) and in some instances may require the approval of the holders of 75 percent of the shares. However, regardless of the number of shares necessary to enact the new lease, it will not be an easy task. What procedures can be followed in getting the new lease enacted?

The first step is for the board of directors to review and understand the new form of proprietary lease. The board will not be able to convince the shareholders to vote in favor of this change unless the board understands the lease and the reason for this change. It would be impossible for the board to pursue the replacement of the standard proprietary lease with the proprietary lease and shareholders agreement without an understanding of why it is necessary to do so.

The main reason is that the existing concept of the proprietary lease is outdated and cooperative corporations must protect themselves from the explosion of co-op-related litigation that has occurred during the last decade. As late as the mid-1970s, there were probably less than a thousand cooperative corporations throughout the city of New York and very little litigation. There may have been a dozen decisions a year and very few of them were prominent. However, between the mid-'70s and the late '80s roughly 4,000 buildings and apartment complexes were converted to cooperative ownership in every part of every borough.

Their sponsors intended this tremendous expansion in the number of cooperatives, which frequently involved buildings in terrible physical condition, as a way around the rent stabilization and rent control laws. The expansion was followed by the real estate recession, which in New York was exacerbated by the inability of sponsors to pay their maintenance. The condition of the buildings and the financial problems of sponsors and many of the new shareholders led to an explosion of litigation.

When shareholders looked for ways to deal with the problems they saw in their buildings they focused on the proprietary lease, which is the basic document establishing the relationship of the shareholders to the board and each other. Every cooperative offering plan issued by every sponsor contained a form of proprietary lease, but almost no one paid very much attention to it. The sponsors and the tenants were interested in the business terms and the condition of the building. The proprietary lease was merely a document that the sponsor's attorney took from his or her file and attached to the offering plan.

Probably the only innovation in proprietary leases during the wave of conversions of the mid-'80s was the extensive provisions protecting the holders of unsold shares. Frequently, a law firm repeated using proprietary leases that had typos, which no one ever noticed. Sometimes the description of the lease in the plan failed to match the copy of the lease attached to the plan. The continued use of ancient leases and the explosion of conversions was a disaster in the making.

The problem of outdated proprietary leases was exacerbated because much of the litigation took place in housing court where defaulting shareholders attempted to use claims that the corporation was a landlord and failed to comply with the law or the lease as a defense to the nonpayment of maintenance and assessments. Not surprisingly, the housing court judges looked at the proprietary lease as a lease between a landlord and a tenant rather than a corporate document between a corporation and its shareholders.

The new form of proprietary lease and shareholders' agreement recognizes that cooperative living is complicated and involves more than the traditional landlord/tenant relationship. It involves corporate law because at the bottom of the relationship there is not just a lease but also a stock certificate.

Notwithstanding the need for the new form of proprietary lease and the likely savings to the corporation by reducing the likelihood of litigation, replacing the existing lease with the new form of lease will not be easy. In order to get the lease enacted, it is important for the board to make certain that the shareholders appreciate that not only are they not giving anything up, but also that the new lease contains numerous benefits.

Nevertheless, the board will have to deal with these issues. For this reason, you should follow this procedure when updating the lease:

Review
The board must first review the new lease and get comfortable with its provisions.

Meet with Counsel
After the initial review the board should probably meet with counsel to discuss the lease and modify it to fit the building, the corporation's shareholders, and the problems the board must address to get the lease enacted. The board should avoid the mistake the sponsor made, that one size fits all. Although we spent a considerable amount of time coordinating the various provisions and making certain that the document was not internally contradictory, there is no reason for the board to not tailor the lease to its needs.

Distribute a Package
Once the board is satisfied with the terms of the lease, the board should distribute a letter to the shareholders explaining the board's reasoning for changing the lease and circulate it with a copy of the new lease and a paragraph-by-paragraph explanation of the meaning of the lease. This should be written in plain English so that the shareholders understand it, but reviewed by counsel to make certain that it is accurate. In order to make the explanation understandable, the package should contain a chart showing which section of the new lease is similar to which section of the old lease. Most importantly, the board must explain to the shareholders that this change cannot occur without the approval of a super-majority of the shareholders and cannot be forced on the shareholders. The shareholders must understand that changing the lease is not something the board can do but requires the approval of either two-thirds or three-quarters of the owners of all of the shares and not just two-thirds or three-quarters of those who attend the meeting or vote. The determination as to whether it is two-thirds or three-quarters depends on the language of the existing lease and what it requires to amend the lease.

Call a Meeting
Once the shareholders have been given an ample time to digest the new lease, the board should call an information meeting of the shareholders to allow them to express their concerns or questions. The notice of the meeting should specifically indicate that no vote will be taken at this meeting, but questions will be answered and the shareholders' concerns addressed. At the meeting, a member of the board, counsel, or the managing agent should start by going through the proposed lease paragraph by paragraph with a brief explanation of the purpose of the provision and how it differs from the existing lease. The corporation's attorney should be present to answer specific legal questions on the new form.

After the initial review, individual questions can be taken but a limited number of shareholders should not be allowed to take control of the meeting with personal issues. For example, if the new lease contains provisions on maintaining terraces, the owners of apartments with terraces should not be permitted to harass the chair regarding their rights. The meeting should continue until all the questions have been addressed. Undoubtedly, there will be issues raised at the meeting, which will necessitate the board's review of the lease and the making of further changes. In a large building, several nights of meetings should be held with a different part of the building or the residents of different floors invited to different meetings in order to keep the group manageable and allow for a free exchange of thoughts and comments.

Review the Results
Immediately after the informational meeting, the board and counsel should meet to review what occurred at the meeting and discuss what, if any, changes should be made to the lease before it is again presented to the shareholders. If there are several paragraphs that seem to be causing a great deal of concern among the shareholders, then the board should consider amending the new form of lease or leaving the language from the existing lease.

Write to the Shareholders
Write to the shareholders and advise them what the board has decided to do with regard to the issues raised at the informational meeting and provide the shareholders with a period in which to comment in writing to the board as to the latest changes.

Vote at a Special Meeting
Once the board is satisfied that the lease is in an acceptable form, the board should schedule a special meeting of shareholders to vote on the new lease. The notice of meeting should contain a copy of the final form of the lease, which is highlighted to reflect the changes the board decided to make as a result of the informational meeting. Because the enactment of the new lease could become contentious, it is better to not attempt to do it at the annual meeting if there is a great deal of opposition. Particularly the concern is that a fight over the lease might prevent the business that has to happen at the annual meeting from taking place.

Because of the super-majority required to enact the new lease it is imperative that the board distribute proxies before the meeting, which it will undoubtedly need to enact the lease. Make certain that every shareholder understands that, since a certain percentage of shareholders must approve the lease, a shareholder who fails to vote is effectively voting against the lease. The reason for this is that at a minimum two-thirds of the shares must vote in favor of the new lease. Any shareholder that fails to vote means that fewer shareholders are left to provide the two-thirds vote. The members of the board may be required to go door-to-door in the building soliciting proxies if there is apathy in the building or a large group of dissidents.

The balloting does not necessarily have to stop at the end of the meeting. The time to solicit ballots can continue for a week, a month, or several months after the meeting ends if, at the special meeting an announcement is made that the balloting on the lease will continue after the adjournment of the meeting until a specific date.

Once the requisite vote is achieved, each shareholder should receive a copy of the amended and restated proprietary lease. Unless the old proprietary lease provides differently, the new form of lease will apply to all of the shareholders once it is enacted even if the shareholder did not vote for it. The new form of lease may not apply to lenders, who are holding leases as security for their loans until the lender trades the old form of lease for a new form. However, as apartments are sold or refinanced the corporation should replace the existing lease with the new form by having the shareholder and the board executes the new lease.
Replacing the lease will be a time-consuming process but an attempt should be made to do it with as little rancor as possible. Unfortunately, these discussions can sometimes get heated and that should be avoided at all costs. Although the experience might be unpleasant, it is in every shareholder's best interest for the board to do everything possible to replace the lease.