Equal Treatment

May a co-op impose a transfer fee (flip tax) after the death of a shareholder, but prior to the sale of the apartment? The answer was "no" in Seif v. 72 Horatio Street Owners Corp. The decision was based on both a lack of adequate notice and fairness.

In this case, the co-op defendant moved to vacate a default judgment heretofore entered in the case, and a restraining notice served on Chase Bank as part of the default judgment. The action related to the imposition of a transfer fee imposed by the co-op after the death of a shareholder, Mary Cantwell Lescher, but before the sale of her apartment by the plaintiff executor, Alan Seif.

The co-op consisted of eight apartments. It owned the building at 72 Horatio Street, in Manhattan. Lescher was one of its shareholders, owning apartment 1-S. Before Lescher's death, the co-op did not impose a flip tax on a transfer of an apartment's, shares. Lescher died on February 1, 2000. On March 29, 2000, the co-op held a special meeting of shareholders, for the purpose, among other matters, of discussing and voting upon a flip tax to be imposed on the sale of apartments of deceased shareholders. The only apartment that would realistically then be subject to the flip tax would be Lescher's apartment.

The notice of meeting was placed on the bulletin board of the building, where, according to the defendant, residents were certain to see it. No notice was sent to Seif, who was representing the Lescher Estate, but was not a resident of the building. Thus, Seif did not appear at the meeting.

Six of the eight shareholders (apparently all building residents, they represented 79 percent of the outstanding shares entitled to vote) were present at the meeting. They approved an amendment to the proprietary lease, which imposed a flip tax of three percent of the sale price on the sale of an apartment of a deceased shareholder.

Although the flip tax, in theory, applied not only to a sale by the Lescher Estate but also to the estate of any shareholder who subsequently died, the defendant admitted that, at the time of its enactment, the resident-shareholders specifically had the Lescher Estate sale in mind. The Lescher Estate sold its apartment for $1,700,000 and paid the flip tax under protest.

Seif then began this action, seeking to recover the amount paid, plus attorneys' fees. Seif filed a motion for summary judgment on February 20, 2001, which was returnable on March 5, 2001. In what may have been a misunderstanding among counsel, when the motion appeared on the court's calendar, it was submitted on default, and granted on default. A default judgment was entered against the co-op on April 24, 2001, in the sum of $51,000, plus interest and costs. The claim for attorneys' fees was severed from the action and referred for an assessment of damages. On June 8, 2001, the court held an inquest and awarded the plaintiff the sum of $15,300 as attorneys' fees. The co-op's counsel did not appear at the inquest.

On June 13, 2001, Seif served a notice of entry of the default judgment upon the co-op and served a restraining notice upon the co-op's bank. The co-op thereupon made the motion to vacate the default.

In order to obtain a vacation of the default, movant had to show a legal excuse for the default and a meritorious defense. Since the period of default was relatively brief, the default was excusable. However, for reasons explained below, the court found that the imposition of the flip tax was invalid and that the co-op did not have a meritorious defense.

Article 1, Section 2 of its bylaws required that, where a special meeting of shareholders is to be called, notice is to be served on each shareholder, either personally or by mail, not less than 10 nor more than 50 days before the meeting. Seif was not personally served.

In holding a special meeting without notifying Seif, the defendant violated the notice provisions of its bylaws. The court noted that it may well be that this was a small co-op which is generally operated on an informal basis, and that a notice of meeting placed on a bulletin board is normally sufficient to give resident- shareholders actual notice of the meeting. This practice did not present a problem where all shareholders consent and were willing to waive formal notices of meetings.

However, in the present case, the resident-shareholders knew or should have known that Seif, who did not reside in the building, was not likely to receive notice by means of a posting on the bulletin board. The proper practice required that Seif receive formal notice of the meeting as required under Article 1, Section 2 of the bylaws, or to serve a less formal notice and obtain from Seif a written waiver of the notice provisions of the bylaws.

Since the co-op failed to give proper notice, the court said that the imposition of the flip tax was invalid. The co-op pointed out that supporters of the flip tax had sufficient votes to enact the measure even if Seif had been given proper notice and he had voted the Lescher Estate shares in opposition to the flip tax. However, that did not cure the illegality. The court said that all shareholders, whether in the majority or in the minority, have the right to appear at meetings and be heard before they vote on such vital issues as flip taxes.

The failure of the co-op to notify Seif of the special meeting would alone be sufficient basis for invalidation of the flip tax. However, even if proper notice had been given, Seif would have had grounds for invalidation of the flip tax itself. In FeBland v. Two Trees Mgt. Co., the highest state court invalidated a flip tax that was based on a percentage of the sales price, holding that all shareholders had to be treated equally. In response to the FeBland decision, the legislature enacted amendments to Business Corporation Law, Section 501, in order to legalize certain actions taken by co-op boards.

Section 501(c) states, in part: "[E]ach share shall be equal to every other share of the same class. With respect to...[cooperative corporations], however, provided that (1) liquidation or other distribution rights are substantially equal per share, (2) changes in maintenance charges and general assessments pursuant to proprietary lease have been and are hereafter fixed and determined on an equal per-share basis...and (3) voting rights are substantially equal per share..., shares of the same class shall not be considered unequal because of variations in fees or charges payable to the corporation upon sale or transfer of shares and appurtenant proprietary leases..."

Resident-shareholders held seven of the eight units in the building, so that the Lescher estate was in the position of a minority shareholder. The court observed that it was settled law that the majority shareholders who have the power and authority to direct and control the affairs of a corporation have a fiduciary duty to all shareholders to adhere to a code of conduct requiring that all shareholders be treated equally and that corporate affairs be managed fairly.

If the shareholders had enacted a flip tax, which was applicable only to the estate of any shareholder who subsequently died, it is possible that the action would have been lawful under BCL Section 501(c). However, in this case, the resident-shareholders admittedly aimed the enactment of the flip tax at a specific estate, and enacted it after Lescher died. The court found that the timing of the enactment, i.e., after Lescher's death but before the estate sold the apartment, was not in good faith. In the court's view, since the shareholders did not treat the Lescher estate fairly, the imposition of the flip tax was invalid. In light of the above, the judgment of the court, awarding Seif the amount of the flip tax, plus interest, costs and attorneys' fees, was affirmed.

Comment: This case illustrates the fiduciary duties that a co-op or condo board has to treat all unit-owners fairly. Decisions made by boards, which are imposed in fact only on a limited number of unit-owners, are always suspect and subject to challenge. Moreover, fair notice of any impending change in the basic co-op or condo affairs or documents is clearly essential if the change is to withstand challenge. Unfairness to minority shareholders often prompts judicial relief.