Restricting the Sponsor

In Matter of Fort Hamilton Development Corp. v. Bay Ridge Towers Inc., a court enforced a bylaw provision restricting a shareholder with a greater than 50 percent interest in the co-op from electing a majority of the board. The provision was not considered to have violated existing statutory and case law.

Under the Business Corporation Law (BCL), Sections 611 and 619, petitioners Fort Hamilton Development Corp., Mark P. Madias, and Peter M. Madias moved, by order to show cause, for an order:

(1) Certifying that petitioners Peter M. Madias and Mark P. Madias, respondents Martin Spencer and James Gallo, and Edward Monahan constituted and were duly elected to the board of directors of respondent Bay Ridge Towers Inc. (BRT) by a majority of the ballots cast at the annual meeting held on May 16, 2001;

(2) Declaring that the purported results of the election of the board of directors of BRT, as announced by respondents Nicholas Gaetani and Maria P. Bernazzani, the inspectors of election, on May 16, 2001 were null because they had refused to permit Fort Hamilton to vote for all five members of the board of directors, and that if its votes had been counted, the outcome of the election would have been different; and

(3) Declaring that all actions which affect the rights of the holders of unsold shares taken on or after May 16, 2001 by respondents Martin Spencer, James Gallo, and Mary Bianchi were ultra vires, a nullity, and of no legal effect. Respondents BRT, Martin Spencer, James Gallo, Mary Bianchi, Nicholas Gaetani, and Maria P. Bernazzani cross-moved for an order dismissing the petition.

Respondent BRT was a co-op formed in 1985, which owned and operated a building containing 106 residential apartments, located at 149 Marine Avenue in Brooklyn, N.Y. Petitioner Fort Hamilton, along with Nicholas Skarvelis, was the sponsor of the conversion of the apartment building to co-op ownership. Fort Hamilton was the holder of 32,286 unsold shares of BRT. These unsold shares constituted 52.48 percent of the 61,520 shares of BRT. Petitioners Mark and Peter Madias, shareholders and officers of BRT, were Fort Hamilton's designated representatives on BRT's five-member board of directors. Respondents Martin Spencer, James Gallo, and Mary Bianchi maintained their residences at the building and were the three tenant-shareholder members of BRT's board of directors. Spencer, the president of BRT, and Gallo, the secretary/treasurer of BRT, had both served on BRT's board of directors for about 16 years. Bianchi, the vice president of BRT, had served on BRT's board of directors for roughly three years.

At the beginning of an annual shareholders' meeting held on May 16, 2001 for the purpose of re-electing the board of BRT, Fort Hamilton nominated and voted for its two representatives on BRT's board, Mark and Peter Madias. Since Fort Hamilton held a majority of the shares of BRT, Mark and Peter Madias were duly elected. Gallo, Bianchi, Spencer, Monahan, and Susan Bucaria were then nominated as the tenant-shareholder candidates for the board of directors of BRT. Gaetani and Bernazzani, two shareholders unaffiliated with any of the candidates, were appointed as the inspectors of election for this meeting, and the shareholders cast their ballots. Fort Hamilton submitted a ballot, attempting to vote its 52.48 percent shares of BRT for the tenant-shareholder candidates. The inspectors then counted the ballots. But they refused to count Fort Hamilton's votes for these three board positions, based on Article II, Section 2, of BRT's bylaws, which was part of the offering plan drafted by Fort Hamilton, as the sponsor.

This section said: "Respecting any shareholder who owns greater than 50 percent of the shares of the Corporation; such shareholder agrees not to elect a majority of the Board of Directors at the earlier of (i) five (5) years after the Corporation acquired the Property or (ii) at such time that the shareholder ceases to own greater than 50 percent of the shares of the Corporation."

Consequently, the inspectors decided that Fort Hamilton, as the holder of greater than 50 percent of BRT's shares, could only use its votes to elect two of the five board member positions, and that, therefore, it was not entitled to vote for the three resident tenant-shareholder candidates. Upon excluding the votes of Fort Hamilton, the inspectors of election announced that Gallo, Spencer, and Bianchi were the three tenant-shareholders elected to BRT's board. If the votes of Fort Hamilton had been counted, Gallo and Spencer would still have been elected, but Monahan would have been elected instead of Bianchi. Petitioners asserted that subsequent to the election, Spencer, Gallo, and Bianchi, in their capacity as BRT's directors, had taken steps to amend the house rules, and that such proposed amendment improperly violated the proprietary lease.

As a result, petitioners brought this petition, seeking a judgment declaring the results of the election of the board, as announced by the inspectors of election on May 16, 2001, a nullity due to their refusal to count Fort Hamilton's votes, certifying the two Madiases, Spencer, Gallo, and Monahan as the duly elected members of BRT's board, declaring actions taken by Spencer, Gallo, and Bianchi ultra vires, and granting them a temporary restraining order and preliminary injunction, restraining Spencer, Gallo, and Bianchi from purporting to act as directors. A temporary restraining order, as requested in petitioners' order to show cause, was initially granted, and later vacated in its entirety by the court's order dated August 23, 2001.

In support of their petition, petitioners relied upon Matter of Park Briar Associates v. Park Briar Owners Inc. They pointed out that, in that case, the appellate division, second department, held that the co-op therein could not prevent a petitioner, which was the sponsor of the co-op corporation, from voting for any director unless it was shown that "the director in question [wa]s on the petitioner's own slate or receive[d] a salary or other remuneration from it." Petitioners claimed that, since it was undisputed that none of the shareholder candidates for BRT's board of directors were affiliated with or in any way nominated or designated by Fort Hamilton, it could not be said to have exercised voting control over BRT's board by voting its shares.

Petitioners' reliance upon Park Briar, however, was, in the court's view, misplaced, because that case did not involve a restriction contained in the co-op's bylaws on the right of the sponsor to vote. Rather, that case involved only the application of the regulation the attorney general set forth in 13 NYCRR 19.3(v)(5)(i), which provides that the holder of unsold shares "must agree not to exercise voting control of the Board of Directors for more than five years from closing, or whenever the unsold shares constitute less than 50 percent of the shares, whichever is sooner)." The appellate division, second department, in Park Briar, in construing this regulation, found that it only restricted the sponsor's nomination or designation of board members, but not its ability to vote for more than a majority of the board.

Park Briar was distinguishable from the case at bar since, here, the inspectors, in refusing to count Fort Hamilton's votes for the tenant-shareholder candidates, did not rely upon the attorney general's regulation, but upon the restriction contained in Article III, Section 2 of BRT's bylaws which, as noted above, did not refer to the sponsor's general exercise of voting control, or its nomination or designation of board members, but expressly referred to its "agree[ment] not to elect a majority of the Board of Directors."

Significantly, in Park Briar, the appellate division, second department, in making its ruling, specifically pointed out that, in that case, existing restrictions on the petitioner's right to vote, which, as in the case at bar, were contained in the co-op's bylaws, were applicable therein because those restrictions only applied if the petitioner held more than 50 percent of the outstanding shares of the co-op, and the petitioner there held less than 50 percent of the shares.

Petitioners' reliance upon the decision of the appellate division, first department, in Rego Park Gardens Associates v. Rego Park Gardens Owners Inc. was similarly misplaced, said the court. In that case, the restrictions at issue contained in the co-op's offering plan, unlike the one in the case at bar, did not specifically refer to the sponsor's general exercise of voting control and provided that such voting control could not be exercised after the sponsor owned less than 50 percent of the cooperative corporation's outstanding shares.

Moreover, subsequent to the decisions in Park Briar and Rego Park, the appellate division, second department, in Matter of Visutton Associates v. Anita Terrace Owners Inc., did not construe those decisions as allowing a sponsor to elect a majority of a co-op's board of directors so long as the board was not controlled by affiliates of the sponsor where there was a provision, which, like the one in the case at bar, restricted the voting rights of a sponsor by prohibiting it from voting its unsold shares for more than one less than the majority of directors to be elected. In Visutton, the appellate division, second department, held such provision to be enforceable and upheld the inspectors' refusal to count the sponsor's votes.

Additionally, in Matter of Flagg Court Realty Co. v. Court Owners Corp., the appellate division, second department, similarly found that the election at issue in that case was conducted in violation of the offering plan and bylaws of the co-op due to the restrictions contained therein, which provided that the sponsor or individuals who owned unsold shares would not "elect a majority of the Board of Directors, even though the number of shares owned by them would enable them to do so."

Indeed, the same argument made by petitioners that, based on the decision in Park Briar, a sponsor or holder of unsold shares could not be restricted to voting for only the sponsor-affiliated directors, was also made by the petitioners therein, and was expressly discussed and rejected by the lower court's decision, which was upheld by the appellate division, second department.

In the court's view, the petitioners' attempt to distinguish Visutton from their case was unavailing. The restrictive provision at issue in Visutton was virtually the same as the one in the present case. The court also dealt with the petitioners' argument that Flagg was distinguishable from the case at bar merely because the restrictive provision therein stated that the sponsor shall have the right to elect three of seven directors and did not specifically refer to the number of directors Fort Hamilton may elect. It said it was without merit. The offering plan in Flagg stated that the sponsor or holder of unsold shares "will not elect a majority of the Board of Directors" and, here, Article II, Section 2, of BRT's bylaws similarly stated that a shareholder of more than 50 percent of BRT's shares (i.e., the sponsor and holder of unsold shares) cannot "elect a majority of the Board of Directors." Thus, the court concluded that such provisions were indistinguishable.

Petitioners also argued that the inspectors exceeded their authority and violated BCL Section 612(a). BCL Section 612(a) provides that "[e]very shareholder of record shall be entitled at every meeting of shareholders to one vote for every share standing in his name on the record of shareholders, unless otherwise provided in the certificate of incorporation." They contended that under this section, the subject restriction in Article II, Section 2, of BRT's bylaws was unenforceable since it was not contained in BRT's certificate of incorporation.

The court rejected this argument. While a restriction depriving a shareholder of the right to vote all of his/her shares can only be accomplished through a provision in the certificate of incorporation, the appellate division, second department, in Visutton, held that a provision restricting a sponsor from voting its unsold shares for more than one less than the majority of directors to be elected is not required to be set forth in the certificate of incorporation. This is because such a provision "do[es] not prohibit the sponsor from voting all its shares; [it] merely bar[s] the sponsor from obtaining control of the board under certain circumstances." .

Petitioners further contended that the inspectors' refusal to count the ballots cast by Fort Hamilton while counting the ballot cast by Marine Properties LLC, which was also a holder of unsold shares, was arbitrary, capricious, and unlawful. The court said that such contention was devoid of merit. While it is undisputed that Fort Hamilton owns greater than 50 percent of the shares of BRT, Marine Properties LLC owns only 4.39 percent of the shares of BRT, and has never held 50 percent or more of the shares of BRT. Therefore, since the subject bylaw only applied to any "shareholder who owns greater than 50 percent of the shares of [BRT]," it was plainly inapplicable to Marine Properties LLC.