Board Approval Required

The inherent power of a co-op board to approve apartment transfers was upheld recently by an appellate court in Barbour v. Knecht. This involved a small co-op where an existing shareholder seeking to acquire an additional apartment argued that board consent was not needed for this latest acquisition.

Plaintiff, a disgruntled minority shareholder in a corporation that acts as a cooperative housing corporation, brought this action, individually and on behalf of other shareholders, against the corporation and three individuals, Gabriele Knecht, the corporation's majority shareholder and one of its three directors, and Christopher Muto and Naomi Lyum, the corporation's other two directors, who were not shareholders. Damages, as well as declaratory relief, were sought.

The complaint asserted six causes of action. The first and second, brought individually, alleged tortious interference with the contract against all the defendants; the third, brought individually, alleged breach of fiduciary duty under Business Corporation Law Section 717 against the individual defendants only; the fourth, brought individually and on behalf of the other shareholders, alleged waste of corporate assets under Business Corporation Law Section 720 against the individual defendants only; the fifth, brought individually, alleged tortious interference against defendant Knecht only; and the sixth, brought individually and on behalf of the other shareholders, alleged oppression of the minority shareholders by the individual defendants.

The matter was before the court on the defendants' appeal from the grant of partial summary judgment in plaintiff's favor declaring that the board's approval of the transfer to plaintiff of shares, reflective of ownership of one of the cooperative apartments, was not required or, if required, had been unreasonably withheld. Plaintiff was one of the shareholders of defendant 411-13 Bleecker Street Realty Corp., having purchased, in 1994, the shares allocated to one of its six residential units. The corporation, formed in November 1976, owned and operated two adjacent, landmarked Greenwich Village buildings. They had been built in the 1800s, were each four stories high, and had commercial space on the first floor and a residential unit, just over 20 feet wide, on each of the second, third, and fourth floors. One hundred shares were allocated to each of five of the apartments and 118 shares to the other apartment. Paragraph 7 of the certificate of incorporation provided that "[n]o shares shall be transferred without the prior consent of the directors."

In January 1977, eight individuals, including defendant Knecht and non-parties John Horrigan and Richard Light, who owned all of the shares of the corporation, entered into a stockholders' agreement that contained a provision affording each shareholder a right of first refusal whenever any shareholder wished to sell his or her shares. Paragraph 11(a) of that agreement stated:

"If any Stockholder (the Transferor) desires to transfer all of his shares of the Corporation's stock, he shall first obtain a bona fide offer to purchase from a 3rd person (who may be another Stockholder) and then give written notice to the other Stockholders offering to sell his said shares in equal parts to such of the other Stockholders as shall elect to purchase. ..In the event any of the Stockholders elect to purchase the Transferor's shares. then the transferor will sell to them for the same sales price set forth in such notice, provided, however, the Transferor first obtains his release from the liabilities and obligations of the Guaranty ''given by the Stockholders to 22 Charles Street Corp. dated January 26,1977 (the Guaranty). In the event none of the Stockholders elects to purchase the Transferors shares or the Transferor cannot obtain such release, then the Transferor shall have the right to proceed to sell the shares to the prospective purchaser for the sales price and upon the terms of the transfer set forth in the Transferor's notices, provided, however, that (i) such prospective purchaser becomes a party to and is bound by the terms of the Guaranty, (ii) the Corporation gives its written consent to the transfer of such prospective purchaser (which consent will not be unreasonably withheld), and (iii) such prospective purchaser becomes a party to and is bound by the terms of this Agreement."

Throughout the corporation's history; all transfers of shares had been subject to the approval of the board. In 1995, Knecht, who originally occupied the fourth floor of the 413 building and owned 100 shares, purchased another 118 shares and acquired the second-floor apartment in the same building, Unit 4, the largest in the two buildings. According to plaintiff and her witnesses, Knecht used this second apartment as a work studio.

In January 2000, Light, another of the original shareholders, offered to sell Knecht his 100 shares for $150,000. Although Light gave the other stockholders the opportunity to purchase, no other stockholder accepted the offer. After Knecht accepted. the corporation provided her with an application form which required her to furnish certain financial information. Included in the documents was the proviso, "The proposed purchase cannot be consummated without the [b]oard's consent." Knecht furnished the requested information. Besides Knecht and plaintiff, who at the time was the board president, the other shareholders, each an owner of 100 shares, were Horrigan, Light, and non-party Carol Wreszin. Even though Knecht's financial information and application were "in order," the other shareholders, concerned that if the sale were consummated Knecht would own a majority of the shares, kept deferring board review, prompting Knecht and Light to begin an Article 78 proceeding against plaintiff and Wreszin to compel a special meeting of the board. The supreme court ruled in Knecht's favor.

At a special meeting of the stockholders held on July 25, 2000, Light and Knecht, who, together, owned 318 of the corporation's 618 shares, removed plaintiff, Wreszin and Horrigan as hoard members and replaced them with defendants Muto and Lyum and non-party Anthony Muto, none of whom was a resident of the buildings. The new board approved the sale of Light's shares to Knecht. The closing took place on August 1, 2000. After Light's death in November 2000, the bylaws were changed so that the board would consist of only three members, Knecht and the defendants Muto and Lyum.

In August 2000, Horrigan, under paragraph 11(a) of the stockholders' agreement, informed the shareholders that plaintiff had offered to buy his 100 shares for $225,000. Both Knecht and plaintiff exercised their right of first refusal. Despite the corporation's efforts to have Horrigan's attorney draw three contracts. one for a sale of the shares to Knecht only, another for a sale to plaintiff only, and a third for a sale of the shares jointly to both, he drafted one contract providing for the sale of the shares jointly to Knecht and plaintiff; the contract provided that if one of them failed to tender a signed contract with the requisite deposit or to close in accordance therewith, Horrigan had the right to sell to the other.

Meanwhile, the corporation requested financial information from both plaintiff and Knecht. Although plaintiff took the position that board approval was not required, she eventually furnished the information sought. Knecht, who did not dispute the requirement of board approval provided the requested information. On December 15, 2000, the board approved the sale of Horrigan's 100 shares to Knecht but refused to consent to the transfer of such shares to the plaintiff. It based its decision on a finding that the plaintiff did not intend to use the cooperative apartment as her primary residence and on alleged concerns relating to plaintiff's "character, fitness, integrity and commitment to the community" plaintiff, upon learning of the board's decision, vigorously disputed these findings and in her moving affidavit asserted that the board never acceded to her request to meet with it, either before or after its disapproval of the sale to her.

On December 18, 2000, Knecht signed and returned the contract Horrigan had sent after making a series of material changes, basically eliminating the provisions relating to a joint sale so that the contract would reflect a sale to her alone. plaintiff, on December 19, 2000, signed and returned the contract, as proposed, without any changes. On that same date, Horrigan's attorney notified Knecht that her changes were unacceptable. Thereafter, on December 27, 2000, Horrigan, elected, pursuant to the specific terms of the contract, to sell the unit to plaintiff based on Knecht's failure to tender a signed unaltered contract, executed and returned the signed contract, revised to show her as the sole purchaser, that plaintiff had tendered. Upon learning of this development, Knecht began an action for specific performance. This action was dismissed for failure to state a cause of action and the decision was affirmed.

In the interim, on January 12, 2001, the plaintiff began this action for tortious interference with her rights under the stockholders' agreement and the contract for the purchase of Horrigan's shares. After joinder of issue, plaintiff moved for partial summary judgment declaring that the consent of the board of directors to the sale of Horrigan's shares was not required or, if required, was withheld in violation of Business Corporation Law Section 717. Defendant cross-moved to dismiss the complaint.

In granting the motion and declaring in the plaintiff's favor, as requested, the motion court ruled that board approval was required for outside purchasers only and that, "[e]ven if... Cooperative approval were necessary, it does not make sense that non-tenant outsider directors should decide who should live in which apartment in the Cooperative." The court further found that the board had unreasonably withheld its consent to plaintiff's purchase of the shares since she required the apartment for living space while Knecht, who already owned three apartments in one building, had failed to demonstrate why she needed a fourth in the adjacent building. The court directed the board to approve the transfer of the shares to the Horrigan apartment to plaintiff.

The court granted in part and denied in part the cross-motion, dismissing the tortious interference claims as moot in light of its grant of partial summary judgment and on the further ground that "it is unclear what contract has been tortiously interfered with."

It denied dismissal of the claims based on corporate waste and improper takeover of the board of directors, as well as the improper use of the Knecht apartment, rejecting defendants' argument that these claims mixed derivative and personal claims. This appeal, which also encompassed, to the extent it was adverse to defendants, the disposition of the cross-motion, followed.

The appellate court said that summary judgment should not have been granted in plaintiff's favor, declaring that board approval to the sale to her of Horrigan's shares was not required or, if required, was unreasonably withheld. On its face, paragraph 7 of the certificate of incorporation clearly and unambiguously required board approval of the sale of shares of the corporation's stock. On the other hand, while board approval was required under paragraph 11(a) of the stockholders' agreement, that approval was limited to instances where, after written notice to the other stockholders, "none of the [s]tockholders elects to purchase the [t]ransferor's shares."

The approval provision, however, did not apply here since Horrigan gave written notice to the other three stockholders of his intent to sell and both Knecht and plaintiff elected to purchase. Thus, in this instance, the certificate of incorporation and the stockholders' agreement are in direct conflict. If the court were to look solely at the stockholders' agreement, the motion court's interpretation that board approval was not required when current stockholders elected to purchase would be correct. However, the court said that, in determining matters of corporate governance, documents should not be looked at in isolation.

The relationship between the shareholders of a co-op and the co-op, as well as the extent of the authority of the board of directors, is determined by the certificate of incorporation, the bylaws, and proprietary lease, which must be read together. Given the conflicting provisions in the certificate of incorporation and the stockholders' agreement, and the ambiguity presented as a result, the court said that the conduct of the parties was the best evidence as to their meaning. As this record showed, in the history of the corporation, no transfer of shares had ever taken place without board approval. This has been the consistent practice even when the purchaser was already a stockholder. When, for example, Knecht, a shareholder since the corporation's formation in 1976, purchased Light's shares in 2000, at a time when plaintiff was the corporation's president, she had to obtain board approval. Thus, the court held, contrary to the motion court's view, that plaintiff was required to obtain board approval.

In determining whether the board, in approving the sale of Horrigan's shares to Knecht and disapproving the transfer to plaintiff, unreasonably withheld its consent in the latter instance, the court said that it was the Business Judgment Rule, not the court's independent assessment of the reasonableness of the decision, that provided the proper standard of review. Under the rule, courts must defer to a board's determination if it was taken in furtherance of the corporation's purposes, was within the scope of the board's authority, and was taken in good faith. The rule is not an insuperable barrier, however, and "permits review of improper decisions, as when the challenger demonstrates that the board's action deliberately singles out individuals for harmful treatment."

Here, only the board's good faith was at issue. Contrary to defendants' argument, plaintiff was not required to show that the board members were self-interested. A showing of unequal treatment was sufficient. In any event, interest was not limited to financial self-interest; interest can be shown if a director is controlled by an interested director.

Plaintiff had submitted evidence of the board's bad faith. According to the plaintiff, Knecht was an obviously interested director, given her effort to purchase the shares and obtain the apartment for herself, and she controlled defendants Muto and Lyum, making them interested as well. The plaintiff argued that the board unfairly refused to permit her to purchase Horrigan's shares on the ground, questionable, at best in the court's view that the Bleecker Street apartment was not her primary residence and that, although she presented proof that this conclusion was incorrect, the board refused to reconsider the question of plaintiff's primary residence.

In addition, the plaintiff claimed that the board failed to conduct an adequate investigation before reaching its decision and that despite plaintiff's request for an interview, the board never asked her to meet with it. In this regard, it was noted by the court that much of the factual basis for the board's purported "concerns [as to plaintiff's character, fitness, integrity and commitment to the community" involved events which occurred prior to the appointment of two of the three board members. This showing, while impressive, was not sufficient to warrant summary judgment in the plaintiff's favor on the third cause of action for breach of fiduciary duty. As their affidavits revealed, defendants Muto and Lyum denied being controlled by Knecht. Since Knecht's interest in the transaction was fully disclosed, her participation In the board's decision was permissible under the express terms of the certificate of incorporation and was consistent with Business Corporation Law Section 713.

Defendants argued that, quite apart from the issue of plaintiff's primary residence, they had sufficient grounds to reject plaintiff's application, citing her recent tenure as president of the corporation during which, as noted, a lawsuit, the first of its kind, was commenced to compel her to perform the ministerial task of calling a special meeting. They cited questionable unauthorized payments during her tenure as president to the former manager of the buildings, who resigned in September 2000, and the approval of a below-market, commercial lease with one of the corporation's two commercial tenants. In November 2000, the corporation served plaintiff with a notice of default to keep the hallway of the first floor clear of her baby carriage, which allegedly created a fire hazard, one which, they claimed, persisted to this day.

Defendants also claimed that, in December 2000, the plaintiff had filed a frivolous complaint as to Knecht's use of a portion of the premises with the Department of Buildings, which, after an inspection, concluded, "No action necessary based upon physical obser[vation]." Defendants further claimed that, in response to the board's request for financial information as to the proposed sale of Horrigan's shares, the plaintiff responded begrudgingly and in an incomplete fashion. Finally, defendants agreed that the plaintiff unfairly attempted to influence Horrigan to sell his shares to her, citing the fact that the plaintiff was secretly paying him $1,000 per month.

All of these grounds, as well as the question of the plaintiff's primary residence, were set forth in support of the board's December 15, 2000 resolution disapproving the transfer of Horrigan's shares to the plaintiff. Thus, the court said that summary judgment was inappropriate since a clear issue of fact was presented as to the board's alleged lack of good faith. By the same token, defendants' cross-motion to dismiss the third cause of action or for summary judgment was properly denied.

As to the balance of the cross-motion, the appellate court said that the trial court should have granted defendants summary judgment on the fourth cause of action, which alleged that the individual defendants wasted the corporation's assets "by paying attorney fees incurred to further the personal economic interests of Knecht and not in furtherance of legitimate interests of the [c]orporation."

In support of the cross-motion, defendants submitted the unchallenged affidavit of Knecht and affirmation of the attorney representing her and the corporation, in which each denied that the corporation paid for any legal services rendered in behalf of Knecht. As they explained, since November 2000, the attorney's firm had separately billed the corporation and Knecht for services rendered to each. Both have separately paid their own bills. Before November 2000, Knecht paid for legal services rendered to the corporation.

Challenging the sufficiency of defendants' showing, the plaintiff argued that defendants should have submitted invoices, canceled checks, or other evidence to support this assertion. In opposing the cross-motion, however, the plaintiff failed to make a showing that "facts essential to justify opposition may exist but cannot then be stated." A party opposing summary judgment must submit evidence in admissible form or explain why he or she cannot do so. Since the plaintiff had failed to do either, summary judgment dismissing the fourth cause of action for waste should have been granted said the court. It also noted the plaintiff's failure to assert this claim, which was derivative in nature, in proper form or to comply with the pleading requirements for a derivative action.

While not well-pleaded, the sixth cause of action, which alleged that the sale of Light's shares to Knecht permitted Knecht to assume majority control and to amend the corporation's bylaws to "disallow participation by the other shareholders in the management and operations" of the corporation, seemed to be asserting a cause of action for oppression of the minority shareholders. The court said that majority shareholders and directors of a close corporation stand in a fiduciary relationship with the corporation and minority stockholders and are required to exercise the utmost good faith. Since the defendant, 411-13 Bleecker Street Realty Corp., was a close corporation, the plaintiff's complaint that she and the other minority shareholders had been frozen out of the management of the corporation asserted a cognizable wrong.

The court said that this cause of action, as pleaded, however, as well as the fifth cause of action, which asserted wrongs similar to those alleged in the sixth cause of action, was a confusing hodgepodge of the plaintiff's personal claims, claims derivative in nature, and claims allegedly asserted in behalf of the other minority shareholders, none of whom were parties to this lawsuit. The mingling of derivative claims and individual claims required dismissal of the causes of action so affected. The dismissal, however, was with leave to replead, should plaintiff be so advised.

Comment: A lower court decision that board consent was not required for this transfer was reversed. The co-op documents and the history of prior transfers, all of which mandated board approval, were the controlling factors, despite a shareholders' agreement and the fact that the purchaser was already a shareholder. This decision reinforces the standard co-op requirement of the need for board approval of apartment transfers.