First Refusal

The board members of the Westchester condominium thought they were in the clear. There was an apartment up for sale in the building, and they believed the asking price was so low it would depress potential sale prices for the rest of the units. So they flexed the one muscle they had: the right of first refusal. They would reject the potential buyer and purchase the unit as a building investment.

Then they dropped the ball.

Like many condominium boards, the Westchester board was not completely versed in the technical nuances of the right-of-first-refusal bylaw. It failed to act within the specified time frame for voting on the issue and had to scramble to hire an attorney to rewrite the bylaw to give themselves more time. In the end, while the board purchased the unit and resold it for $150,000, it earned only $10,000 in profit, barely enough to cover all the headaches and costs involved.

Not being familiar with its own rules cost the board thousands of dollars in profit, says the condo's attorney, Ken Jacobs, a partner with Smith Buss & Jacobs. "In this case, the board members didn't understand all the extra steps that would be needed."

As more condominium boards are seeking to exercise control over the sale of units in their buildings - because the price is too low, because they don't like the buyer, because they need the space themselves - condominium attorneys are warning boards to read the right-of-first-refusal bylaw carefully, and perhaps amend it, so they have enough time both to stop a sale and raise the money needed to purchase the unit.

Although it is still rare for a board to invoke first refusal, "you have to be prepared, if you are going to do it," says Jacobs, which means boards need to have the money available and understand the deadlines under which they are working.

While the language varies from condo to condo, most of the bylaw's language is standard. The right of first refusal typically gives a board 20 days from notice of the sale to make a bid to purchase the unit for itself at the same price. Some boards have misinterpreted that to mean they have 20 days from the time they receive a completed application. Don't make that mistake, warns Jacobs, because misreading the timeline means the board can be sued for stopping a sale. The boards must also hold a meeting of the unit-owners so they can all vote on whether to buy the unit; again, time is critical and under the bylaw, the owners often have to vote before the board votes to exercise first refusal.

"The board has to make a very, very fast decision," observes attorney Bruce Cholst, a partner with Rosen & Livingston. "There are a lot of technical and procedural rules that have to be followed if a condo is going to exercise the right of first refusal, and there are often grounds for litigation over whether the board, in trying to exercise its right of first refusal, has properly abided by all the proper technical requirements."

Despite the potential sand traps, attorneys say that the current trend among condominium boards is to ask for as much information as possible from prospective applicants, and to use the threat of refusing to waive their right as a means of getting the information they want.

"What's happening is the condo board is saying, that in order for us to make an informed decision, we need the following information, and they ask for a wide scope of information - tax information, loan information - all the stuff a co-op usually asks for," observes Jacobs. "Some are even asking for an interview. If you say, 'Look, you're being too intrusive,' the condo board says, 'In that case, we can't tell you whether or not we are willing to exercise the right of first refusal.' Nobody has ever tested whether asking for all this information is, in fact, relevant. The hope, on the condo board, is somebody might get tired of the contract and say, 'We are not going through with this,' and then somebody else will come up who meets the condo board's standards."

So when is it appropriate for a board to exercise its right? Among the possibilities: if it has legitimate concerns about a potential applicant (for example, if it believes the applicant can't pay the common charges); if the unit is being put up for sale at a price that's dramatically less than its market value; or if the condominium needs the extra space (for a community room or housing for the superintendent).

More and more condo boards are invoking first refusal, because the building has either been "burned financially, or they are very concerned about who will be living there," observes attorney Mark Axinn, a partner with Brill & Meisel. Condo board members are growing increasingly wary of apartments that will be used on a transient basis, or that the person buying is not being forthright about who the occupants will be. "There are a lot of buildings that have a terrible problem with over-occupancy - many, many people living in small apartments - which puts tremendous strain on the building's resources."

But be warned, adds the lawyer: boards that look to turn the right of first refusal into a general "right of approval" may end up getting sued by an angry seller. "A lot of boards are overreaching, they are asking for things they don't have a right to. That's an area where there is a potential for litigation."

The best way to handle this sticky issue is for the board members to review the bylaw and consider amending it to give them more time to decide on whether to invoke it, and to consider laying out reasons why they would invoke it. Then, too, board members may want to consider having the power of proxy amended so they can hold a vote on exercising first refusal without holding a meeting of the unit-owners.

Boards need to move with caution, says Cholst, or "people might misconstrue the board's motives and challenge the board's authority. It should be done in coordination with counsel, because there are lot of technical procedures that have to be strictly complied with, which are always set forth in the bylaws, and the failure to comply with them could void the whole deal."

Adds Axinn: "It has to make good business sense for a board to exercise its right of first refusal, and it rarely does. I would say the rate of waivers versus exercise is probably 99 percent to 1 percent." So condominium owners who are worried that their sales may be delayed, shouldn't. Most boards don't want to deal with the headache of taking on a sale, and, points out Axinn, "not every board has hundreds of thousands of dollars available in its reserve fund to buy apartments."