Misusing Business Judgment

May a co-op board use the business judgment rule to justify its actions when it enters into a business transaction with a shareholder and then fails to perform? This question was answered in the negative in Rouette v. One West 126th Street Housing Development Fund Corp. where arguably the co-op board breached its contractual obligation to exchange apartments with a shareholder.

Plaintiff Rouette was a shareholder and proprietary lessee in premises owned by the defendant co-op and managed by its board of directors. Under contracts of sale dated April 29, 2003, Rouette agreed to sell his current apartment to the co-op and the co-op agreed to simultaneously sell another apartment on the same floor to Rouette. By their terms, each of the contracts was contingent on the other; in other words, Rouette was essentially exchanging one apartment for another. Eventually, the parties set October 17, 2003, as the closing date for the transactions. It was undisputed that the closing did not take place and the plaintiff still occupied his old apartment.

Rouette brought this action seeking relief, arguing that the board had breached its obligation under the contract of sale by refusing to close. By an order to show cause dated December 4, 2003, the court issued a temporary restraining order preventing the board from selling or transferring the unit and requiring that it be maintained. It also restrained the board from terminating Rouette’s rights in his current premises.

Rouette moved for a preliminary injunction pending resolution of this action for the relief granted in the aforementioned restraining order. The board opposed the application, arguing that Rouette breached the sales contract by failing to allow the premises to be inspected before the sale and that its actions should be judged under a “business judgment rule” standard based on the Court of Appeals decisions in Matter of Levandusky. In the court’s view, the board’s arguments were unpersuasive. The court granted Rouette’s application for a preliminary injunction pending resolution of this action.
To secure injunctive relief, the court said that Rouette had to demonstrate “(1)  that it is likely ultimately to prevail on the merits; (2)  that it will suffer irreparable harm without the preliminary injunction; and (3)  that, on balance, the equities are in its favor.”

As to the issue of irreparable harm, the court noted that paragraph 13 of the contracts of sale provided that the purchaser shall have such remedies as he is entitled to at law or in equity, including but not limited to specific performance because the unit and possession thereof could not be duplicated. Although specific performance was not an exclusive remedy under the contract, the unit was located in the same building where Rouette lived and owned residential apartments.

Further, the court concluded that a balancing of the equities favored Rouette. Although an injunction would prevent the co-op from reaping an immediate return by selling the apartment to a third party, had it not breached its implied covenant of good faith, the closing would have taken place and defendant would have already received its compensation. The court said that the foregoing principles were applicable in this matter where the contract of sale provided for the remedy, and the board had failed at this stage of the litigation to allege sufficient grounds to find that Rouette engaged in conduct aimed at frustrating the contract.

Rouette had also sustained the burden of demonstrating a likelihood of success on the merits. The board’s only defense to Rouette’s contractual claims was that Rouette had failed to allow the co-op to inspect his current apartment before the closing. However, the affidavits of board members Barbara Adger and Tamara Pierson submitted in opposition to this motion did not support this argument. Those affidavits state that on October 16, 2003, at 4:20 P.M., one day prior to the scheduled closing, Adger and Pierson went to Rouette’s apartment to do an inspection but received no answer. Following this, there ensued a series of telephone conversations during which Rouette stated that the apartment would be available for inspection between 8 and 9 P.M. on October 16, 2003, or between 1 and 4 P.M. on October 17, 2003. The board members argued that they were not able to inspect the apartment at those times and that it was too close to the closing which was scheduled for 4 P.M. on October 17, 2003.

The contract of sale for Rouette’s current apartment stated at paragraph 21 that “Purchaser and Purchaser’s representatives shall have the right to inspect the Unit within 48 hours prior to Closing, and at other reasonable times upon reasonable request to Seller.” The court said that it was acknowledged by both parties that the board members made no attempt to contact Rouette to arrange a mutually convenient time to inspect the apartment prior to simply appearing at Rouette’s doorstep the day before closing. The co-op also admitted that Rouette agreed to make the apartment available at least three hours prior to the closing.

In the court’s view, these facts weakened the board’s argument that Rouette breached the agreement by unreasonably refusing to allow the co-op to inspect the apartment, and thereby justifying the board’s refusal to close on the sale. In the absence of such justification or other defense, Rouette was likely to prevail on the merits of its contract claims and therefore was entitled to an injunction.

The court further noted that the contract of sale provided that Rouette should purchase the premises in an “as is” condition as of the closing date, April 29, 2003, thus providing support for Rouette’s application to have the premises maintained in such condition.

In the court’s view, the co-op’s reliance upon the Court of Appeals decision in 40 West 67th Street v. Pullman was misplaced. In that case, as in Levandusky, the court held that a court could not review actions taken by a co-op board when the board acted in good faith for the purposes of the co-op within the scope of its authority. However, the court in Pullman specifically referred to a number of cases where courts “withheld deference in the face of evidence that the board acted illegitimately.”

Among the cases cited by the Court of Appeals was the First Department’s decision in Dinicu v. Groff Studios Corp. where the court held that the business judgment rule did not protect a co-op corporation from liability for breach of contract. In this case, the board, by entering into contracts of purchase and sale with Rouette, subjected itself to possible liability with respect to those contracts under standard contract principles to which the business judgment rule was inapplicable. The court held that the defendants could not circumvent their contractual responsibilities by attempting to resort to procedures available to them under the business judgment rubric applicable to relations between co-op boards and shareholders.
Accordingly, the court ordered that Rouette’s motion for a preliminary injunction was granted and further ordered that the defendants, and persons acting under the jurisdiction, supervision and/or direction of defendants, were enjoined and restrained, during the period of this action, from (1)  contracting for the sale or rental of, renting, allowing a tenancy to be formed in, or in any manner encumbering or disposing of Unit 5C located at 1 West 126th Street; and (2)  terminating any rights of plaintiff as to Unit 5A located at 1 West 126th Street; and (3)  failing to maintain Unit 5C located at 1 West 126th Street, New York County, in at least the same state and condition of repair in which it existed on April 29, 2003.

Comment: This case illustrates a co-op board’s misuse of the business judgment rule standard of review from the Levandusky case to justify its action. The rule only protects board decisions within the scope of the board’s authority taken in good faith for legitimate business purposes of the co-op. It does not permit the co-op to breach its contractual obligations to buy and sell a co-op apartment with one of its shareholders.