The Sponsor Votes

Who controls your cooperative board? Many buildings have been subject to litigation over time as residents have fought sponsors for control of their boards. The decisions have never been very clear, but perhaps the courts are becoming more sympathetic to residents.

Years ago, sponsors attempted to keep control of the board for years, even when they continued to own very few shares. The attorney general’s office tried to put a stop to this, prohibiting voting control by sponsors after 50 percent of the shares were sold. Since late 1982, the cooperative conversion regulations of the attorney general’s office have gone further, providing that non-eviction offering plans may not permit sponsors to have voting control after five years, even if the sponsor still owns a majority of the shares.

The term “voting control” is unclear. Does it mean the sponsor can’t designate a majority of directors, nominate a majority, or vote for a majority? The regulations might even conflict with the basic requirement of corporate law that, unless the certificate of incorporation says otherwise, every shareholder is entitled to one vote per share.

Initially, the courts didn’t permit a conflict to occur. An appellate court in 1991 decided that “voting control” meant that if the sponsor owned a minority of shares, it could designate a minority of the seats on the board of directors and still vote for the remainder. Thus, if the sponsor had a friend in the building, or moved in one of its employees, or sold a few unsold shares to an ally, it might maintain effective control indefinitely with a solid block of votes. Therefore, tenant-shareholders gained little benefit from the restriction on “voting control.” The attorney general’s office was satisfied because it stated it didn’t want to stop sponsors from voting, only from designating a majority of the board members. In other words, the restriction really wasn’t on voting at all, but on designating board members without voting.

Some later cases have made this less distinct, and the words “voting control” have not been interpreted in a consistent fashion by all courts. If the sponsor does not have a majority of shares but does have a substantial minority, may it vote all its shares after designating a minority of the directors? Some courts have said, “yes,” because there is no way to prove the sponsor would have actual voting control. Other courts have excluded sponsor votes when they would put someone the sponsor favored over the top. These may be ignoring the basic requirement of corporate law.

More recently, the tide has begun to turn. In Matter of Visutton Assoc. v. Anita Terrace Owners (1998), the appellate division for Brooklyn, Queens, and Staten Island seized on language in an offering plan to change the balance. The court stated that the bylaws (written by the sponsor) provided that the sponsor could only vote its unsold shares for more than one less than a majority of the directors to be elected. In an election, the sponsor attempted to do what had become accepted practice: it designated a minority of the board of directors and proceeded to vote for the remainder. The inspector of elections refused to count the vote of the sponsor because, under the bylaws, the sponsor had agreed to vote for one less than a majority of the directors. The court agreed with the inspector of elections.

The court’s position means that the sponsor is essentially defeated by its own language in the bylaws. This language might now be considered differently than language that merely parrots the attorney general’s regulations. This goes well beyond the intent of the attorney general’s office, which only wanted to keep sponsors from designating a majority of directors. By limiting its right to vote in the bylaws, the sponsor has apparently given up its right to both designate and vote.

This is a key case. It was followed by other courts, including one that makes decisions covering Manhattan and the Bronx, although the decision hasn’t always been consistently followed. Perhaps the case has begun to open up the idea that this whole area should be thoroughly revisited. In any event, the terms “voting control” and “one less than a majority of directors” have now both been given definitions that ignore their plain meaning.

The interpretation of Visutton raises questions. Take a seven-member board, for example. If the plan specifically says the sponsor can designate up to three seats, and it can vote for one less than a majority, does the case really stand for the idea that the sponsor can appoint three directors, but not vote for anyone?

It appears that the thrust of the Visutton case, and decisions following it, mean that the courts are now trying to give purchasing shareholders more rights than the attorney general’s office originally wanted. It is possible that it was intentional that the attorney general’s regulations were not succinctly stated. The exact language of the cooperative conversion regulations says: “If the plan is presented as or amended to a non-eviction plan, sponsor and other holders 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.” Because this is a specific demand as to what must be included in an offering plan, if it were to be challenged in court by a sponsor, it might be thrown out entirely.

In other cases involving specific requirements of the attorney general to cure violations or remove asbestos, challenges to the authority of the attorney general were successful. That is because, for the most part, the attorney general only has the legal authority to require full disclosure in offering plans not to mandate what they contain. Thus, the attorney general’s office often tries to get what it can. If substantive requirements aren’t challenged, it is satisfied. (It didn’t even include the same requirement for condominium offering plans, requiring only the plan to include a “special risk” if the sponsor may keep control longer than five years.)

How should the tenant-shareholders deal with this issue? Of course, it is important to read the documents carefully with your attorney to see how the language in your building’s documents will probably be interpreted. If there is a good chance of success, litigation is a possibility. The expense, however, is daunting, so you may want to look at other choices. Among them:

(1) Communicate with the sponsor or holder of unsold shares. Since any court’s interpretation is not a sure thing, both sides have an incentive to compromise. Boards often jump into hostile relations with sponsors that seem to last forever. Other times, gradual turnover in the board and a mellowing in the sponsor’s attitudes provide an opportunity to change the dynamics of the relationship. Sometimes, wise sponsors and holders of unsold shares see how a board operates and have no interest in taking control. A novice sponsor sometimes feels the board would go on a spending spree, which would raise maintenance and make it harder for the sponsor to sell. An experienced sponsor often realizes the board is cheaper than the sponsor would be. Still, in a mixed-use building, conflicts between the tenant-shareholders and the sponsor and/or commercial shareholder can be profound. Agreements as to what should be controlled and how can be difficult.

(2) Organize the tenant-shareholders. Make sure you know all the nominees for board seats well. If there is a conflict with the sponsor, speak to all likely candidates. Take the necessary steps to unify your votes just as the sponsor does.

(3) Examine amending the cooperative documents. If the sponsor is not truly in the majority but is merely controlling elections by a block vote, perhaps the control language in the bylaws can be changed by a vote of the board or a majority of shareholders, if it is not expressly prohibited. Examine the certificate of incorporation carefully. Under the business corporation law, that is the document that can be specifically changed to alter voting on a per share basis, or cumulative voting. Note, however, that amending the certificate of incorporation might have tax implications for the cooperative.

Recently, the attorney general’s office has proposed a revision to its regulations to add: “Disclose whether sponsor represents and provides in the bylaws that a majority of the apartment corporation board must be owner-occupants of the building or members of an owner-occupant’s household, who are unrelated to the sponsor or its principals, after the end of the sponsor control period.” This language only relates to disclosure, and only concerns new cooperative conversions. It is not beyond possibility, however, that it will someday lead to more litigation.