When Fiduciary Duty Is Breached

In Cohen v. Seward Park Housing Corp. , a court refused to grant a motion to dismiss a complaint where shareholders were denied the right to buy an additional apartment in the co-op in which they currently were shareholders.

Plaintiffs Daniel and Malki Cohen were shareholders of the Seward Park Housing Corporation. According to their complaint, the Cohens were Orthodox Jews who had lived in the Seward Park Apartments for over 13 years. Their application to purchase apartment C402, which adjoined their current unit, was denied by the cooperative board in 2001 and again in 2002. The Cohens’ complaint alleged causes of action for breach of fiduciary duty, breach of contract, and unlawful discrimination based on religion.

The Cohens owned the shares and have proprietary leases for Apartments C503, C502, and C403. According to the co-op, in addition to being a shareholder, Daniel Cohen served on the board of directors for eight years and was a commercial tenant with storefront space in the apartment complex. In February 2001, the Cohens entered into a contract to purchase the shares and proprietary lease for Apartment C402 for $160,000 from the estate of Milton Greenberg. Apartment C402 was contiguous to other apartments already owned by the Cohens. The Cohens sought to add it to their existing space for living purposes.

In March 2001, the Cohens submitted their application to the cooperative board. On about April 5, 2001, the board asserted a “right of first refusal” with respect to the contract on the ground that the purchase price was too low or not within the market range for such apartments. Daniel Cohen averred that the board’s use of the “right of first refusal” was a tactic that was no longer employed because the board was advised that it violated the shareholders’ rights to freely buy and sell apartments. The Cohens claimed that the price was within the fair market price.

Sometime in December 2001, Daniel Cohen and board president Donald West discussed the fact that the apartment was still vacant and available and the Cohens were told to submit a written offer. On about January 28, 2002, the Cohens delivered such an offer of $190,000, a price within the fair market, and were prepared to propose a higher price if the board requested it. The board apparently rejected the offer, but never informed the Cohens. The Cohens only learned that apartment C402 had been sold (in May 2002 for $230,000) when they overheard construction work being done.

In their lawsuit, the Cohens alleged that the board had acted in a discriminatory manner, in bad faith, and without a legitimate purpose. They had never been in default on their maintenance or other obligations with respect to any of the three apartments they own in the Seward Park Apartments and have “excellent financial qualifications.” They noted that the board had approved other applications by shareholders and residents to purchase similar apartments at prices equal to or below the market price, and allowed certain shareholders and residents “who have personal relationships with particular board members” to purchase apartments at below market rates without asserting a right of first refusal.

Moreover, there were “well over a dozen multiple-residences of similar size” in the cooperative complex, and one board member owned four apartments and was approved to purchase a fifth after the Cohens’ application was rejected. In addition, West and other members of the board allegedly held “personal animosities” against the Cohens, and some of the board members “discriminated generally against Orthodox Jewish residents and shareholders.” The Cohens sought a total of $3 million in damages for the claims of breach of fiduciary duty, breach of contract, and discrimination based on religion.

In its ruling, the court said that on a “motion to dismiss,” the law requires the court to accept all the facts alleged in the complaint as the truth. The court had neither knowledge of, nor an opinion of, whether the board or any of its individual members has acted in a manner that discriminated based on religion. However, the court said that the Cohens must be accorded the “benefit of every possible favorable inference,” and the court’s role at this juncture was only to determine “whether the facts as alleged fit within any cognizable legal theory.”

Where the grounds for dismissal were founded upon documentary evidence, the court said that “the documents relied upon must resolve all of the factual issues as a matter of law” or dismissal will be denied. In order for a defendant to prevail on a motion to dismiss, it must convince the court that nothing the plaintiff can reasonably be expected to prove would establish a valid claim.

Here, although the defendants proffered many varied documents – including minutes from various board meetings, portions of the proprietary lease and the bylaws, certificates for the apartment shares owned by the Cohens, the assignment and bill of sale and the Cohens’ lease for the commercial store – the documents did not resolve all the factual issues at hand. Therefore, the court was compelled to deny the co-op’s motion to dismiss the complaint.

Citing several cases from the appellate division involving rejected cooperative buyers, defendants argued they did not owe the Cohens a fiduciary duty, because as purchasers of shares and the proprietary lease for apartment C402, the Cohens were technically strangers to the board and had no standing to sue. They were “mere contract vendees” and not parties or third-party beneficiaries of the proprietary lease between the cooperative and the owner of the contracted-for shares. The courts in prior decided cases also explicitly found that there had been no showing of bad faith on behalf of the cooperatives, nor evidence of self-dealing. The defendants also contended that the Cohens had failed to state their claim of breach of fiduciary duty with the required particulars.

Relying on Bernheim v. 136 East 64th Street Corp., the Cohens argued that because they were existing shareholders, defendants did in fact owe them a fiduciary duty. In Bernheim, the appellate division reinstated a claim for breach of fiduciary duty because there was a question of good faith rejection of the Cohens’ application as the Cohens were shareholders of the co-op.

While it was true that the allegations set forth in the complaint were stated in general terms, it was clear to the court that the Cohens had clearly alleged that the board had refused to sell the apartment to them, shareholders in good standing, who raised their initial offering price and expressed a willingness to pay even more. They had further alleged with specificity that the decision to keep the apartment off the market for more than a year before selling it without informing the Cohens was not done in good faith.

Regardless of whether the Cohens had standing to sue, the co-op further contended that dismissal of this cause of action was required because the board’s decision to reject the Cohens’ application was shielded from court review as it fell within the board’s business judgment in furtherance of proper corporate purposes. The court of appeals established the parameters of judicial review of board actions in Levandusky v. One Fifth Ave. Apt. Corp.

So long as the board acted for the purposes of the cooperative, within the scope of its authority and in good faith, based on Levandusky, the court said that courts will not substitute their judgment for the board’s. Stated somewhat differently, unless a resident challenging the board’s action is able to demonstrate a breach of this duty, judicial review is not available.

Levandusky requires a plaintiff challenging an action by a board of directors to demonstrate a breach of the board’s fiduciary duty. Thus, the court when reversing the denial of summary judgment and dismissal of the complaint in Jones v. Surrey Co-op. Apts., Inc., explained that, “without a showing of a breach of fiduciary duty to the corporation, judicial inquiry into the actions of corporate directors is prohibited...inquiry into claims of fraud and self-dealing is permitted only where a factual basis exists to support such a claim.”

The co-op contended that the Cohens’ resort to conclusory allegations, such as the one that the board president and other board members illustrated “personal animosities” toward them. Such allegations were explicitly characterized as legally insufficient in Levandusky, and argued that the complaint accordingly failed to state a cause of action.

Here, however, the court said that the Cohens had not simply asserted that the board held personal animosity toward them but had set forth circumstances, which, if true, showed a board seemingly unwilling to allow them to buy the apartment they wanted at any price. They alleged that their application was treated differently from others, since other apartments sold for prices similar to what they had offered, and that a board member had been given approval to buy a fifth apartment. In the court’s view, a showing of unequal treatment was sufficient to allege bad faith.

Moreover, it should be noted that Levandusky was distinguishable in terms of its procedural posture. In the pre-discovery stage of litigation, it is inappropriate to dismiss a claim by invoking the Business Judgment Rule, given that the Cohens had set forth more than conclusory allegations concerning defendants’ fiduciary duties. Accordingly, defendants’ motion to dismiss the first cause of action was denied without prejudice to renewal upon completion of discovery.

The co-op moved to dismiss the second cause of action on the same grounds stated above concerning the breach of fiduciary duty. The board also said that the Cohens had not articulated the provisions of the contract allegedly breached. According to the complaint, the contract at issue consisted of the documents between the shareholders and residents and the co-op. Here, the bylaws set forth the duties of the board of directors, forbid the misuse of corporation information, and set forth the procedure for the right of first refusal. The Cohens did not allege that the board of directors misused information when it did not deny their application, nor did they argue that the right of first refusal procedure was carried out improperly.

Accordingly, since the Cohens failed to establish a separate breach of contract claim apart from their claim for breach of fiduciary duty, the co-op’s motion in this area was granted. The second cause of action was dismissed.

The Cohens’ third cause of action was based on a violation of New York Executive Law, Section 296(5)(a), which made it unlawful to refuse to sell real property to a qualified person on the basis of his or her “creed.” To prevail, the court said that a plaintiff had to first prove, by a preponderance of the evidence, a clear case of discrimination. If the plaintiff succeeded, the burden shifted to the defendant to articulate a legitimate, nondiscriminatory reason for its actions. If the defendant succeeded, the plaintiff then had to prove, by a preponderance of the evidence, that the legitimate reasons offered by the defendant were not its true reasons, but were a pretext for discrimination.

Here, bearing in mind that in this procedural context, the court’s focus was to examine the allegations of the complaint before it, while accepting them as true, the court held that the Cohens clearly had standing to bring a claim based on religious discrimination. They belonged to a protected class of persons: Orthodox Jews. The co-op argued that this cause of action must be dismissed because the Cohens had asserted only that the board’s president had a “personal grudge and animosity” toward Daniel Cohen, and that he and other board members had “personal animosities against the Cohens,” and “discriminated generally against Orthodox Jewish residents and shareholders,” but without setting forth specific factual allegations that would tend to substantiate their claim. However, in this early stage of the litigation, it was sufficient in the court’s view for the Cohens to allege that they were denied the shares for the apartment based on the board’s animus to Orthodox Jews.

The court said that defendants should answer the complaint, and the Cohens permitted to undertake discovery. It was simply not the role of the court at this juncture to evaluate the truth of the Cohens’ allegations. The board may well defend this action by answering that it simply wanted to sell the apartment for the best price. However, it was simply too early at this juncture to evaluate whether this defense constituted a neutral reason for its actions and, if so, whether the reason was pretextual in nature.

The court concluded that the co-op would be free to renew its motion to dismiss after they answer and after there have at least been depositions of the parties. Accordingly, the branch of the motion that sought dismissal of the third cause of action was denied.

Comment: To win a case on a motion to dismiss the complaint is not easy. The motion looks solely to the complaint and assumes that all of the statements therein are true. In such instance, trial judges are reluctant to grant the relief sought – preferring to view additional evidence to be developed in the case by both sides. A party making a motion to dismiss the complaint – not to be confused with a motion for summary judgment which addresses the complaint, the answer, and other evidence – usually must be highly confident of its legal position.