The Ethical Path

You’d think this was a clear-cut, legally prohibited conflict of interest. Unfortunately, that isn’t the case. New York State corporate law does not require directors to be absent from a meeting dealing with a matter in which they may have a personal interest, nor does it mandate that they refrain from voting on those matters.

Section 713 of the New York State Business Corporation Law (“Interested Directors”) provides the rules for dealing with conflicts of interest. Under the law, if the “material facts” of the director’s interest in the transaction have been disclosed to the other board members and the vote in favor of the transaction is sufficient without the vote of the interested director, the decision is binding. If the vote in favor of the transaction carries because of the vote of the interested party, however, the co-op may set aside the transaction unless it can be shown that the transaction “was fair and reasonable to the corporation.”

In my opinion, the rules set forth in Section 713 do not adequately protect co-ops from potential abuses. Too often, I have heard of a broker who is a member of a board reviewing a purchase application from his or her own client; a managing agent sitting as a board member reviewing and supervising his or her own performance as agent; a lawyer on a board who represents clients in the building; or a board member who owns a “friendly” company that supplies goods or services to the building.

To deal with these situations, I have devised a code of ethics. It is designed to establish practical rules for issues pertaining to the need for confidentiality of information obtained by board members, and to set up prohibitions against personal profiteering from their service, through bribes, kickbacks, or other means. The code would be implemented by an amendment to the bylaws that would require, as a condition of qualification to serve, an agreement to be bound by the code. The bylaw amendment would also incorporate the provisions of the code into the bylaws. (The language of the bylaw amendment may be obtained from the Council of New York Cooperatives & Condominiums.)

The code of ethics follows, with my explanations, as needed.

CODE OF CONDUCT AND ETHICS FOR MEMBERS OF THE BOARD

Section 1 Introduction

I start the code with an introduction that essentially reminds you that once you’re elected, you enter a different milieu. You are now a fiduciary serving the entire corporation, looking out for the interests of all the shareholders. People don’t always get this. For example, the other night I was at a board meeting where a newly elected director essentially said, “Well, I want to continue my efforts lobbying for things I want done in the building.” I gave her a little speech about how she’s now a fiduciary owing allegiance to the interests of all the shareholders. I suggested that lobbying with specific groups should be tempered by that fact.

The wording for the section: “Each board member shall abide by the highest standards of ethics in the performance of his or her duties as a director. Each director is a fiduciary, owing allegiance to the interests of the shareholders of the corporation. A director shall not perform any act for his or her personal gain or benefit. A director shall not perform any act detrimental to the interests of the shareholders of the corporation.”

Section 2 Compensation

My ethical definition of what is meant by “compensation” is purposely left very broad. That’s to be certain that no one receives subtle forms of payback. I want a red line drawn that says that the trip to Las Vegas, paid for by the corporation, is not permitted; it is essentially a kickback. On a less grand scale, allowing the super to repair a leaky faucet when others are told to hire a plumber is a form of compensation, as well. That may be legally permissible, but it is ethically wrong. Board members are supposed to serve without pay – and that’s a form of pay. We’re adopting a higher standard than what is set forth by law.

The wording for the section: “As stated in the bylaws of the corporation, no director shall receive compensation for his/her service as a director. The term compensation shall include: (a) any economic benefit that may be received by the director (or by any designee or affiliate or relative of the director), whether direct or indirect; and (b) any economic benefit to any company or entity in which a director has any interest (whether direct or indirect); and (c) any gift, gratuity, rebate, or other consideration that may be received by the director (or by any designee, affiliate, or relative of a director) from any person or entity doing business with the corporation. Notwithstanding the foregoing, a director may own stock in any publicly traded company doing business with the corporation provided that such interest is disclosed to the board of directors of the corporation.”

Section 3 Qualification of Directors

Section 4 Voting

Serving on the board while also giving professional service to the building is a bad idea for any number of reasons. First, you can’t be objective in your board role. You have a clear self-interest when issues come up relating to your job. Of course, you can have a lawyer or broker serve, but he or she should say, “I’m not going to represent anybody in the building.” It is a clear conflict. Both Sections 3 and 4 deal with this issue.

The wording for Section 3: “The bylaws provide that no person shall be qualified to be a member of the board if such person: (a) is a real estate broker or salesperson and does not agree in writing to refrain from engaging in selling apartments in the building or participating in such sales, either directly or indirectly, as listing broker, co-broker, or otherwise as an economic participant in such sales; or (b) is an attorney and does not agree in writing to refrain from representing shareholders of the corporation in matters arising between the corporation and such shareholders; or (c) is a principal or owner of, or has a financial interest in, any company supplying goods or services to buildings and does not agree in writing that such company shall not be involved in any business with the corporation; or (d) receives any economic benefit of any nature, including any remuneration, gift, or other consideration, from any person, firm, or entity dealing with the corporation, as a result of, or in any way associated with, transactions involving the corporation, unless such economic benefit shall have been specifically disclosed to, and approved by a two-thirds vote of the disinterested directors prior to receipt thereof; or (e) has had a contract of sale entered into with respect to the apartment in the building owned or occupied by that director (provided that the director will not continue to own or occupy another apartment in the building or was not an owner or occupant at the time he or she became a director); or (f) is, as of the date of his proposed election to the board, in default with respect to any obligation to the corporation under the shareholder’s proprietary lease provided that the shareholder has received notice of such default and the period for cure of such default has expired.”

The wording for Section 4: “The bylaws of the corporation provide that no member of the board shall vote on any matter, or participate in the discussion of any matter, in which the member has a financial interest, other than a general interest as a shareholder or proprietary lessee of the corporation. The term ‘financial interest’ shall include, without limitation, any of the following situations: (a) interests as an owner, agent, or principal of, either directly or indirectly, or otherwise possessing a financial interest of any nature in or with, any company or other entity, in any way involved in the subject of such vote; (b) interests as a party involved in any manner in the transaction being voted upon, including, without limitation, as a broker in any way involved in the sale or listing for sale of an apartment in the building; (c) interests as attorney for, or other legal representative of, any shareholder or any other party being the subject of such vote or discussion. The bylaws also provide that the board may, by majority vote, require that a director be recused from participating in any discussion or voting on any matter, when the board determines that there is a conflict of interest between the interests of the director and the interests of the corporation or that such a conflict of interest reasonably appears to exist.”

Section 5 Dealings with Contractors and Vendors

The next section is designed to deal with kickbacks. It essentially says, “Bid the job out without any collusion.” This has to be spelled out because most of the boards simply leave it with their managing agent and don’t realize what is happening. You don’t want anyone having pre-bid conferences, for instance, because those can be a venue for improper actions: Contractor A goes in a pre-bid meeting with some of the board members or the manager and they work out what he’s going to bid to win.

In Section D, I have carved out an exception to the three-bid rule for practical reasons: if you want $200 worth of supplies, you may not need to get three bids. I usually put the ceiling at $500. Sometimes, the manager gets a little angry with that because he or she thinks that ordering $2,000 worth of plastic bags should not require the approval of the co-op. But I have seen plastic bag contracts that were so sloppy that bags for Building A were delivered to Building B and paid for by Building A. So I want the board to be involved in as much as they can.

The wording for the section: “The following requirements pertain to the selection of a contractor or supplier of goods or services to the corporation. Each director shall comply with the following requirements: (a) No director shall have any dealings with any prospective contractor or supplier of goods or services to the corporation prior to the solicitation of bids from prospective contractors or suppliers unless the full board is advised thereof in writing in advance of any such dealings. (b) No director shall have any financial relationship whatsoever with any contractor or supplier having any business with the corporation without the prior written consent of the board, given only after full written disclosure to the board of all facts concerning such relationship. (c) The board shall maintain a list setting forth each prospective contractor or supplier to whom request for bids are to be sent and shall include as prospective contractors any firm requested by any director. (d) Solicitations for bids for work, goods, or services involving more than x dollars [an amount set by the board] shall state that all bids will be sealed, which will be opened at a specified time and place. (e) All directors shall be advised of the time and date of opening of sealed bids and any director may attend such bid opening. (f) Information concerning any pre-bid site meeting for potential contractors will be broadly disseminated by the board and each director will be advised of the time and location of such meeting. There shall be no communications by directors with prospective contractors prior to opening bids unless in writing, authorized by the board in advance of such communication. (g) Under no circumstances will any director advise any prospective contractor or supplier of any information whatsoever concerning any other prospective contractor or supplier, including the identity of other contractors or suppliers or confirmation of receipt of bids from other contractors or suppliers, or of any information pertaining to matters in negotiation or litigation with contractors or suppliers. (h) The officers of the corporation shall advise the board of the method utilized to identify potential contractors and suppliers and will advise the board of the identify of all potential contractors and suppliers who are reviewed and identity any reasons for disqualification of any contractors or suppliers who are deemed not qualified to submit bids. (i) Any negotiations concerning the selection of a particular contractor or supplier shall be conducted only by authorized officers or agents of the corporation with the specific authorization of the board after full disclosure to the board of the issues to be negotiated and no director shall disclose any terms of any matters to be negotiated to any third party. (j) No director shall, without the prior written agreement of the board, accept or receive any fee, gratuity, gift, or any other consideration whatsoever from any contractor or supplier who is solicited to bid for the performance of any services for the corporation or provide any materials to the corporation.”

Section 6 Proprietary & Confidential Info

Everyone deserves privacy. Just repeating that Pavel Chekhov, a famous opera singer, makes $50,000 an appearance, is bad. It’s gossip. Second, misusing information for private gain is worse. For instance, you are on the board and work for the same company that a potential buyer works for and suddenly you know how much he earns – and decide to use that in your next pay raise negotiation. That may not be illegal, but it’s wrong. Third, if you start talking about the negotiations on a contract with electricians to rewire the building, the person you’re gossiping with may have a relationship with a different contractor and can feed information out that may be relevant. Information you get is sensitive and can be abused. If you open your mouth, you don’t know where what you say is going to go. It could come back and hurt the co-op financially.

The wording for the section: “No information obtained by a director as a result of his service as a director shall be used for the personal gain or benefit of an individual director. Such information shall not be disclosed to any third party. Information from and about prospective shareholders of the corporation in connection with their applications for approval of the board of directors is strictly confidential and no portion or part thereof shall be disclosed to anyone. Directors shall, to the maximum extent possible, recognize that discussions at meetings of the board of directors are confidential and that the opinions expressed by board members and the proceedings of the board should not be disclosed to third parties.”

Section 7 Status of Directors as Shareholder

and Proprietary Lessee

This section addresses preferential dealings by board directors for their own apartments or beliefs. For example, I knew a board where a director wanted to spend $50,000 of the co-op’s money to set up a special elevator that he would be able to use on the Sabbath. You could say it benefited all the Orthodox Jews in the building, but should the board spend that much money for a handful of people? It’s tricky because everything that the board deals with is someone’s special interest.

Nonetheless, some things are more obvious: like the temptation for a board member to say to his colleagues, “I’m refinancing, you don’t need to do the usual review of my economics that you might do to somebody else and therefore you should rubberstamp my approval because I’m on the board.” Or, take another situation, where a director might say, “I don’t understand all these legal requirements for review in the recognition agreement. Why don’t you, Mr. President, just sign it to save me the recognition agreement review fee?” But the only person who should be making that determination is the board’s attorney because there are procedural steps that have to be taken with recognition agreements.

The wording for the section: “Directors shall avoid using or appearing to use their position as a director to obtain preferential treatment from the corporation in their status as a proprietary lessee of the corporation. No director shall seek to deal with the managing agent of the building or the building superintendent or building staff other than in the same manner as is provided for all proprietary lessees in the building’s operations guidelines. Directors shall strictly comply with all applicable building policies and procedures, including, without limitation, obtaining all necessary board approvals of refinancings, and sublets, legal approval of all documents to be executed on behalf of the corporation (such as recognition agreements with lending banks), execute appropriate corporate forms of alteration agreements when appropriate, and pay all late charges, legal fees, and other charges required of shareholders.”

Section 8 Disclosure and Waiver

These ethical guidelines are not absolutes. If you have full and adequate disclosure, some of these provisions can be waived. For instance, you’ve gotten 10 quotes on supplying plastic bags to the co-op and director Ed Platt is a manufacturer of plastic bags. And he says, ‘Look, I can get you these much cheaper.’ You’ve done your due diligence, you’ve gotten other quotes. Platt is prepared to do it for a lower price than the others and he then leaves the room voluntarily and does not participate in the discussion of his offer. Now, there’s no prohibition in the law about an interested director participating in a discussion. So, I’m raising the stakes here and I’m saying when it comes up he should leave the room and not vote. You’re okay as long as you’ve created the red line and say, “We now know that we’re in an ethically difficult area and we choose to waive it,” and keep the interested director from participating in this discussion or voting.

The wording for the section: “Directors shall disclose any matters involving the corporation in which they may have any direct or indirect interest other than as a shareholder or proprietary lessee. It is recognized that there may be situations in which application of the rules set forth herein may not be in the interest of the corporation. Waivers of any of the foregoing rules may be given by vote of the board, provided that the director seeking the waiver fully discloses all of the circumstances that raise the possible conflict of interest and does not participate in the discussion or vote concerning the waiver request.”

Section 9 Violations of the Provisions of the Code

Section 10 Consent and Agreement

These last two provisions are important because removing a director is very tricky. You can always remove a director for what is called “legal cause.” But it’s very hard to define that without a code of ethics. So, here we’re trying to define what is legal cause. A violation of any of these provisions should be sufficient legal cause.

The wording for Section 9: “In the event any director receives any financial benefit prohibited by the terms of this code, such director shall be liable to corporation for the amount of such benefit and shall pay that amount to corporation upon demand. The violation by any director of any of the foregoing provisions or any undertaking made in compliance with the foregoing provisions shall be grounds for removal of such director for legal cause by majority vote of the board or shareholders.”

The wording for Section 10: “Under the terms of the bylaws of the corporation, each director shall agree to be bound by the terms of this code as a condition of his election and shall sign a copy of this code to confirm such agreement.”