In the Beginning Was the Word

Stuart Saft is a partner in the law firm of Wolf, Haldenstein, Adler, Freeman & Herz.

Can your cooperative or condominium afford to repay thousands of dollars to former shareholders? It’s not an idle question. After a lawsuit, the Hotel des Artistes, a cooperative on the Upper West Side of Manhattan, was forced to repay several former shareholders almost $350,000 because the board was collecting a sublet fee that had not been incorporated into the corporation’s proprietary lease – even though it had been enacted by a majority of the tenant-shareholders.

There are other examples, also drawn from life. What if you were on the board of the building in which a shareholder’s Picasso was damaged by a leak – how would you feel about shelling out several million dollars for the painting? Or, perhaps you are on a board that gets sued and find that your indemnification provision does not cover legal fees, forcing you to spend tens of thousands of dollars of your own money?

If any of these issues bother you, perhaps you should carefully examine your proprietary lease and bylaws to make certain that you are operating according to their terms and that the two documents reflect modern legal practice.

Twenty years ago, when most New York co-ops were formed, there was little litigation involving cooperatives and none involving condominiums (because there were no condominiums). Most co-ops were on the Upper East and West Sides of Manhattan and few had reason to litigate.

However, when the great co-op explosion started in the early 1980s and continued through the decade, thousands of buildings were converted and suddenly the words “cooperative” and “luxury” were no longer synonymous. The sudden and substantial growth of cooperatives, particularly in moderate- and lower-priced housing resulted in an increased amount of litigation over maintenance. Housing court judges were asked to interpret corporate documents in which the landlord and the tenant were the same or, in the case of condominiums, there were no landlords or tenants. The result was a huge increase in litigation covering every aspect of the relationship. Soon, decisions started coming out interpreting every nuance of the cooperative’s proprietary lease and bylaws and the condominium’s declaration and bylaws.

Those documents, which guide the relationship between the owners of the housing units and their boards, were not created by the sponsors with a great deal of thought as to how the building would operate. Rather, they were an afterthought, and whatever document was on the sponsor attorney’s word processing system was included in the offering plans. They were never intended to be permanent; they were only meant to enable the sponsor to sell apartments. In many instances, they were outdated before they were used and now, 20 years later, with so much litigation over the relationships and the meaning of the documents, they are downright ancient. And that’s not an esoteric point. Every outdated or incorrect provision in your corporate documents could result in a judgment against your cooperative or condominium of hundreds of thousands of dollars. Even if you win the litigation, you could still face thousands of dollars of legal fees over an interpretation of an ambiguous sentence.

Revising the Lease

Now that I have your attention, I suppose you are probably asking what ambiguities need to be corrected. Certainly, every proprietary lease and set of bylaws is different, but there are a number of similar problems in all the older documents, including the following:

1. Term If your proprietary lease has a remaining term of less than 35 years, you could have difficulty obtaining financing. If you let your proprietary lease expire, you cease to be a cooperative.

2. Lessor’s Repairs Is the provision sufficiently specific, or does the lease just provide that the lessor is responsible for anything that the lessee is not responsible for doing? If you get into a dispute with a shareholder over an important provision that basically says that the corporation is responsible for anything not covered by paragraph 18, will you be obligated to make expensive repairs that the lessee should make?

3. Damage to the Apartment Does the paragraph cover leaks from outside the building or from another floor? If it does not, then who has to pay for repairing the leak and the damage that resulted?

4. Terrace and Roofs If shareholders have roof space, are they responsible for any damage they might inflict on the roof or terrace floor, which is part of your roofing system? If the lease is not specific, then you may have to pay to correct a problem caused by a negligent shareholder or a bored child.

5. Late Fees Does your lease provide that the shareholder has to pay “promptly”? If not, then does the lessee have to pay the maximum fee permitted by law? If those provisions are in your lease, you may have to litigate over the definition of “promptly,” and the maximum rate of interest is 9 percent per annum. Unless your lease is more detailed, you will not be able to collect a dime more.

6. House Rules Does your lease contain a mechanism to enforce the house rules, or do you have to rely on the good faith of your fellow shareholders?

7. Use of Premises Is your lease written so broadly that the board has no control over who can live in the apartment? Are you going to have to deal with the teenage children of a shareholder or an out-of-town “cousin” who is going to make noise all night long?

8. Subletting If you have a sublet fee, you can only collect it if it is specifically provided for in this paragraph. Don’t allow yourself to become the subject of the next Hotel des Artistes-type lawsuit. Also, can the board limit sublets? Do you want transients in the building?

9. Assignment Unless your transfer fee or flip tax is included here, then it is not legal and should not be collected. The board does not have the right to reject a purchaser unless that right is specifically contained in this provision. There is no natural right to reject purchasers – that right has to be granted to the board.

10. Repairs by the Lessee Does the lease provide that the lessee is acquiring the apartment in an “as is” condition, or are you leaving yourself open to a claim by a buyer that the board has to prepare the apartment for the buyer? Is the lessee who replaces a building system responsible for any repairs to that system or any damage to other portions of the building? If not, you could be responsible for those repairs.

11. Alterations Is a lessee allowed to make all alterations, or is he/she required to have them approved by the board and the lessee made responsible for any damage to the building caused by the alteration?

12. Right of Entry If a lessee refuses to leave a key with the superintendent and the board has to gain entrance to the apartment, is the lessee responsible for reimbursing the board for its expenses?

13. Reimbursement of Lessor’s Expenses If the lease provides that the lessee has to reimburse the lessor for its legal fees after a default, then the board will probably not be reimbursed because you would first need a finding that a default occurred.

14. Lessee’s Insurance Does your lease require the lessees to maintain insurance on their apartments? If not, you could be exposing yourself to unnecessarily high bills in the event of an injury or damage in an apartment.

15. Indemnity If a lessee uses a building employee for private work in the apartment, is the lessee responsible if the employee is injured? If not, the corporation could be exposing itself to unnecessary risk.

Revising the Bylaws

1. Annual Meeting Do the bylaws accurately reflect when the annual meeting should be held, or do they refer to a different part of the year because that was the date the sponsor used, which bears no relation to reality?

2. Inspectors of Elections Do the bylaws require the appointment of an inspector? If so, do the bylaws also specify his or her duties?

3. Fixing of Record Date Do the bylaws provide who has the right to vote the shares if the shares have been transferred before the meeting?

4. Voting by Two or More People Do the bylaws indicate how the corporation should act if the shares are held in the name of more than a single shareholder and they disagree as to how to vote the shares?

5. Directors Do the bylaws permit non-shareholders or shareholders who are significantly in arrears to serve on the board? Can a shareholder and his or her spouse serve at the same time?

6. Nominations Do the bylaws contain a mechanism for nominating directors or is it haphazard?

7. Resignation Can defaulting directors or directors who fail to attend meetings be removed, or do all removals require a vote of the shareholders?

8. Meetings Can meetings be held by conference call or only with the physical presence of the directors?

9. Confidentiality Do the bylaws limit what directors can say until the board agrees to release the information?

10. Conflicts of Interest Do the bylaws describe conflicts by board members and provide mechanisms for dealing with them?

11. Indemnification This is the single most important change that must be made. In 1988, the New York State Legislature amended the Business Corporation Law, increasing the indemnification available to board members to reduce lawsuits against board members. If your bylaws do not contain the current language, your personal assets may be at risk.

If your answer to any of these questions is “no,” it could cost you and your cooperative hundreds of thousands of dollars in legal fees and refunds. There are only two documents contained in the hundreds of pages included in the offering plan for your apartment: the proprietary lease and bylaws for a cooperative and the declaration and bylaws for a condominium.

The rest of the 400 pages is part of the sponsor’s selling tool and has no relevance after the closing. It is imperative that you make certain that those two documents are updated to reflect all the changes that have occurred in the last 20 years.