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Will the business judgment rule protect a co-op board when it rejects a shareholder’s application to purchase another apartment in the building? That was the question in Del Puerto v. Port Royal Owners Corp.

Plaintiffs Lisa Aguilera del Puerto, Fernando J. del Puerto, and Julia Aguilera brought an action for fraud, tortious interference with contract, and breach of fiduciary duty on the ground that the co-op board and board members did not treat them “fairly and evenly” compared with other similarly situated shareholders. The del Puertos moved for summary judgment on the breach of fiduciary duty claim. The co-op and board members opposed the motion on the ground that the criticized decisions were insulated from judicial scrutiny by the Business Judgment Rule. The board defendants also cross-moved for a summary judgment dismissing the complaints against them.

Del Puerto owned the shares allocated to Apartment 117 at the co-op, a residential vacation property in Montauk. The del Puertos alleged that in October 2001 they entered into a contract of sale with another shareholder, Rita Toole, to buy Apartment 217 for a purchase price of $55,000. In or about November 2001, Kathleen Sagona, a member of the board of directors, allegedly informed del Puerto that the board would waive the application fee for sale of 217 and would be “thrilled” if del Puerto purchased the unit. Sagona allegedly told del Puerto that the board had previously waived the application fee for a shareholder who had purchased another unit in the co-op. Del Puerto informed Sagona that she and her husband needed to purchase the additional unit because they were planning a family and needed extra space. Del Puerto also allegedly told Sagona that they planned to sell Apartment 117 once they purchased 217 and had a buyer for 117 “lined up.”

On November 13, 2001, the del Puertos mailed an application seeking board approval for the purchase of 217. They claimed that on November 24, 2001, they witnessed a couple enter 217 even though the unit was under contract to them. Toole confirmed that no one was authorized to be in it. A guest of a shareholder, however, stated that he had witnessed a board member, Esther Ruiz, inform someone that she had shown 217 to Jack and Miriam Olivero. On or about November 25, 2001, del Puerto spoke with Sagona regarding the status of her application and was told that not all of the board members had received a copy. Thereafter, on December 2, 2001, Sagona sent a letter to del Puerto requesting more information with respect to the financing for the purchase of 217 (del Puerto was obtaining a private loan), as well as the submission of an application fee.

On December 3, 2001, del Puerto spoke with Sagona via telephone regarding the pending application and her concerns that the unit was being shown to other prospective buyers. Del Puerto claimed that Sagona was “hostile” during this conversation, that she accused del Puerto of “blackmail,” and that she hurled insults at her. On December 6, 2001, del Puerto sent the board the application fee and financial documents it had requested. By a letter dated December 12, 2001, the board rejected del Puerto’s application. The del Puertos reacted strongly. They claimed that they were financially qualified to purchase the unit by reason of their combined income of $300,000 plus “substantial equity in Apartment 117 and other assets.” They also alleged that the Oliveros were interviewed by the board on January 5, 2002, despite not yet having signed a contract for the unit, and thereafter purchased the unit for $55,000.

The del Puertos claimed that either Ruiz or her boyfriend Jean-Pierre Kerr received a payment of $5,000 from the Oliveros, even though Kerr was not a licensed real estate broker and would not have been eligible for such a fee if del Puerto had purchased the unit. Allegedly, Ruiz and Kerr had been evicted from their home and were in “dire straits” financially. Del Puerto also asserted that Kerr had found a buyer for Sagona’s apartment, thereby allowing her to purchase another unit in the co-op. Finally, del Puerto claimed that Ruiz was a long time friend of the Oliveros.

With respect to the sale of the Toole unit to the Oliveros, their application to purchase was approved on or about February 4, 2002 and it closed on February 15, 2002. The del Puertos alleged that the Oliveros demanded that certain repairs be made subsequent to entering into the contract with Toole and, in response, Toole threatened to terminate the deal. However, a board member informed Toole’s attorney that Toole was to continue with the sale of the unit to the Oliveros or else they would not approve any other purchaser she found or interview any prospective purchasers for three months. The board also allegedly stated that it would require Toole to repair the bathroom floor of the unit and fine her for renting the unit. Toole allegedly informed del Puerto that she was forced to accede to the board’s demands as she “could not afford a legal fight.”

The del Puertos further alleged that on October 13, 2002, Aguilera learned that Sagona had informed another shareholder that the board charged the application fee and denied their application in order to “teach Ms. del Puerto a lesson.” The del Puertos claimed that the denial of their application constituted retaliation for del Puerto’s opposition, in May 2001, to a proposed dog ban at the co-op, which, contrary to the wishes of Sagona, allegedly led to the “grandfathering” in of all pets then owned by the shareholders.

Sagona allegedly told Julia del Puerto at a board meeting that her application had been denied because del Puerto had tried to bribe the co-op into allowing her to purchase 217 by Fernando del Puerto’s refusal to provide free legal services regarding the refinancing of the co-op’s mortgage unless their application was approved.

In addition to the above facts, the del Puertos argued that the board failed to treat them “fairly and evenly” by: (1) rejecting their application to purchase a second unit even though no other shareholder had ever been rejected with respect to such a purchase; (2) failing to interview them in conjunction with their application although all other shareholders were interviewed; (3) approving applicants who had worse debt-to-income ratios than theirs; (4) allowing at least one shareholder whose application was deemed deficient to cure their subject deficiency but failing to afford them the same opportunity; and (5) approving applications in incomplete form despite requiring a completed application from the plaintiffs. Moreover, the del Puertos claim that two of the four reasons cited by the board in support of their rejection did not appear in their credit reports.

In support of their motion, the del Puertos submitted evidence that three other shareholders had higher debt-to-income ratios and were nonetheless approved to purchase additional units at the co-op. They also submitted the deposition testimony of a shareholder confirming the alleged “personal animosity” of some board members toward them and the alleged payment by the Oliveros to Kerr, the boyfriend of Ruiz.

The board argued that its decision to deny the application was insulated from judicial review under the Business Judgment Rule. With respect to the cross motion, the board contended that there was no evidence that the board had interfered in the contract of sale for Apartment 217 and, in any event, since the decision to deny the del Puerto application was protected by the Business Judgment Rule, a cause of action for tortious interference with contract based on such denial cannot stand.

The board maintained that the decision to deny the application was based on all the financial information provided by del Puerto, and the board did not treat their application differently than it did the applications of other co-op shareholders. Finally, the board argued that the fraud cause of action had to be dismissed because del Puerto did not identify any misrepresentations made to them by the board upon which they relied to their detriment.

The board submitted the deposition testimony of Sagona, who testified that the del Puerto application was denied due to deficient credit information, insufficient income verification and their record as shareholders. She also testified that the income Ms. del Puerto stated on her application was greater than the support she gave for such a figure.

At his deposition, board member Eric Lehmann testified that the del Puertos had very little income coming in as far as their debt-to-income ratio. He also said the board was concerned about 31 inquiries in a 12-month period on their credit report and that the credit report showed multiple deficiencies. Lehmann further explained that del Puerto was borrowing money to purchase the unit from a friend or an associate. The only thing he could see was that they could not get an institutional mortgage with 31 inquiries against them and that was why they had to borrow the money privately.

Ruiz stated at her deposition that the del Puertos had an unfavorable debt-to-income ratio and that the large amount of debt carried concerned the board.

In considering all of the evidence, the court stated the general principle that summary judgment should only be granted where there are no triable issues of fact. In order to prevail on a motion for summary judgment, the moving party had to present a case demonstrating entitlement to judgment as a matter of law. Once that had been established, the party opposing the motion was required to produce evidence to require a trial of material questions of fact. Mere conclusions, expressions of hope, or unsubstantiated allegations or assertions were insufficient. The evidence presented on summary judgment was to be scrutinized in the light most favorable to the party opposing the motion, since summary judgment deprived a party of his or her day in court. It is considered a drastic remedy that will only be awarded when there are no issues of fact needing to go to trial and the court can offer a decision as a matter of law.

The court determined that the board defendants were entitled to summary judgment dismissing the complaint as against them. The court found that the Business Judgment Rule applied to the board’s decision to deny the application to purchase an additional co-op unit. The court explained that under the Business Judgment Rule – and without a showing of discrimination, self-dealing, or misconduct by board members – corporate directors were presumed to be acting in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. Accordingly, so long as the board acted for the purposes of the cooperative within the scope of its authority and in good faith, the court would not substitute its judgment for the board’s. The court explained that, unless a resident challenging the board’s action is able to demonstrate a breach of this duty, judicial review is not available.

The court further held that, in determining whether a co-op board unreasonably withheld its consent to a transfer of shares, it is the Business Judgment Rule, not the court’s independent assessment of the reasonableness of the decision, that provides the proper standard of review. The court noted that the rule is not an insuperable barrier but instead permits review of improper decisions. Given a board’s duty to treat all shareholders “fairly and evenly,” a substantiated showing of the unequal treatment of shareholders by the subject board was sufficient to overcome the application of the rule.

The court found that the board established that its decision to deny the del Puertos’ application to purchase an additional co-op unit was made for the benefit of the residents collectively, within the scope of its authority and in good faith. Three of the board members testified at their depositions that the application was denied because of an unacceptably high debt-to-income ratio, the failure of Ms. del Puerto to provide adequate verification of her income, the existence of a large number of credit card delinquencies and open credit cards with balances, accumulated arrears and late maintenance payments with respect to unit 117, the proposed interest-only private financing for the purchase by an individual for whom del Puerto provided little information and the dearth of information made available to the board with respect to the sale of Apartment 117, which allegedly would take place after the del Puertos’ purchase of Apartment 217. Accordingly, the board presented sufficient evidence to support its contention that it denied the application with the purpose of protecting 56 other shareholders from a possible debt problem and from possible arrears occasioned by the del Puertos’ demonstrable financial deficiencies.

In response to the evidence produced by the board, del Puerto failed to raise an issue of fact that could go to trial. The del Puertos submitted calculations demonstrating that at least three other shareholders had less favorable debt-to-income ratios than they did, nonetheless were approved by the board to purchase additional units in the co-op. One, however, was approved only after she obtained a guarantor and placed eight months of maintenance payments in escrow until she sold her original unit.

The court found that the del Puertos’ allegations had no merit. Although the debt-to-income ratios of some shareholders approved to purchase additional units might have been less favorable than the del Puertos’, they did not proffer any evidence that such shareholders also demonstrated additional comparable financial deficiencies such as poor credit reports, past arrears in mortgage or maintenance payments, unverified income or private interest-only financing. Absent admissible evidence of such comparable financial deficiencies and the board’s approval of the shareholders’ purchase applications despite same, the court did not find that a question of fact existed with respect to the alleged disparate treatment of shareholders by the board.

To the extent the del Puertos alleged the existence of self-dealing or bad faith on the board’s part, there was no admissible evidence that the board denied the application based upon factors other than the best interest of the shareholders. Rather, the del Puertos primarily relied on unsubstantiated hearsay statements that the denial of their application was done in retaliation for Ms. del Puerto’s opposition to the proposed dog ban.

The Oliveros were also entitled to summary judgment dismissing the complaint. The gravamen of the del Puertos’ claims against them were that the Oliveros allegedly paid a finder’s fee of $5,000 to Kerr, the boyfriend of board member Ruiz, thereby engaging in fraud and tortiously interfering in the contract of sale between Toole and the del Puertos. Given that the Oliveros’ alleged liability for tortious interference with contract and fraud was inextricably intertwined with similar claims asserted by the del Puertos against the board defendants, the claims failed for much of the same reasons.

Comment: Once again, the courts give great deference to a decision of a co-op board under the Business Judgment Rule. Here, the plaintiffs made several allegations of bad faith and disparate treatment. There were sufficient allegations so that discovery was warranted to consider and investigate plaintiffs’ claims. However, it was ultimately determined that plaintiffs did not satisfy their burden to show that the board treated them differently. The board demonstrated its basis for rejecting plaintiffs’ application to purchase. The court applied the rule as plaintiffs were already shareholders and not, as most purchasers, strangers to the co-op. Notably, the Business Judgment Rule requires courts to defer to board decisions made in good faith, in the exercise of honest judgment, and for lawful and legitimate purposes and places the burden on shareholders challenging a board’s actions. However, once challenged and faced with specific allegations of wrongdoing, it is necessary for a board to set forth the specific, legitimate basis for its rejection.

Counsel in the Case
For Plaintiff: McElroy, Deutsch, Mulvaney & Carpe
For Defendants: Winget, Spadafora & Schwartzberg Abraham & Lerner and Porzio, Bromberg & Newman