Grand Hotel – Co-op Style

May a tenant that operates a luxury hotel under a long-term lease convert portions of the hotel to cooperative ownership? That was the question facing the court in Mark Hotel LLC v. Madison 77th LLC.

The Mark Hotel is located at 25 East 77th Street in Manhattan. Madison 77th owned the property and leased it to Mark Hotel, as tenant, subject to a 150-year lease expiring in 2131. The tenant wanted to perform renovations and, at the same time, convert portions of the building to luxury cooperative hotel units. The lease provided that the premises could not be used for any purpose “other than a luxury hotel (including a cooperative or condominium hotel such as the Hotel Carlyle).”

By letter sent in December 2007, the tenant advised its landlord of its plans to renovate the premises to include several floors of luxury cooperative hotel units. The letter included a complete copy of the architect’s plans and anticipated schedule for the project. The lease required the landlord’s consent for the project, which consent was “not to be unreasonably withheld.” In addition, the lease provided that if the landlord did not respond to a request for fifteen days, the tenant could send a second request and, if no response was had within five days, “the consent or approval of the Lessor so requested shall automatically and conclusively be deemed to have been given.” When the tenant did not receive a response to its initial request, it sent a second request. The landlord’s attorneys finally responded, stating that the tenant was not permitted to convert the premises to cooperative hotel units. The letter further stated that, if the tenant confirmed that it had no intention of converting the premises, “the landlord would be pleased to review any renovation plans.”

The parties wrote throughout January 2007. On January 10, the tenant disagreed with the landlord’s position, stating that the lease expressly provided for the construction of luxury cooperative hotel units. The tenant also noted that the form of ownership had no bearing on the requested renovations and that the landlord had not commented upon the renovation plans.

Six days later, the landlord’s lawyer sent a letter noting that the lease disagreed and that it could not be used as a cooperative or condominium hotel such as the Carlyle. The tenant responded by letter and referred to the landlord’s position as “absurd and completely inconsistent with any reasonable interpretation of the language of the provision.” The tenant also reiterated its position that conversion to cooperative ownership had nothing to do with the physical alterations that it sought to make and that, because the landlord never commented on the plans, it was “deemed to have consented to and approved those plans.”

The tenant applied for permits from the Department of Buildings (DOB), identifying itself as the “owner” of the building. The landlord informed the DOB that it was the “owner” and that it had not authorized or consented to the tenant’s filing of the application.

On March 7, 2007, the landlord served a notice of default on the tenant, claiming that it would terminate the lease unless the tenant cured its alleged default. The tenant obtained an order enjoining the landlord from terminating the lease (a “Yellowstone Injunction”) and sued for a judicial determination that it was not in default of the lease because (a) it was permitted to convert to luxury hotel cooperative units under the lease; (b) it was permitted to perform renovations because the landlord did not object to them; and (c) it was permitted to identify itself as the “owner” when it applied for DOB permits.

Both parties moved for summary judgment. The court discussed the standard for summary judgment – “The proponent of a summary judgment motion must make a prima facie showing of entitlement to judgment as a matter of law, tendering sufficient evidence to eliminate any material issues of fact from the case.” Upon presentation of a prima facie case, the burden then shifted to the opponent to offer evidentiary facts sufficient to raise a triable issue of fact.

Both parties agreed that the crux of the case was the interpretation of the lease, and specifically the phrase, the “Lessee covenants and agrees that it will not use or occupy the leased premises, or permit the said premises to be used or occupied for other than a luxury hotel (including a cooperative or condominium hotel such as the Hotel Carlyle).” The court found that the case involved a pure contract interpretation and that, as such, it was proper to resolve it on a motion for summary judgment.

The court found no ambiguity in this provision of the lease. The court explained that given the plain meaning of the language, only one rational meaning emerged – that the word “including” meant that the use of the hotel for luxury cooperatives is “included” in the uses which can be made of the premises. It did not mean that the use was excluded, as the landlord claimed.

The landlord also argued that the Condominium Act, which applies to property for which a condominium declaration is executed and recorded, describes “property” which can be converted as property owned in fee simple absolute (the way in which one would own a house). Because the plaintiff was nothing more than a lessee which did not own the property in fee simple, the landlord argued, the lease provision was in violation of law. The landlord thus claimed that the entire clause should have been declared illegal.

The court explained, however, that the Condominium Act did not apply to a cooperative interest, which consists of the ownership of stock in a cooperative corporation. Moreover, the court explained that, even if the lease clause violated the Condominium Act, it should be parsed to preserve all legal aspects of the agreement. As the lease itself stated, “if and to the extent that a provision of this lease shall be unlawful or contrary to public policy, the same shall not be deemed to invalidate the other provisions of this lease.” Accordingly, the court found that the tenant was entitled to a declaration that it was permitted to use the premises for cooperative luxury hotel units.

The court also found that the tenant was entitled to a declaration that it did not violate the lease by proceeding with the alterations. While the lower court found that the landlord did respond to the tenant’s second notice within five days, as required, but that it unreasonably withheld its consent because of its improper and strained interpretation of the lease, the appellate court merely noted that, because the landlord did not object, it was deemed to have consented under the lease.

Finally, the court found that the tenant was not in default under the lease when it executed DOB documents as the “owner” based on a provision of the administrative code. The court granted judgment to the tenant and denied the landlord’s motion for summary judgment.

Comment: Once again, the court reviewed and upheld the clear terms of the contract between the parties. Of particular interest was the landlord’s attempt to declare the lease provision invalid by asking the court to apply the provisions of the Condominium Act to a request to convert premises to cooperative ownership. As the appellate court properly noted, the two are distinct and separate forms of ownership. While the Condominium Act applies to condominiums (which requires residential real property to be owned in fee simple), the court correctly explained that it does not apply to cooperatives, in which shareholders own stock in a corporation owning real estate, which permits them to live in a specific apartment pursuant to a proprietary lease.

Moreover, the court made it clear that the landlord’s attempt to delay a review of the tenant’s alteration plans until the tenant agreed that it would not seek to convert the building to luxury hotel cooperative units would not be permitted. The lease gave the landlord a final five-day opportunity to submit its objections to the renovations and specifically provided that, absent such objections, approval is deemed given. Thus, the court found that when the landlord failed to object, it could not preserve a right to object at a later date, i.e., when the tenant agreed that it would not convert the building to cooperative units.

Finally, the term “owner” as used by the Department of Buildings, must be reviewed by all cooperatives and condominiums. Although this case relied on an interpretation of the administrative code, we note that new DOB rules, in effect as of August 4, 2008, may require buildings to change their practices concerning who may sign certain permit applications as “owner.”

Attorneys for the parties:
For landlord: Paul, Weiss, Rifkin, Wharton & Garrison
For tenant: Kramer, Levin, Naftalis & Frankel