Legal Lessons: Board Responsibilities

Legal Lessons

Choosing an attorney for your building requires a series of steps. First is taking the task at hand and figuring out what legal skills are required to solve your problem. Then comes the hunt, often through word of mouth, for the lawyer possessing those skills. In the past, many boards have used Habitat’s annual attorney survey to identify potential firms and lawyers. This year, to make that resource more valuable, we have increased the scope of what we asked participating lawyers to provide. Besides the basics (fees, size, areas served, etc.), we asked them to write about typical issues or cases they have encountered and then to offer advice and comment. In doing this, we hoped to capture each lawyer’s unique thinking and tone. And we took some additional steps, too, visiting every attorney’s office and taking photos of him or her so you could see who was telling the legal tale. Digesting the advice and legal cautions will take some time, but for board directors who monitor the legal lines, it’s a good investment.

Limits of Power

Hill Wallack

ISSUE When a governing board determines that major repairs to a community and a special assessment to pay for them are necessary, but it is unclear from the governing documents whether owner approval of the project is required, how may the board protect itself from lawsuits?

BACKSTORY A mid-rise condominium we represented had major water infiltration problems, requiring the replacement of the curtain wall structure and the windows. The association’s bylaws required unit-owner approval for capital improvements exceeding $10,000. The anticipated cost for the recommended corrective work was more than $1 million. The issue was whether this work was a capital improvement, requiring owner approval, or a replacement that the board alone could authorize.

To prevent the association from signing a binding contract only to have the work stopped by a lawsuit, we suggested a two-step approach. The association conducted a membership vote that failed to garner enough votes for approval. We then applied to the court for a declaration that the vote had not been necessary and that the board had the authority to contract for the work, to preserve the building and the owners’ property. Alternatively, we asked the court to declare that exigent circumstances necessitated the work notwithstanding the failure of the owners’ vote. Although a few owners opposed the application, the association had so well documented the need, the court granted the necessary authorization, and the corrective work was completed.

A failure to seek homeowner approval for major projects, on the other hand, can have serious consequences, as demonstrated by a matter we handled for objecting homeowners. In that case, the association’s trustees decided to completely replace the community’s roofs and siding at an expected cost in excess of $5 million. The project was to be funded by reserve funds and a bank loan, but would require a special assessment to repay the loan. The association’s bylaws stated that no special assessment exceeding $5,000 could be imposed without the members’ two-thirds approval. The board notified the homeowners that they would be specially assessed a total of approximately $3.5 million, but did not schedule any membership vote.

A group of homeowners retained Hill Wallack to challenge the association. The homeowners also obtained sufficient signatures to demand a special meeting to vote to remove the board members. We filed a lawsuit on behalf of three homeowners, seeking to enjoin the roof/siding replacement project unless the membership voted to approve it, seeking damages from the board members for breach of fiduciary duty, and requesting that a meeting be held to vote on the removal of the board. The association argued that the bylaws provision requiring the member vote applied only to capital improvements and the planned project constituted a repair, not an improvement.

The court rejected that reasoning and entered an injunction barring the replacement project unless the members voted to approve it and an order that the special meeting be held. All trustees on the board were subsequently replaced by the members’ votes. The new board reduced the scope of the replacement project, canceled the construction contract and the bank loan, and eliminated the special assessment. The association’s insurance company reimbursed the plaintiffs a portion of their expenses to settle the claim against the former trustees.

COMMENT Governing board members are elected by the unit-owners to act for the benefit of the entire community. Sometimes, directors or trustees need to take action despite opposition by a large percentage of owners – for example, to raise money by special assessments to properly maintain the property. However, board members should never forget who their constituency is and who they are serving. At the very least, when a board intends to embark on a major financial project, it should seek the opinions of the members and adequately explain why the project is necessary before moving forward. Informing the members and asking for their input improves the chances of convincing them of the work’s necessity and may also lead to suggested remedies that the board had not previously considered.

When there is any question about the authority of the board to institute a major project, it is wise to expressly seek membership approval to avoid or minimize the chance for legal challenges later. A vote can be conducted while expressly preserving the board’s argument that no vote is required. However, conducting such a vote will protect the board members from claims of breach of fiduciary duty.

If the members decline to authorize the project, the board may seek judicial authorization. That, too, may fail. There can be no assurance that the members will not seek to replace the board, but following these procedures will avoid claims that the board acted unlawfully.

— Ronald L. Perl

Extending Power

Kurzman Karelsen & Frank

ISSUE Does a co-op/condo board undermine the “best interests” of its constituency when it fails to consider matters not exclusively affecting the building and its residents?

BACKSTORY Two of our clients, neighboring cooperatives located in a residentially zoned neighborhood, discovered that a nearby church was quietly being converted into a commercial catering hall – not only an incompatible use, but an impermissible one under current zoning. As we subsequently learned, the church had entered into a long-term (20 years plus renewal options) triple-net lease for its entire building to a commercial caterer. In its dealings with the local community board, the state liquor authority (in connection with an application for a liquor license), and the Department of Buildings (in connection with an application for a certificate of occupancy), the caterer had represented that it planned to limit its operations to the church auditorium and basement for an occasional wedding or other affair, much as is done in other houses of worship throughout the city. But, after government approvals were granted, it later became clear that nothing less than a full-scale commercial catering enterprise was contemplated, operating seven days a week, and holding large-scale corporate and charitable events in addition to the “occasional” wedding, oftentimes accommodating guest lists of over 1,000 people.

The steady stream of deliveries of food, flowers, supplies, and sound and other equipment, as well as the events themselves, significantly altered the residential character of the neighborhood. The resulting increase in street and sidewalk traffic, the stream of double-parked delivery trucks, the garbage generated by these events, the noise from late night revelers, and the early morning and late night deliveries and pick-ups seriously and adversely affected the local residents. Many of these events were scheduled on weeknights – often as many as three or four in one week – and the impact upon families trying to put their children to bed, or residents trying to get a good night’s sleep before work, was serious.

It was, in sum, a situation our clients and their respective shareholders found intolerable. As a result of a search of the public record and requests under the Freedom of Information Law, we found what we believed to be not only misstatements and inconsistencies in statements to various government agencies concerning the planned commercial catering operation, but also evidence that what was actually planned would violate the law.

Armed with this information, and knowing the difficulties of the upcoming battle, our clients approached the boards of several neighboring cooperatives and organized a neighborhood coalition to address their mutual concerns. They pooled their know-how and contacts as well as their financial

resources. They reached out to the larger community and continued to build their coalition. Together with their neighbors, they embarked on an effort to shed light on the commercial catering operation. This included speaking at community board meetings, writing and meeting with government officials, issuing press releases, and formally challenging the issuance of permits before the relevant government agencies.

As a result of these efforts, several elected officials became closely involved in the matter and worked with the neighborhood coalition to protect their respective constituencies. While the battle was and continues to be fought on many fronts, including a pending federal lawsuit by the church against New York City, as a result of the neighborhood coalition’s efforts to date, the Department of Buildings (DOB) permit for a change of use was revoked (although the revocation is now the subject of a federal lawsuit), and the caterer’s two liquor license applications have both been rejected.

COMMENT Co-op and condo boards are charged with acting in the best interests of the entities they serve. Typically, this encompasses issues such as the maintenance, replacement, repair and upgrading of building systems, the review of new purchaser applications, and addressing shareholder/unit-owner grievances and disputes. An effective board should, however, be equally cognizant of and anticipate the changes transpiring on the outlying sidewalks and streets, as well as in their hallways, for these issues can significantly affect the quality of life. As most boards have limited financial resources and often must choose among competing problems, a community issue may be tabled in favor of a new roof or other building repair.

But a board that ignores community issues does so at its own peril. Often, these issues are too big for individual shareholders/unit-owners to fight on their own and yet, these issues may well have a serious impact upon them, as illustrated by the backstory. Acting on behalf of all the residents in its building, a board can share the costs of its neighborhood activism. In addition, by operating through a coalition of boards, community opposition can be organized quickly and efficiently. The participants can tap into the existing organizational structures of these local boards, utilizing the established and open lines of communication these boards maintain with their residents.

A diligent board can keep itself informed about developments in its neighborhood with a minimal amount of effort. We recommend the following: (1) review the community board’s monthly calendars to develop a sense of the current and potential issues and applications that it is considering; (2) designate a board representative to attend local community board meetings to represent the interests of the building, as well as to monitor the proceedings; (3) subscribe to and scan the local papers and newsletters for articles of interest; and (4) to learn about proposed new construction, major alterations, and full demolitions in the community, visit the DOB webpage:

http://a810-bisweb.nyc.gov/bisweb/my_community.jsp

—Phyllis H. Weisberg

Condo Power

Samson Fink & Dubow

ISSUE In performing façade work required by Local Law 11, are there any limits on the scope of work a condo board can authorize without unit-owner approval?

BACKSTORY Our client was a unit-owner in a condominium building in Morningside Heights that was over 90 years old. In 2003, the condominium’s board of managers received a Local Law 11 inspection report, indicating that several elements of the façade were in need of repair. Among the areas of concern were the building’s windows, some of which (according to the engineer’s report) were in need of repair or replacement. The windows were – save for a handful that had been replaced by unit-owners – original, double-hung wood-framed models with multiple lites (that is, each sash was divided into a number of smaller pieces of glass, in a “tic-tac-toe” board pattern).

After reviewing the report and considering various alternative courses, the board concluded that it made better economic sense to replace all of the windows with new double-glazed, insulated units. The board also decided that, for aesthetic reasons, the new windows on the street side of the façade windows continue to have multiple lites; but for the windows in the rear, less expensive single-lite sashes could be used.

The board then obtained bids from several contractors; and selected a bidder who agreed to replace the windows at a total cost of $1.2 million.

As is not uncommon, the bylaws of the condominium provided that capital expenditures in excess of a certain level – for this building, $25,000 – required the advance approval of 50 percent of the unit-owners. The bylaws, however, excluded from unit-owner approval capital improvements or additions “required by law.”

Because some repair of the windows was necessary in any event, the board concluded that it had the authority to proceed with the proposed work without first obtaining unit-owner consent.

To finance the project, it assessed the unit-owners the full $1.2 million, based solely on their common interests. This resulted in the owners of rear units (who were to receive less expensive single-lite windows) subsidizing the cost of providing the multiple-lite windows to the owners of street-facing apartments.

After the decision was made, the board called an informational meeting of the unit-owners, at which the nature and costs of the project were discussed. However, no formal approval of the project was sought or obtained.

Our client (who owned a rear apartment) objected and refused to pay the assessment, claiming that (1) a unit-owner vote was required before the board could levy the assessment, and (2) it was improper to force the owners of rear apartments to pay for aesthetic improvements that benefited only the front apartments.

The board sued the recalcitrant unit-owner to collect the assessment, together with its attorney’s fees; and, ultimately moved for summary judgment. The board claimed that, under the Business Judgment Rule, it was entitled to respond to the requirements of Local Law 11 in the manner it deemed best. It further claimed that, whether or not a formal meeting of unit-owners had been held, the expenditure had been approved, as every unit-owner, save one, had paid the disputed assessment.

COMMENT The lesson here is straightforward: whenever you propose to take any action that affects the unit-owners, scrupulously follow the rules set forth by the bylaws (and, in the case of co-ops, the Business Corporation Law). Although the Business Judgment Rule (which, in essence, forbids a court from second-guessing actions by a board, taken within the scope of its authority and untainted by conflicts of interest) forgives many errors, an action that is taken without compliance with the rules can be deemed to be beyond the authority of the board.

In the example, the consequences were manifold. Not only could the board not collect the assessment (or, for that matter, the attorneys’ fees incurred in the action), it was left open to an action by another unit-owner to recover the improperly levied assessment – money which (having spent the entire assessment on installing the new windows) the board did not necessarily have to give back

And while that risk could be obviated by calling a proper unit-owner meeting to approve the assessment after the fact, there could be no assurance that owners of the rear apartments would vote for the assessment once they learned that they would be getting cheaper windows than, but paying as much as, the owners of front-facing apartments.

All in all, a very untidy outcome; and one that could have been avoided altogether by the simple expedient of finding, and following, the rules.

—Jonathan J. Fink

Controlling Management

Stark & Stark

ISSUE What is an association’s best legal recourse against a management company that has stolen its funds?

BACKSTORY Our law firm was recently retained as general counsel to a large condo association. A few months before our engagement, the condo board also hired a new management company. During the first few months of our engagement, our office had limited contact with the board and the new management company. However, all of that changed dramatically when we received a call from the board’s treasurer advising that a large sum of money was missing from the condo’s bank accounts, and that he was unable to reach the management company in order to obtain an explanation.

Upon further investigation, it became evident that the management company had absconded with roughly $300,000 of the association’s funds and that they had closed shop and disappeared. It was also discovered that, in addition to stealing almost all of the condo association’s funds, the management company failed to pay many vendors. That meant the potential shut-off of vital services because of non-payment, including the loss of utility services throughout the building.

We immediately consulted with the board and devised and implemented a plan of action. The board’s first priorities were cutting off access to the association’s funds from further pilfering by the management company and preventing the shut-off of the building’s services by the condo’s utility provider. These tasks proved more difficult than you would initially think.

For starters, the association’s bank accounts, which had been established by the management company, had signature cards that were solely in the name of the management company. This meant that the condo board had no legal right to make any changes to the accounts without first providing appropriate corporate resolutions and proof that the board was authorized to control these bank accounts. Our law firm immediately prepared the appropriate legal documents to establish the board’s authority over its accounts, and the management company’s access was severed.

The next order of business was preventing the building’s utility services from being shut off by its utility provider, which had not been paid in several months. Unfortunately, even when the extenuating circumstances were explained to the utility provider’s collections department, the collections manager insisted that an immediate payment be made or that the building’s utility services would be cut off in a matter of days.

Because of the condo’s inability to meet the utility provider’s payment demands, our office filed a civil lawsuit against the utility, seeking a court order preventing the provider from shutting off services to the building until the condo became solvent. In addition, the lawsuit sought to recover the stolen funds from the management company’s corporate entity and its principals. The court ruled in favor of the condo and a temporary restraining order was issued prohibiting a shut-off.

Another top priority was entering into a contract with a new management company and having that company assume management duties immediately. Luckily, the management firm that was the runner-up in the most recent bidding process (in which the rogue management company was hired) was willing to step in immediately after an expedited reference check and management contract negotiation and review.

With the immediate fires extinguished, the board launched a three-pronged campaign to recover its stolen funds consisting of the following: (1) continuing the civil lawsuit against the management company; (2) contacting law enforcement officials to initiate a criminal prosecution; and (3) filing claims under all applicable insurance policies.

COMMENT A management company stealing from an association is a rare occurrence, but, like every other industry, bad people will do bad things if they find an opportunity to exploit. Here, there was strong evidence to support a civil lawsuit and a criminal prosecution against the management company, so common sense would suggest that the condo should have pursued these remedies simultaneously. However, this is not necessarily the case as there are benefits and burdens to civil lawsuits and criminal prosecutions, and sometimes pursuing both at the same time will cause conflict between them.

The goal of a civil lawsuit is to obtain a court order and judgment in your favor – in this case a ruling that the management company and its principals were indebted to the condo for the amount of money they improperly took from the condo’s bank accounts. The goal of a criminal prosecution is to obtain a conviction and put the bad guys in prison; obtaining financial restitution to the victims is secondary.

Generally speaking, in a civil lawsuit the parties have to pay their own legal costs, while in a criminal case, the government pays the prosecution costs. When defendants are confronted with the prospect of being ordered to repay a debt or serving time in prison, their priority will be staying out of prison. This often entails liquidating all of their assets in order to fund their criminal defense legal team. If this occurs, even if a plaintiff is successful in obtaining a judgment in a civil lawsuit, it will be worthless because the defendant will be “judgment-proof.” That is, the defendant will have no assets to satisfy a civil judgment after it pays its criminal defense costs. As a result, you should conduct a cost benefit analysis when you are deciding whether civil, criminal or both remedies will be pursued.

So what is the best legal recourse, civil or criminal? That answer depends on your particular circumstances. In our case we pursued a civil lawsuit, a criminal prosecution and payment from an insurance carrier under a crime bond.

The bigger lesson to be learned here is that the best offense is a good defense. If a management company is intent on stealing it will find a way a to do so. However, the amount of the loss can be minimized if certain safeguards are put into place and the association’s finances are monitored closely.

The starting point of this process is selecting an established and well-recommended management company. However, even the best management company could have an employee who decides to become a criminal one day.

To safeguard your association against such rogue employees, you should verify that your management company has its own crime bond. You should also procure a separate crime bond to cover the association’s employees with the management company’s employees included under such coverage.

—David J. Byrne

Communicating to Owners

Tarter Krinsky & Drogin

ISSUE How can a board successfully plan for and execute a unique project when building-wide cooperation is imperative?

BACKSTORY A co-op client had a serious, building-wide bedbug infestation. Neither the board nor the managing agent had any experience with the issue. After fruitless attempts to treat the problem using traditional exterminators, the board hired a company specializing in bedbug eradication, utilizing a specially trained dog to sniff out the bugs. This was successful.

The first step was to inspect each room in the building; every room in all apartments; every common area, including closets, utility rooms, and other basement areas, with particular attention paid to the laundry room where residents unknowingly laundered infected garments.

The second step was to treat all areas, including apartments. This entailed bagging and sealing all articles of personal property, removing them from the infected units or common areas, treating the empty rooms, and disinfecting the personal property when possible, and discarding them when not. The co-op board assumed financial responsibility for this.

However, a handful of residents failed to cooperate completely. The elderly and infirm were particularly problematic and some had great difficulty in cooperating with the second step, bagging and treatment. A few complained of allergies or hypersensitivity to the chemical used. Some simply could not handle the organizational efforts required to fully cooperate. Some refused access to their apartments; others made appointments but found reasons not to cooperate when the appointed time came.

The property manager and board members met personally with these folks, and were highly sensitive to residents’ special needs. Assistance was provided for those who needed help in preparing for the treatment phase and in bagging the personal property. Only a few letters from counsel demanding access were necessary. In the end, because of the tremendous efforts by board members and the property manager, the project was successfully completed.

COMMENT When tackling new and different issues, it is important for board members to have open minds, to take the time and make the effort to fully understand the problems. Often, managing agents are new to the issues as well, so boards need to thoroughly investigate all aspects of the project. Internet research is a great start. Speak with the Council of New York Cooperatives & Condominiums to tap into its vast wealth of knowledge and experience. Consult several experts. Require written proposals. Ask about the downsides and where the landmines might be found. Plan ahead so that when problems arise – and they usually will – the project doesn’t go seriously off track.

Issue clear, concise, and repeated communications to residents, via memos and newsletters. Hold town meetings where your expert(s) will attend. Be prepared to answer all questions that residents have, even if it means consulting another expert and getting back to residents via follow-up memo or another meeting. Clear and repeated communications have proven to be absolutely necessary to gain the required cooperation of residents, whether owners, subtenants, or protected tenants.

Be prepared to deal with residents who have special needs, such as the elderly, the infirm, and families with children. Be flexible in dealing with these residents. Don’t expect each resident to be able to carry out instructions without assistance. Board members need to play active roles in dealing with special needs residents; don’t delegate all responsibility to the managing agent. Use the superintendent and his/her staff, who often know of special needs residents that board members may not. Be sensitive to those who are unable to carry out instructions without help, and provide extra assistance whenever possible. Court intervention or notices to cure should be an absolute last resort.

—Steven Troup