Legal Lessons: Finances

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.

Recovering Fines

Arthur I. Weinstein

ISSUE When dealing with such problems as bed bugs, water damage, and mold, is it possible for a co-op to recover from the shareholder costs the corporation has spent?

BACKSTORY Several years ago, co-ops had not heard the term “bed bugs” in any context other than in the phrase, “sleep tight, don’t let the bed bugs bite.” At that time, a handyman in one of the buildings I represent was called into an apartment to make some routine repairs. During his visit he noticed that the very elderly, very wealthy, very well-traveled shareholder was scratching himself uncontrollably. He reported his observation to the building’s superintendent, who discretely asked the shareholder’s housekeeper if there was a problem. It was determined that he was the victim of some sort of insect bites. The building management was asked by the housekeeper to have the apartment inspected. The building’s exterminator concluded that the cause was an infestation of bed bugs. The board, management, and attorney began to learn the now-familiar facts that many buildings have unfortunately been facing: bed bugs can hide within walls and in bed frames, clothing, picture frames, bed springs, and electrical outlets. They can spread to other apartments through plumbing and electrical chases, air ducts, and gaps in floors. The board sent its exterminator into all neighboring apartments – above, below, adjacent – and was relieved to determine that the infestation had not spread.

Extermination requires treating all of the “hard” hiding places as well as the clothing and bedding that may have been exposed, and can cost thousands of dollars. Fortunately, the shareholder had a reasonable attorney who recognized the importance of protecting her client from further stress. A plan of attack was devised: it was agreed that the ultimate costs would be borne by the shareholder, but that multiple, almost simultaneous steps were immediately necessary. The shareholder moved into a hotel with all-new clothing and toiletries, and the entire apartment, including furniture and personal property, was treated by an exterminator who had been properly “vetted” as an expert. The shareholder’s clothing was either securely bagged for treatment or double-bagged for careful disposal. The co-op advanced the money needed for quick action, including contracting with the exterminator for the necessary multiple follow-up visits to the apartment, and, as agreed, the shareholder reimbursed the co-op for all costs incurred.

COMMENT The legal principles that enabled the co-op to recover the costs it incurred in connection with curing the bed bug infestation are complex and are applicable to the wide range of possible disputes between co-ops and their shareholders, including water damages to apartments, mold, noise, odors, as well as vermin infestation.

There are three governing concepts:

• New York State Real Property Law, Section 235-b, provides a “warranty of habitability” to every residential tenant. The warranty requires the lessor to provide premises “fit for habitation” and not “dangerous, hazardous, or detrimental to their life, health or safety.” The obligation covers peeling paint, mold, vermin infestation, excessive noise, and perhaps even infiltrating cigarette smoke. The law is applicable to co-ops.

• The proprietary lease between the shareholder and the co-op imposes obligations on each shareholder with respect to the maintenance of the cooperator’s apartment, and conduct by occupants of the apartment. The lease imposes shareholder obligations to maintain the interior of the apartment and its fixtures and any systems or equipment installed by the shareholder. The extent of those obligations can vary among the different forms of proprietary leases in use; however, all proprietary leases that I have seen provide that the shareholder is responsible for painting, lighting, electrical fixtures, and electrical wiring from the circuit-breakers or fuses throughout the apartment. Some leases specifically provide that the shareholder is responsible for maintaining a vermin-free apartment, and others explicitly prohibit excessive noise and odors. Most proprietary leases also require the shareholder to reimburse the co-op for any costs incurred by the co-op as a result of any act of the shareholder.

• Established principals of common law make the co-op corporation, as well as its shareholders, responsible for their own negligent actions or inactions. Negligence has been defined as a failure to exercise the standard of care that a reasonably prudent person would exercise in a similar circumstance. For example, the sudden bursting of a 75-year-old pipe does not prove that the break was caused by the negligence of the co-op corporation that owns the pipe. On the other hand, a shareholder, who fails to stop a child from “drowning” his teddy bear in a toilet and clogs it, is probably negligent.

In each dispute between a cooperative corporation and one or more of its shareholders, the ultimate resolution involves an interpretation of these three concepts: the warranty of habitability, the proprietary lease, and general principles of negligence. In an easy case, such as water penetration in an apartment caused by the ordinary wear and tear of plumbing or building waterproofing, the co-op is responsible for restoring the structural integrity of apartment walls and providing a base for painting of the damaged apartment by the shareholder. The co-op corporation would not be responsible for replacing the “gold wall paper” installed by the shareholder.

If the water penetration was caused by the negligence of a shareholder in a neighboring apartment, however, the negligent shareholder would, under general principals of negligence, be obligated to reimburse the occupant for painting and damages to personal property caused by the water penetration. The negligent shareholder would also be responsible for reimbursing the co-op for its cost to repair the structural damages caused by the water penetration under the provisions of the proprietary lease and negligence principals.

Although it is the universal recommendation of lawyers and managing agents that each shareholder maintain homeowner’s property and liability insurance, there have been numerous cases in which the insurance companies get embroiled in sorting out the ultimate legal liability in these cases. From the co-op’s perspective, it is always preferable for the dispute to be between insurers rather than among multiple shareholders and the co-op.

—Arthur I. Weinstein

Spending the Wrong Reserves

Herrick Feinstein

ISSUE What happens when a new board unknowingly spends a reserve that was required in an original lending agreement?

BACKSTORY When the co-op building’s mortgage was refinanced, the lending agreement stipulated that the building keep a financial reserve at all times. Years later, with some new board members and a successor lender in place, the board’s accounting firm discovered that during the co-op’s annual audit the reserve was depleted.

The accountant documented the missing funds in his financial statements, despite the current board’s claims of ignorance of the reserve requirement. The accountant would not amend his statements until the board negotiated an agreement to replace the reserve.

Facing a looming reserve commitment and claims of impropriety, the board needed to act. The negative statements would depress co-op sales. Completing the financial statements as submitted by the accountant would ward off potential buyers for the next year, with a lingering effect on future statements. The board was not in a position to replenish the reserve immediately, and it would have been fraudulent to replace the accountant at that time.

After nine months of failed discussions between the board president and the accountant left sales stalled, he board called us. We reached an agreement with the lender to allow the board to replace the reserve funds incrementally. The accountant accepted the repayment and terms, and ultimately, we were able to get the accountant to issue a new letter that contained language satisfactory to the board.

COMMENT The first lesson is that the board should not have touched the reserve. This is not, however, an unheard-of occurrence, especially for co-ops with new boards and/or lending agreements that go back many years. Boards should know their lending agreements and the co-op’s accounting history thoroughly to avoid mismanaging funds or, worse yet, violating the loan terms. Most boards do not have the time or expertise to handle this function. This case highlights how important it is for boards to select the right advisors.

Boards should conduct their own preliminary due diligence before retaining any advisors. Accountants should have in-depth industry knowledge and broad experience working with co-op and condos similar to your building’s size and revenue. They should also be clear communicators who can work with your board and lender easily. Conduct interviews and ask questions, such as how have you resolved audit discrepancies? What measures are taken in the event of auditing disputes? Ask for a list of their co-op/condo clients and contact these boards for references.

Avoid costly mistakes by having your attorney review your lending document before expending previously untouched funds to ensure there are no issues that can hurt your board down the road. When you have an accounting team in place, be prepared to keep them for the long haul. Your accountant can foresee and prevent issues if he or she has a long history of working with your co-op.

—Douglas P. Heller