Legal Lessons: Sponsors

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.

Asserting Board Control

Braverman & Associates

ISSUE How much change can an organized group of owners accomplish in a building with a sponsor-controlled board?

BACKSTORY While it is exceedingly unlikely that a sponsor-controlled board in a new construction building would agree to unit-owner demands to redecorate an otherwise brand new lobby, many sponsor-controlled boards will be receptive to requests for reasonable changes in building operations (i.e., adjustments in staff shifts and, where permissible, staff responsibilities). Likewise, where a sponsor is less than forthcoming in disclosing building finances or refusing to complete construction, a large, well-organized group of owners can be very effective in enforcing rights.

Hillary Clinton was correct when she said, “It takes a village.” Just ask the more than 100 owners at the Sheffield condominium who, earlier this year, banded together in the face of adversity to help save the 575-unit, 58-floor, mixed-use building from economic ruin. In March 2009, after being continuously stonewalled by the sponsor and an affiliated managing agent in its attempts to secure information regarding the condominium’s finances, a handful of unit-owners retained us to assist them in asserting their rights. While our clients were aware that things were amiss because of the cessation of construction work and a highly publicized dispute between the sponsor’s partners, which included one partner assaulting the other with an ice bucket, nobody quite imagined just how bad things were.

We demanded and obtained access to the condominium’s books and records and through that investigation learned that: (1) the sponsor had accrued $6 million in common-charge arrears, and neither the condominium’s board of managers (comprised solely of the three principals of the sponsor); nor the sponsor-affiliated managing agent had taken any steps to collect the arrears or protect the association by filing liens against the unsold units; (2) the sponsor had “borrowed” millions of dollars from the condominium’s reserve fund to pay its own expenses; (3) millions of dollars of mechanics’ liens had been filed against both sold and unsold units by contractors who had not been paid by the sponsor; and (4) the sponsor had filed plans for rooftop amenity space that were materially different from what was promised in the offering plan and marketing materials.

Realizing that the situation was dire, this handful of unit-owners embarked upon a grassroots campaign whereby they created a limited liability company (LLC), and, through a series of informational meetings, convinced over 100 of their neighbors to become members of the entity and to make monetary contributions based upon the size of their unit to fund the cost of their ongoing legal efforts. The group then elected a board that was charged with making the day-to-day strategic decisions on behalf of the entire group.

Thereafter, a three-pronged strategy was devised that included: (1) the start of litigation to compel the sponsor-controlled board to file liens for the unpaid common charges; (2) the filing of a complaint with the attorney general’s office; and (3) the involvement of local politicians.

The litigation was successfully resolved with an agreement that ensured that the sponsor’s common charge arrears would be paid upon a recapitalization or bulk sale, and the intervention of the attorney general’s office and local politicians provided instrumental assistance with regard to the ongoing investigation into what went wrong with the project.

Ultimately, control was wrested from the sponsor when one of its mezzanine lenders foreclosed and subsequently purchased the equity in the sponsor entity at a foreclosure sale, but not before the owners group helped stave off attempts by two of the sponsor partners to have a receiver appointed (who, presumably, would have put the sponsor into bankruptcy) and to enjoin the foreclosure auction.

Today, there is a new sponsor and new managing agent, all of the common charges have been paid, and the liens have been removed. In September, three residential unit-owners will be elected to the nine-member board of managers.

COMMENT When it comes to the management and operation of their properties, people who live in buildings that are still controlled by the sponsor often (justifiably) feel that they are on the outside looking in. While there are limitations on what can be accomplished vis-à-vis a sponsor-controlled board, a well-organized group of unit-owners can be very effective acting in a watchdog-type capacity until the time comes for the sponsor to relinquish control of the board.

In order to maximize the likelihood of success of an owner’s group, keen organizational skills are needed at the outset; these are what made our client, Sheffield 57 Owners, so successful. In our case, initial activists went to great lengths to organize their neighbors by sending out informational material on what they had learned in the early stages of their investigation, making phone calls to unit-owners and literally going door-to-door urging people to band together to protect their investments.

In addition, none of these individuals assumed the mantle of leadership simply because they were the “founders” of the group. Instead, the leadership was elected by the full group. This has resulted in a complete absence of internal power struggles and fractionalization within the group.

Regular and effective communication has continued throughout the process with blast e-mails containing updates sent out and regularly scheduled meetings of the full owners’ group held in space rented at a building across the street. Even those owners who were unable to attend were provided with a call-in number that enabled them to participate in the meeting via speakerphone.

The “lesson” here is clear. Simply because a sponsor may control a board does not mean that an organized group of unit-owners cannot form one unified voice to ensure that their rights are protected.

—Robert J. Braverman

Newly Built, With Flaws (I)

Dewey & LeBoeuf

ISSUE How can the first board of a newly constructed building deal with all the issues caused by the sponsor’s failure to complete the building?

BACKSTORY CitySpire is the nation’s second tallest residential tower, having 340 apartments, a garage, retail space, and offices on the second through twenty-fifth floors. Although today CitySpire’s residential condominium units sell for more than $2,000 a square foot, in 1991, West 56th Street Associates, the developer, responded to pressure from its lenders and lienors by filing an involuntary bankruptcy petition in the United States Bankruptcy Court in the southern district of New York. At the time of the filing, the city had withdrawn the building’s temporary certificate of occupancy because only one of four elevators had been installed; the fire safety and waterproofing systems had not been installed; and the dome of the building violated the environmental laws because of a high-pitched whistle that emanated from the roof.

In addition, the developer’s covenants with the city had been breached because the building was 14 feet too high; there were $400 million worth of liens and claims in the bankruptcy proceeding; and 265 residential units had been sold and occupied. European American Bank (EAB), the construction lender, held a mortgage on the unsold units and the Bank of Nova Scotia (BNS) held a mortgage on the commercial portion of the building. The situation appeared hopeless, especially to all of the unit-owners who had closed on their apartments who were fearful that they would lose their investment and their homes.

However, as a result of the sponsor’s bankruptcy filing, I was able to organize the unit-owners sufficiently to elect a residential board. It then opened negotiations with the EAB and BNS to develop a bankruptcy reorganization plan. Under the plan, the 75 unsold units were deeded to a subsidiary of EAB; the commercial unit was deeded to a subsidiary of BNS; the city was paid $2 million (to satisfy its claims against the property) and the city then took over the building of the rehearsal space for the City Center Theatre; and the three proponents funded the completion of the building, including building a multi-million dollar through-block connection between 55th and 56th Streets. With the help of the building’s managing agent, we were able to solve the noise problem at a cost of $3,500 by removing alternate slats in the cupola on the roof rather than the $5 million alteration proposed by a structural engineer. I was also able to have the residential board borrow $5 million for its share of the completion costs by pledging future common charges, which was ultimately repaid using sales proceeds from unsold apartments. The problems were all solved by the residential board working together and trusting the seemingly crazy strategy that I developed in which the board would take the lead in solving the financial problems.

COMMENT Although this all happened 18 years ago, considering the world in which we presently live, there are many lessons that can be learned. After all, as George Santayana noted, “Those who do not learn from history are doomed to repeat it.”

Question your engineer and look for a better solution. We were told by the biggest names in engineering that eliminating the whistle would require taking apart the roof and rebuilding it at a cost of $5 million. However, since we didn’t have $5 million, Vito Lanotte of Bellmarc Management, and I went up to the roof and looked ourselves. We found that the cupola was constructed of five-inch vinyl slats, so we had two workmen remove every other slat at a cost of $3,500.

Take a chance. We could not proceed unless the board could find $5 million for the completion cost, and it had nothing to finance. Therefore, I came up with the idea of pledging future common charges and wrote an opinion letter supporting it. Before the repayment of the loan, I led a group that spent two years writing and lobbying Albany to amend the Condominium Act to permit condominium boards to borrow. After a veto by Governor George Pataki, we were able to revise the proposal and it became Real Property Law section 339-jj. Each time I think that something can’t be done, I look at the framed pen I received from the governor’s office after he signed the law.

Keep the unit-owners united. We had 265 unit-owners and a five-member board who didn’t know or trust each other, but they united behind a tenant named Orly Binder, who spent countless hours keeping everyone together and fighting the city, state, the banks, and the sponsor’s creditors. The unit-owners took a leap of faith and, as a result, the value of their units skyrocketed after the economy improved.

Listen. Although I had been doing this for 20 years and had written two books on financial workouts, it was important that I listened to what the unit-owners were saying because they had to be kept in the loop. In fact, Leslie Winkler, the building’s managing agent, and I spoke every single morning at 8:45, at which times I told her what had happened the previous day and what I planned on doing that day, and she told me what she had heard from the board and the unit-owners. No one ever had to deal with the myriad of problems with which we dealt and we had to have a united team or the lenders would have steam rolled right over us.

Don’t get bogged down with peripheral issues. It is imperative to stay focused on your main goal and not get bogged down with peripheral issues. Some of the unit-owners wanted to go after the sponsor, others wanted to sue the banks, while others wanted to get the attorney general involved. However, I felt that both actions would just be expensive and not lead to an expeditious resolution of the problems. As for the attorney general’s office, it can be very helpful but, as it is now, it was overwhelmed with other issues, and we did not have the time to deal with a long investigation and proceeding against the sponsor. We needed to get the problems resolved before the reputation of the building was permanently damaged, and we needed to get the building completed before anyone was hurt.

—Stuart Saft

Newly Built, With Flaws (II)

Gallet Dreyer & Berkey

ISSUE How should board members act when managing a new construction condominium that has severe construction problems, a financially weak sponsor, and poor cash flow?

BACKSTORY We are dealing with several clients (condominium boards) faced with the triple threat of (1) defective or poor construction of their new or rehabilitated buildings and a sponsor that has few assets and will not correct the problems using its own funds; (2) the need for immediate and extensive repairs; and (3) the difficulty of raising common charges or passing assessments when unit-owners are faced with their own personal financial setbacks. In some buildings the income stream from sponsor-owned apartments has stopped or become intermittent at best. Some boards that we represent are also being served with bank foreclosure complaints naming them as potential defendants in actions brought to foreclose mortgages on sponsor-owned or individually owned condominium units whose owners are also not paying common charges to the board.

The impact on a condominium’s cash flow is tremendous when new expenditures are forced upon the board for necessary repairs (e.g., to replace a roof or repair windows or walls that leak). When the economy is good, a board could assess its unit-owners for these expenses or borrow the funds needed to perform the work and pay back the loan over time. When the economy is harsh, and a sponsor has defaulted in paying common charges for its unsold units, and there are instances of individual unit-owners in financial distress, it may be difficult to collect the funds needed for the repairs and impossible to borrow the needed funds from a bank.

If the board does not take steps to repair the building, it risks a further decline in common charge collections, as unit-owners suffering from leaks or damage to their apartments are likely to stop paying their own common charges. They also may file complaints with the Department of Buildings or the Housing Preservation and Development agency that could lead to fines and orders compelling boards to make such repairs at once.

Board members are fiduciaries and are obligated to take the steps needed to assure the sound financial operation of their condominium. They cannot delay taking action with the hope that the problems will “work out” when the economy improves. Those unit-owners who are paying in a timely fashion should not be saddled with an extended period where they not only are paying their share of operations, but also are paying the delinquent owner’s share to maintain services in the building.

What is the board to do? We try to work with the members to devise a strategy that applies the most pressure to the sponsor and delinquent unit-owners in the shortest time, with the least expense.

The first step is to document the problems and the costs to correct them. It requires the assistance of engineers retained by the board to examine the building, determine the causes of defects, estimate the costs of correction, and prepare a report that justifies the financial demand to be made on the sponsor. The report should be prepared quickly. Offering plans often contain written warranties that require that notice of defects be given to the sponsor within a short time frame. The report is also a useful starting point for the preparation of plans and specifications to be used for the needed repairs, whether the sponsor helps fund them, or the condominium pays the expense.

COMMENT We recommend a two-front assault on the sponsor. First, the board should file a complaint with the New York State Attorney General’s office (AG), asking the AG to convince the sponsor to perform needed repairs. The AG’s powers include bringing an enforcement action against a sponsor under the Martin Act and, if successful, imposing sanctions including payment for the cost or repairs and barring the sponsor from further real estate development in New York State. Second, the board can sue the sponsor for the cost of curing the defects in a suit brought by the condominium. We recommend trying the AG first, or concurrently with a direct suit against the sponsor if a contractual or statutory limitations period is about to expire, because the ultimate costs to the condominium will be less if the AG can obtain a settlement and the board does not have to prosecute its own action against the sponsor to conclusion.

We also recommend vigorous enforcement of the condominium bylaws against the sponsor or other unit-owners who do not pay their common charges on time. The remedies include filing and foreclosing a lien against the unit for unpaid charges, which subjects the unit-owner to possible loss of the unit at a foreclosure sale. Additionally, or as an alternative, the cooperative can bring a suit to collect the unpaid charges. That can result in a money judgment against the unit-owner that can be enforced against any of the unit-owner’s assets. In either case, the condominium bylaws usually provide that the defaulting unit-owner must reimburse the condominium for its collection costs, including reasonable attorneys’ fees.

Most boards realize that timely payment of common charges is a necessity for all condominiums and that a delay in collection only results in larger unpaid amounts that must be written off as uncollectible. When the board develops a reputation as being an aggressive collector of unpaid charges, fewer unit-owners will pay late.

—David L. Berkey

Taking Control

Kagan Lubic Lepper Lewis Gold & Colbert

ISSUE What steps should a board of managers consider after taking control from a sponsor of a newly established condominium?

BACKSTORY Many of our recent clients are newly established condominiums addressing the same basic problem. The sponsor managed the building and controlled the board until control passed to a board of unit-owners unrelated to the sponsor. The new board quickly discovers that building common areas have major construction defects; residential unit-owners are complaining of additional defects; the condominium budget is not balanced, leaving insufficient funds to pay expenses for operations; the reserve account is underfunded; and the sponsor is in no way helpful.

Construction defects may be as minor as completion of “punch list” items within common areas of a building or within units or may be as major as defective foundations and/or windows, leaking roofs, and/or deficient electrical and plumbing systems. Sponsors often make minor repairs while selling units but do not necessarily correct nor disclose the underlying nature of the problematic conditions.

Fiscal problems start when there is simply not enough money in the bank to pay the bills, and insufficient funding for major repairs. A sponsor may not make proper contributions to reserve funds, might misuse reserves, and/or improperly budget expenses. A newly constructed building or fully renovated building may not provide for the separate metering of certain utilities, or may rely upon a sponsor-engaged engineer’s report estimating projected costs for allocations of certain utilities – possibly in the most favorable light for a sponsor.

A careful review of such allocations by a professional may result in the reallocation of certain expenses permitted under the offering plan but ignored by inexperienced boards. One of our clients will save tens of thousands of dollars a year because of the installation of submeters that determine the proper allocations of certain utilities and allows for the reallocation of expenses between the residential unit-owners and owner of the commercial units. Often, the sponsor or a sponsor-related entity retains ownership of the commercial units of a condominium and has no incentive whatsoever to take any measures that may increase any costs allocable to its units.

COMMENT What to do? Act and act promptly. A board of managers must work fast to confirm that the building is safe and the condominium fiscally viable. Further, a board will want to assure itself that the building was constructed and delivered as promised in the offering plan, and that the sponsor-controlled board acted responsibly and in good faith during the period of time it managed the affairs of the condominium.

Any plan of action for the new board will likely include engaging a professional team consisting of a law firm, accounting firm, and engineer/architectural firm, each experienced in such matters to investigate and diagnose potential issues. Once these professionals conduct their assessment, a board of managers may make an informed and timely determination as to next steps, such as beginning a lawsuit, filing a complaint with the attorney general’s office, or preferably, though not always effective, engnging in dialogue to resolve any misunderstandings or bring about an amicable resolution to open issues.

Such situations may prove overwhelming to newly elected volunteer board members, who, like their fellow unit-owners, are frustrated and feel cheated by a developer that failed to deliver what was promised. Good management is essential, as an experienced managing agent will be familiar with these types of issues and able to assist board members in putting together a strategic plan to handle such matters. Time may be of the essence. Offering plans often contain provisions that limit warranties and guarantees as well as the time frame during which unit-owners and boards may make claims, particularly relating to alleged construction defects.

Regardless of the legitimacy of the complaints, sponsors will not voluntarily step up and address them unless formal action is taken. Mere letter-writing and dialogue will too often result in promises on top of promises but no real action. Often, the attorney general’s office is able to mediate a resolution. Sometimes, a board and unit-owners must be willing to take the fight to the sponsor and sue.

Unfortunately, there is no easy answer and the costs of a solution at times may exceed the value of the potential benefit that may be obtained. Accordingly, boards should carefully analyze the nature of the issues and disputes it may have with a sponsor and the economics of its options to obtain relief in order to make an informed and sensible decision on whether and how to seek relief.

— Ronald J. Gold