Fine and Punishment

There’s a right way and a wrong way to go about establishing and levying fines. Doing it the right way can lead to a harmonious building; doing it the wrong way can lead to a courtroom.

The board of directors at Castle Village, a 585-unit co-op on the Upper West Side, decided several years ago that it was being hamstrung by outdated governing documents.

“Our corporate documents were from the 1980s,” says Jerry Fingerhut, an accountant who joined the co-op’s board in 2005 as treasurer and is now president. “There were all kinds of problems. For example, if we wanted to get directors’ and officers’ insurance for people who served on committees, we couldn’t do it. We were precluded from charging rent for storage spaces in the basement. That was thousands of dollars of lost revenue every year. And as for fines, the only fine we could levy was for late payment of monthly maintenance, a flat fine of $25.”

But a co-op board can’t simply decide to start imposing fines. It must rewrite its proprietary lease, which requires approval by a “super-majority” of shareholders, a percentage that’s spelled out in the lease. The super-majority at Castle Village was 75 percent.

Rather than rewriting the proprietary lease, the board decided to overhaul all of its corporate documents – the proprietary lease, bylaws, and articles of incorporation. The board’s attorney, Theresa Racht, a partner at Racht & Taffae, came up with drafts of the three documents, which were reviewed by the full board and its legal committee.

The proposed overhaul was many-pronged. It gave the board power to levy unspecified fines for violations of house rules; it gave the board power to levy a $500 fine if a shareholder failed to carry homeowner’s insurance; it established a 3 percent transfer fee, a storage fee, and a sublet fee; it instituted staggered terms for directors; and it reduced the required super-majority from 75 percent to 67 percent. It also specified that the fine for late payment of monthly maintenance would rise from $25 to either $50 or 1 percent of the maintenance, whichever was greater.

“There were also improvements to the language, more sharply defined terminology, so they’re more modern documents,” says Racht. “For example, we updated the indemnification provision so the board is indemnified to the maximum allowed by law. This is important because state laws have increased that amount since the late 1980s and early 90s. Any lease or [set of] bylaws from the 80s needs to be updated.”

The board sent out regular memos explaining the rationale for the changes, and it held several informational meetings that Fingerhut describes as “wide-open.” At those meetings the board listened to shareholder concerns and explained the potential benefits of such sweeping changes.

“For example, we had to explain that maintenance would go up without the three percent transfer fee,” says Fingerhut. “That, plus the fact that we would phase the fee in over the course of one year, persuaded the short-timers who were planning to sell.”

As for the toothless $25 fine for late payment of maintenance, Fingerhut says, “We had become a popular lending institution, which is not what we wanted to be. We didn’t want to be punitive, but we didn’t want to have to borrow money when people failed to pay their maintenance.”

Once the proposed changes were made final, the board faced what Fingerhut calls the “Herculean” part of the process – getting the necessary votes. The board convinced 30 sympathetic shareholders to serve on a steering committee and brought in the Honest Ballot Association to oversee the election. To get out the votes, the steering committee members were assigned to specific shareholders and told to knock on doors, prodding residents to show up for the election or return proxies in sealed envelopes. The secrecy eliminated intimidation and cheating.

It worked. The changes were separated into six items on the ballot, and every one of them passed with a plurality of anywhere from 75 to 90 percent.

History may help explain those impressive numbers. Back in 2005, Castle Village’s retaining wall collapsed into the Henry Hudson Parkway (see “And the Wall Came Tumbling Down,” Habitat, October 2006). In the wake of the calamity the board worked hard to make the repairs and help shareholders navigate the thickets of insurance claims.

“The board built up an enormous amount of good will [after the wall collapse],” says Fingerhut. “There’s no question we decided to spend that capital in order to change the governing documents. But I think we actually gained more good will from the vote because we showed we’re a transparent board with nothing to hide. The shareholders believed in us before the vote, and they still do.”

The new fines have already made a difference. Half a dozen shareholders who neglected to renew their home-owner’s insurance policies were fined $500 – and warned that a second fine would be levied if they failed to get coverage within 30 days. If they still failed to get coverage, the board would buy a policy and bill them. The shareholders promptly bought the insurance.

“So far, the fines have been largely psychological,” Fingerhut says. “The threat of a fine has changed people’s behavior. But we’re nearing the point with some people – people barbecuing, letting air conditioners leak rusty water, letting their dogs use the lawn as a toilet – there are a few nagging situations we’re going to have to address. Our role is not to be behavioral psychiatrists. The fact that we have to use this club is distasteful to us.”

For some boards, using that club has been downright disastrous. Bruce Cholst, an attorney and partner at Rosen Livingston & Cholst, is currently litigating a case on behalf of an upstate condo owner who distributed letters critical of the board. The letters charged that the building’s reserve fund is not empty, as claimed by the board, but actually contains $36,000. For making what it regards as “baseless attacks,” the board slapped the unit-owner with four fines of $100 apiece – then added $3,000 to his common charges to cover lawyer’s fees. The unit-owner sued the board, seeking dismissal of the fines and charges.

“The board has no fining authority in the original bylaws,” says Cholst. “They do have authority to fine for breaking house rules and failure to pay common charges. But even that’s through a board resolution – not from a super-majority of unit-owners.”

Some people think fines are misguided. “Fines don’t control behavior, and they don’t create harmony,” argues James Samson, an attorney and partner with Samson Fink & Dubow. “If a problem is so great, you ought to deal with it instead of slapping a $25 fine on the guy. I don’t like the fact that these controls on the quality of life are turned into revenue producers. In a condo, you need fines. But in a co-op, if you do it right, a person risks losing his apartment for his behavior. You send a default notice and he has to go to court to stop you. He has to prove his case.”

Castle Village’s Fingerhut begs to differ. “I’m in total agreement that you shouldn’t have to impose fines,” he says. “But that’s naive. There is no way short of hitting them in their pocketbook to make some people behave.”

The moral of the story? “Imposing fines has got to be done right,” Cholst says. “Otherwise it’s unenforceable and it will actually spawn litigation.”