Saying “No” to Self-Dealing Sponsors

When Paul Hindle bought his condo unit in 2007, he was excited. The building was a reasonable size – 36 units – located in Manhattan, and best of all, it was new construction. Hindle looked at the building, examined the offering plan, and signed on the dotted line.

Then he moved in. And the problems began.

“The heat didn’t work. The plumbing didn’t work, [and] there were cosmetic issues,” like the closet doors not being finished. “I thought it was like buying a new car, everything would work properly.” But it didn’t. For the first six to twelve months, Hindle estimates, the problems kept cropping up. It was only through casual discussions with neighbors that he discovered he wasn’t alone. From conversations in the corridor, he learned that one unit-owner’s shower leaked and another’s vanity had fallen off the wall. Some kitchens weren’t completed, and there were floors that weren’t finished.

“We went through the first winter and we discovered a big problem with the heat – it kept turning itself off. It turned out that the valves in every unit had been installed upside down.”

When the developer refused to offer any restitution, and in fact, refused to acknowledge there were any problems at all, the owners got angry. Then they got organized. They formed a board and hired an attorney. They hired a new management company and then started using the building’s reserve fund to employ plumbing, roofing, and heating experts to look at the systems in their building.

Their organization paid off. “The minute we started to take control, he kind of walked away,” Hindle recalls of the developer. “Since that day, he has been unbelievably disengaged.”

“Looking back on it, it was almost like the developer still saw it as his building, and we were almost treated as tenants.” The unit-owners couldn’t get a straight answer about getting their problems addressed. Says Hindle. “That’s why we formed the board. Had we not done that, nothing would have gotten fixed.”

While the problems are not all eliminated, Hindle’s building is on its way to digging out of the repair pit –next year, owners will see an increase of 10 percent in their common charges, to help pay in part for all the needed repairs. The developer will be feeling the pinch the most, since he still owns 20 percent of the units.

Welcome to home ownership 101 – it’s your unit, it’s your building, and you need to take responsibility.

For new boards just learning to flex their management muscle, the New York State legislature has offered an additional tool in their tool kit – a revision to the General Business Law that explicitly states that sponsors must proactively inform boards that they have the right to void any self-dealing contracts once the shareholders take over a majority of the board.

To wit: once shareholders or condominium owners gain a majority, they can end sweetheart leases a sponsor may have with commercial space in the building. They can fire the sponsor’s building manager and hire their own (as Hindle’s building did) and they have to be told, in writing, by the sponsor, when they can do this.

The revision in the law mirrors the 1980 Federal Condominium and Cooperative Abuse Relief Act, with one change, the revision requires the sponsor inform the shareholders and unit-owners that they can void contracts that specifically benefit the sponsor.

Under the federal law, the act permits tenant-shareholders or unit-owners in conversion projects which have five or more residential units to terminate self-dealing or so-called “sweetheart” contracts within two years of the date that the sponsor ceases to control the board or owns 25 percent or less of the units, whichever occurs first. However, because the federal relief act does not contain a notice provision, many fail to exercise their rights.

According to the language in the new revision to the General Business Law, the revision “now requires sponsors of cooperative or condominium conversions to notify tenant-shareholders or unit-owners entitled to terminate such contracts within 30 days of the date that right commences and at least six months prior to the date such right expires.”

But to get their rights, shareholders and unit-owners must make sure that they control the board. To that end, “you have to get elected,” says Geoffrey Mazel, partner at the law firm Hankin & Mazel.

Mazel, who counseled Hindle’s building, says the problem with self-dealing sponsors is not as great as it was in the 1980s, when there were all kinds of conversions going on, though there are still ways in which sponsors try to skirt the law, such as finding shareholders friendly to their point of view, who run for the board as essentially secret proxies of the sponsors.

“I did have a situation [like that] about three years ago. The sponsor was supposed to give up control 20 years ago. I was approached by a shareholder group,” who wanted to know, how can we get rid of the sponsor? “You’ve got to win the election,” Mazel told them. But the anti-sponsor shareholders couldn’t dislodge the pro-sponsor board.

“Years ago, co-ops and condos used to come to me and I would take a look at the contracts they had and often they would have self-dealing contracts, but the time period for the shareholders to vote to terminate had expired. This amendment would have prevented that,” says attorney Steven Wagner, a partner with Wagner Davis.

The revision to the law would have prevented the self-dealing because the shareholders “would have known right away and sought advice much earlier.” These days, says Wagner, “when I look at offering plans I don’t see the self-dealing contracts because sponsors [now] know what they can and can’t do.”