Who Owns the Apartment After Foreclosure?

Must a successful bidder at a nonjudicial foreclosure sale of co-op shares, who agreed to be bound by the terms of sale and thus the co-op’s governing documents, obtain permission of the board prior to obtaining the shares and lease?

That was the issue in LI Equity Network LLC v. Village in the Woods Owners Corp.

This was an action for specific performance whereby the plaintiff, LI Equity Network LLC demanded that the co-op, Village in the Woods Owners Corp., transfer its shares allocated to Apartment A2 located at 2 Eucalyptus Court, Selden, New York, to LI Equity. It purchased the shares at a nonjudicial foreclosure sale. The terms of sale bound the purchaser to the governing documents of the co-op. The documents required that the board approve prospective purchasers before they obtain possession of a unit and the shares allocated to it.

After LI Equity purchased the shares, the co-op’s board of directors notified it that it would reject any application for delivery of the shares and lease. LI Equity sued for specific performance on the ground that it was statutorily entitled to own the apartment, regardless of the terms of the co-op’s governing documents.

The case began in 1998, when Alfred Gerard and Greg Walters obtained a loan from Washington Mutual Bank that was secured by a lien on the shares allocated to the unit. In January 2007, the co-op evicted Gerard and Walters for failing to pay their maintenance fees. After their eviction, they defaulted on their loan. The lender declared the loan in default and scheduled a public auction.

The auction was a nonjudicial sale under Article 9 of the UCC. The auctioneer conducted the sale in accordance with the terms of sale, and prospective bidders agreed to these terms by executing a memorandum of sale. LI Equity was the successful bidder.

The co-op advised LI Equity that, in accordance with its offering plan, proprietary lease, bylaws, house rules, and application process, the board would not approve the transfer of the shares to LI Equity. LI Equity never filed a formal application with the board to obtain the shares. However, the board independently reviewed and rejected its proposal to close on the unit and then sell it to a board-approved purchaser.

In May 2007, LI Equity began this action. It also sought damages for breach of the implied duty of fair dealing. The lower court directed that the co-op transfer the shares to LI Equity, reasoning that it did not have the power to interfere with the transfer of the lease and shares from a “judicial” sale. The appellate court, however, reversed.

It found that LI Equity was subject to the approval requirements found in the co-op’s governing documents. Once subject to the documents, the terms of sale did not exempt LI Equity from the approval requirements. The court found that the co-op board properly exercised its business judgment when it applied the approval requirements to the bidder’s request to close on the shares.

LI Equity argued that the co-op approval requirements could not prevent the transfer of the shares allocated to the foreclosed unit by “operation of law,” i.e., the UCC. LI Equity relied on cases holding that co-ops may not interfere with a judgment creditor’s levy and execution on the shares or with a decedent tenant’s right to bequeath the shares.

The court discussed the terms of sale, which stated, at Paragraph 6, that “the apartment is sold...subject to the...bylaws; rules, regulations, procedures, resolutions, Offering Plan, charges, fees and any amendments thereto of [the co-op].” At the direction of the lender’s counsel, the apartment was sold in accordance with these provisions. The auctioneer provided the representative of LI Equity with the terms of sale prior to the auction, and LI Equity signed a memorandum of sale and acknowledged that it agreed to “comply with the terms and conditions of the sale of the said apartment” as set forth in the terms of sale.

The court said that LI Equity incorrectly argued that the terms of the governing documents could not interfere with its ability to close title because they contravened the rights conferred by UCC 9-610(b). The court explained that the statute provided that when a debtor defaults on a security agreement, the secured party “may sell, lease, license, or otherwise dispose of the collateral” and that disposition of collateral must be commercially reasonable and, if so, the collateral could be disposed of “by public or private proceedings...at any time and place and on any terms...” The court thus found that the terms of sale to which LI Equity assented were in addition to, and not in conflict with, the statutory rights derived from the UCC.

Moreover, the court explained that transfers that occurred by operation of law could be modified by a proprietary lease, bylaws, or other governing documents. The courts have consistently upheld that a co-op’s governing documents may permissibly modify the rights prospective co-op tenants obtain by operation of law.

The court discussed a previously decided case, wherein a co-op tenant/debtor pledged the shares of his apartment for a business loan from a creditor. When the tenant defaulted, the creditor took possession of the shares and the co-op issued a new stock certificate and lease to the creditor. Thereafter, the creditor agreed to reconvey the shares and lease to the debtor if he paid the entire balance on the loan, but conditioned it upon the consent of the co-op. The debtor sued, claiming that it had the statutory right under UCC Article 9 to redeem the shares from the creditor. The court disagreed and held that the proprietary lease, not the statute, governed the terms of the reconveyance.

The court noted that it previously applied these same rules in cases involving trusts and estates and that trusts were bound by the terms of proprietary leases and any restrictions contained therein.

The co-op made an additional argument supported by reference to several provisions of the lease and bylaws: that the governing documents prohibited the transfer of shares to a corporate entity. Moreover, the co-op’s application package included the following language: “Occupancy of the subject unit must be for a period of one (1) year, thereafter subletting will not be allowed... I understand apartments can only be purchased and/or owned by natural persons, not by corporations, partnerships or other entities...”

Here, the court reviewed the terms of sale. Paragraph 6 stated that the apartment was sold subject to the bylaws, lease, and other governing documents. Paragraph 8 of the terms of sale did the same in some greater detail; however, the terms stated that corporate bidders were specifically exempt from the provisions of Paragraph 8.

The court discussed general rules of contract construction and determined that LI Equity could not enforce Paragraph 8 against the co-op because the co-op was not a party to the terms of sale. The terms of sale formed a contract solely between LI Equity and the lender by virtue of execution of the memorandum of sale.

Accordingly, the appellate court reversed the lower court, denied LI Equity’s motion for specific performance to compel the closing of title, and granted the co-op’s motion to enjoin LI Equity from entering the apartment during the pendency of the action.

Comment: The case is consistent with other cases that have held that, provided the terms of sale contain a provision making the sale subject to the rules of a co-op, a successful bidder should not expect to be able to immediately move in to the apartment. To the contrary, the bidder must be prepared to comply with the rules, regulations, and policies established by the co-op. This may result in the co-op refusing to issue the shares and lease to the successful bidder.

Based on the court’s analysis of who is bound by the terms of sale, we do not know how the court would have decided the case if the terms of sale had not included language making the auction subject to the terms and conditions of the co-op’s governing documents.

As there may be more nonjudicial foreclosure sales given the recent economic climate, we caution boards to be proactive and make certain that the terms of any sale include provisions making it clear that the sale is subject to the co-op’s governing documents.

Attorneys:
For Plaintiffs:
Windels Marx Lane and Mittendorf LLP
For Defendants:
Havkins Rosenfield Ritzert & Varriale LLP