Flipping Out

My board is thinking of raising our co-op’s flip tax to the higher of ten percent of the profit or two percent of the sales price as calculated for each transaction. We feel that is the best way to maximize the amount that we receive from both longtime owners selling for big profits and newer owners just hoping to break even or minimize their losses. Our current flip tax has been in effect for many years and is just $20 per share. Is there any problem with this new flip tax, and can we do it with a board vote at the next meeting?

This is the type of question that gets co-op/condo attorneys’ blood flowing. The answer seemingly should be so simple, and in certain respects it is. But there are many traps along the way to adopting or modifying a flip tax (more accurately, and euphemistically, a transfer fee), and the consequences are great if the co-op gets it wrong. An improperly implemented flip tax might remain in effect for many years, and then one successful challenge could require the co-op to refund the amounts collected on scores of sales, amounting to many hundreds of thousands of dollars of losses.

Flip taxes channel two distinct legal streams emanating from a common source, coming together into a murky river, and flowing toward a potential ocean of substantial relief for revenue-starved co-ops during particularly hard times.

The common source is that co-ops are corporations governed by the Business Corporation Law (BCL), applicable also to those New York corporations formed to make money. The first stream is BCL 501(c), which provides that “each share shall be equal to every other share of the same class.” Co-ops have one class of stock, and each “apartment owner” actually owns just some of that stock, and also gets a proprietary lease.

So, if a co-op charges a flip tax other than on a strict “per share” basis, it could run afoul of this law, as New York’s highest court found for one co-op in the landmark 1985 case of Fe Bland v. Two Trees Management Co. That is true unless the flip tax qualifies for the exception to BCL 501(c) that was adopted in 1986 to allow co-ops to treat shareholders disproportionately to their stockholdings with regard to flip taxes, so long as so adopted in the “proprietary leases, occupancy agreements or offering plans, or properly approved amendments” to them.

The second stream contains the principles of corporate governance that are found in a co-op’s bylaws and, to a lesser extent, proprietary lease, as well as the BCL. After its original formation by its “incorporator” (for a co-op, usually the sponsor), a co-op is governed by its board of directors, except when the governing documents or law deems an action important enough to require shareholder approval.

So, for example, a co-op’s proprietary lease – which typically provides the requirements for transferring (selling) apartments, and thus is one logical place to provide for a flip tax – usually can be amended only by a super-majority vote of shareholders, typically two-thirds or three-quarters. Co-ops’ bylaws, however, typically provide that, on transfers, co-ops are entitled to reimbursement for related expenses. Bylaws also are a logical place for co-ops to provide for flip taxes. Some confusion arises from this, though, because bylaws typically can be amended by a super-majority vote of the board of directors alone, as well as by the shareholders alone.

When these streams merge into the flip tax river, things become quite murky. One might conclude that co-ops can use the just-discussed BCL 501(c) to impose flip taxes on shareholders in whatever discriminatory and otherwise diabolical ways that they want (short of unlawful discrimination, bad faith, and self-dealing); and can do so simply by amending their bylaws instead of proprietary leases, and thus with board action alone.

But two fairly recent cases highlight that this is far from clear. Strikingly, they approvingly cite each other (made possible by some unlikely procedural timing) and then reach different results in somewhat similar circumstances.

In Weigel v. 30 West 15th St. Owners Corp., shareholders voted to amend a co-op’s bylaws to impose a flip tax equal to one percent of the sales price, and then 20 years later the board unanimously approved an amendment to the bylaws increasing the charge to two percent. Since the shareholders determined that a one percent fee was appropriate, shareholders arguably should have been allowed to decide that twice that fee was later appropriate. But the court concluded that co-ops can adopt flip taxes in their bylaws, which could be so amended by board vote alone, and thus upheld the flip tax there. (Most co-op bylaws state that provisions adopted by shareholders must be amended by shareholders. In Weigel, such a provision apparently was not present, or was overlooked or ignored for some reason.)

In Pello v. 425 E. 50 Owners Corp., a co-op board claimed to have adopted a flip tax equal to two months’ maintenance and a year later to have increased it to 2.5 percent of the sales price. The court noted first that “Imposition of a flip tax may be effected by amendment to the co-op bylaws, and it is not necessary that the proprietary lease also be amended [citations omitted].” The court found, however, insufficient evidence of proper board or shareholder approval for the initial flip tax, and only marginally adequate evidence of board approval alone for the amended flip tax. The court held that insufficient apparently because the lack of evidence of the board’s adoption of the initial flip tax invalidated the “raise” to the flip tax, at least by board vote only. More clearly and importantly, the court concluded that the new flip tax was a charge “totally disproportionate” to stockholdings, thus enforceable only if qualifying for the BCL 501(c) exemption, which the court concluded required shareholder approval (indisputably not present there), possibly unless (the court noted) there had existed the Weigel scenario (which Fe Bland dodged) of shareholder approval of the initial flip tax and board approval of the amendment.

To add to the confusion, the Weigel shareholder sought and received the court’s reconsideration of its earlier decision, although to no different result. In the second Weigel decision, the court first decided that the two percent fee was not disproportionate to stockholdings by noting that Fe Bland struck down a two percent fee because it was adopted only by board resolution and not because it was disproportionate. Fe Bland, however, did not rule one way or the other whether a flip tax based on a percentage of sales price is disproportionate.

This Weigel conclusion also defies logic, as well as Pello, because the sales prices of co-op apartments (and thus flip taxes based on them) are not, of course, strictly linked to the number of shares allocated to the apartments. Weigel then held that BCL 501(c) allows the two percent fee even if disproportionate to stockholdings, based on the duly adopted amendment to the bylaws even though by the board alone. But Weigel cited Pello for this even though Pello held (consistent with the express statutory language) that proprietary lease amendment by shareholders also is required to qualify a flip tax, under BCL 501(c), for disproportionate application to shareholders.

So Weigel and Pello were definitely reading and citing each other and trying to reconcile their conflicting conclusions about the validity of the flip taxes that each faced. But this created even more confusion. Under Weigel, co-op boards seemingly can adopt increases to flip taxes initially adopted by shareholders even if disproportionate, and even possibly such flip taxes having just board approval from the outset. Under Pello, co-op boards seemingly need shareholder approval for disproportionate flip taxes, possibly with the exception of the Weigel situation in which shareholders previously approved a lower but still disproportionate flip tax. Pello also could be requiring shareholder approval even if the flip tax is not disproportionate. Last but not least, Weigel does not find flip taxes disproportionate if based on a percentage of sales price, while Pello surely does.

Where does this leave our questioner and those co-ops similarly situated? The law has evolved in fits and starts and has all kinds of pitfalls. So, if adopting a flip tax that is arguably disproportionate, to be safe, you must get shareholder approval. The consequences of not doing so are just too great. Also, of course, it is more democratic. The questioner’s flip tax is even more than usually at risk because it has alternative rates that might apply to each shareholder. If charging on a per-share basis, the risks seem far less for board-only modification, or even initial adoption, of a flip tax, provided that it is properly done as a board-permitted amendment to the bylaws. But even then, I would seriously consider taking no chances, and securing shareholder approval. Taxes, these days, are none too popular in any realm, and the mandate of voters for something like this is a very nice thing to have.