Recognition Refusal

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May a cooperative housing corporation refuse to execute a recognition agreement for a shareholder attempting to use the shares allocated to his apartment as collateral for a home equity loan? That was the question in Kikis v. 1045 Owners Corp.

Thomas P. Kikis is the owner of shares allocated to several apartments located at 1045 Fifth Avenue in the Metropolitan Museum of Art district. Kikis began an action against the co-op, 1045 Owners Corp., and Elisabeth Brenhouse, president of the board of directors.

Kikis wanted to use his apartments, one of which was appraised at $7 million, as collateral for a home equity line of credit (HELOC) for $3 million. The board denied his application and refused to sign a recognition agreement. As a result, the bank would not approve the HELOC. Kikis brought an action for an order requiring the board to approve his loan and sign the recognition agreement. He also sought exemplary damages and punitive damages and claimed that the board breached its fiduciary duty to him. Kikis challenged the procedure surrounding the board’s alleged corporate resolution concerning HELOCs. Kikis and the defendants all moved for judgment.

The board stated that it denied the request to use the shares to secure the HELOC because such loans were not approved for any shareholders even though this rule was not stated in the proprietary lease, bylaws, or any other formal policy other than the purchase application and the corporate resolution that Kikis had challenged.

The court explained that on a motion to dismiss (made by the defendants), the pleading was to be afforded a liberal construction so that the facts as alleged in the complaint were accepted as true. Kikis was to be given the benefit of every favorable inference, and the court could determine only whether the facts, as alleged, fit into any cognizable legal theory.

The co-op submitted that failing to approve the HELOC is “policy” and that it had “never been done before” in this building.

The court noted that in the Levandusky v. One Fifth Avenue Apartment Corp. case, the Court of Appeals – New York’s highest court – allowed boards “virtually unfettered power to make decisions based on the Business Judgment Rule.

Kikis argued that he was denied due process because there was nothing forbidding HELOCs in the bylaws or proprietary lease and further claimed that there was no notice of an alleged resolution and that the corporate resolution was created just for him. Kikis also asserted that Brenhouse had an intimate relationship with the secretary of the board, which created a conflict of interest.

The court held that even if there were a relationship, it would not necessarily constitute a conflict and further that there was no hint of any such conflict. There was also no proof that the board’s actions were discriminatory. Nor was there evidence that Kikis was treated differently than anyone else. There was no indication that others in the building were permitted to use their shares to secure a HELOC. While there was no sign that Kikis lacked the finances or assets to support the HELOC, the board did not wish to have such encumbrances on the shares allocated to apartments in the building. The court found that the board had the power to determine this.

The court then addressed Kikis’s claims of breach of fiduciary duty. The court explained that a fiduciary, in the context of property management, is one “who transacts business, or who handles money or property, which is not his (or her) own or for his (or her) own benefit, but for the benefit of another person, as to whom he (or she) stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.”

The New York State Court of Appeals had determined in another case that the managing agent was a fiduciary to the corporation, but not to the individual unit-owners. Defendants argued that, as a result, there could be no claims for breach of fiduciary duty on the part of the board or individual defendant. The court found this position to be correct.

The court addressed whether the board members should have been individually liable for breach of fiduciary duty. The court reviewed Kikis’s arguments and found that they were largely based on personal relationships that established no conflict.

The court then discussed the Levandusky case wherein the court of appeals established a standard of review analogous to the corporate Business Judgment Rule for challenges to a decision of a cooperative corporation’s board of directors.

Accordingly, Kikis had to allege facts showing that the board or any of its individual members acted outside the scope of their authority or in a way that did not further the co-op’s legitimate purpose or in bad faith.

The court explained that when dealing with individual liability, courts dismiss complaints against individual board members if the pleadings do not allege, with specificity, that the board member committed an independent tortious act. This showing was necessary to overcome the Business Judgment Rule.

The court referred to another case where the appellate court held: “That the cooperative corporation’s board of directors may have taken action that ‘deliberately singles out individuals for harmful treatment’ does not, ipso facto, expose the individual board members to liability. The proposed cause of action ascribes no independent tortious conduct to any individual director, and plaintiff proposed... cause of action is therefore deficient as a matter of law... ”

Under Levandusky, the court said, the exercise of a board’s power for the common and general interest of the corporation could not be questioned even though the results showed that what it did was “unwise or inexpedient.” The choice of the board may not have been what others might have done. But the collective decision on the part of the board did not expose individual board members to liability since there would have been no independent tortious conduct by any individual director. Kikis did not set forth in the complaint that there was a plan to harm him.

As to Kikis’s claim that the board adopted the resolution without due process, the court observed that, even so, it would not change the outcome because the board’s action, with or without a resolution, would still be in accord with Levandusky.

Accordingly, the court dismissed the action against the defendants.

Comment: This case involved a situation where the board asserted that it had a policy in place concerning home equity loans, but the policy did not appear in the proprietary lease or bylaws. If a board resolution was passed, it was very recent. While it is difficult to determine from the decision, it appears as if the form purchase application distributed by the managing agent advised purchasers that HELOCs could not be secured by the shares. In any event, the case raises the question of whether a board can promulgate and enforce a policy even if it is not in the governing documents or house rules. Although the court did not cite or reference the proprietary lease or bylaws, we must presume that the policy did not violate any specific provisions of the documents.

Accordingly, the court found that the policy – which was consistently applied to all shareholders – would be upheld in accordance with the Business Judgment Rule. This is consistent with a number of other post-Levandusky cases that have refused to interfere with decisions of boards provided the shareholder did not demonstrate that the board acted beyond its authority or in a way that did not further the co-op’s legitimate purpose or in bad faith.

It is also consistent with a pre-Levandusky case reported in this column in the July/August 1985 edition of Habitat. There, we discussed Browne v. 930 Fifth Corporation, where a shareholder wanted to use his shares to secure a loan to purchase real estate in Westchester County. The board refused to sign a recognition agreement, and the shareholder sued. Consistent with the later decision in Kikis, the court dismissed Browne’s complaint as the co-op was not required to execute the recognition agreement.

Kikis also reminds us that cases will not be sustained against individual board members absent a showing, with specific allegations, that they committed a tort separate and independent from any action they may have taken in their capacity as board members.

For Plaintiff:
Finkelstein Newman Ferrara
For Defendants:
White Fleischner & Fino