Revising Sublet Policy Unilaterally - Novitt, Sahr & Snow

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Tara Snow, Partner, Novitt, Sahr & Snow. Can – and should – a co-op board overhaul its sublet policy without shareholder approval?

BACKSTORY We are general counsel to an 80-unit co-op that has a long history of being liberal with its sublet policies. Needless to say, when a co-op has roughly 30 percent of its apartments owned by a sponsor or investors, it will probably have investors on the board who are not averse to lenient sublet policies. At a recent annual meeting, several new resident-owners were elected to the board. The new members sought our opinion as to the permissible and advisable level of sublets, as well as the board’s authority to modify the existing sublet policies. We discussed a number of issues including whether the co-op should anticipate problems from prospective lenders (end-loans as well as underlying financing) if the owner occupancy rates are not high enough. We advised them that, in the quickly changing world of lender underwriting requirements (i.e., a co-op’s finances, insurance coverage, etc.), low owner occupancy is always an issue. We then conducted a review of the co-op’s proprietary lease and bylaws to determine the authority of the board to create new policy. The plan’s language gave the board broad authority.

After these discussions, the new board members proposed a new and stricter policy that included:

1) A restriction that shareholders could not sublet their units for more than two out of any five years.

2) A sublet fee.

3) A ceiling of 30 percent for sublets in the building.

Though we advised that the board was authorized to pass such a policy, we cautioned that the policy would pressure the investors (but not the sponsor) to sell their units soon. Another unintended effect could be downward pressure on unit values if too many apartments hit the market at once. We counseled that a policy leading to a more gradual change in the number of sublet apartments would probably face a less cohesive opposition.

A divided board proceeded to pass the new, stricter policy. Several investors hired an attorney and started an action in Supreme Court. They claimed that the board had illegally instituted the new sublet policy. The suit alleged that the new policies should have been approved by the shareholders.

While a final determination of the case was never reached, as part of the order to show cause, the court refused to enjoin the co-op from instituting its new policy. The court found that it was likely that these policies were legal and properly instituted. Victory? Several months later, at the annual shareholders meeting, the investors banded together and were able to secure enough seats on the board to roll back and modify the much-debated sublet policy. Defeat?

COMMENT The courts have been very clear in stating that the relationship between a shareholder or unit-owner and the co-op/condo is contractual and the rights in each instance are based on the language in the particular documents. Every co-op/condo is not the same.

Boards need to consider the ramifications of creating new policies before instituting them. It is not enough that a policy be legal. It should also make sense, both logically and politically, within that particular building. In this situation, the board instituted a policy that, while legal (and supported by the court), was neither practical nor politically maintainable. The individual shareholders who began the lawsuit and the co-op board spent a significant amount of money fighting over an issue that probably could have been prevented by compromises. Policies with a more gradual impact could have been instituted, which, over a period of time, would have maintained reasonable sublet levels without immediately threatening a large group of shareholders.

The number of investors in the building gave them a powerful political voice. This tenuous balance of power should have been considered before the board imposed such sudden and drastic changes in co-op policy.

From the Desk of TS:

The firm cried “sue-ee” when forced to evict a woman co-habitating with a potbellied pig.

When a fistfight broke out at a condo’s annual meeting, the police were called, but before they arrived – 45 minutes later – the meeting and the fight sporadically continued. The two men would punch each other, take a break, and then punch again, all while the meeting chugged along.