Sublet Restrictions

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May a shareholder who purchased two apartments from the sponsor and subleased them continuously and with minimal board review for 30 years continue to do so even after the board passes a resolution limiting the amount of time shareholders can sublet? That was the issue in Bregman v. 111 Tenants Corp.

Plaintiff Cornelia Sharpe Bregman alleged in her complaint that, in 1972, she was a tenant living at 111 East 75th Street in Manhattan when the building owners, who were converting the building to cooperative ownership, approached her about buying apartments in the building. Bregman asserted that she lived in apartment 6C but that, because of an insufficient number of subscriptions to qualify for conversion, a principal of the sponsor asked her to purchase her apartment as well as penthouse Apartment 10A.

Bregman claimed that she entered into an agreement that gave her “full, unconditional, and perpetual sublet rights” to both apartments because the sponsor recognized that she would have to sublet one or both apartments.

Bregman’s understanding, however, was not reflected in any documents that she signed. In fact, the court noted that the proprietary leases she signed specifically contained a provision requiring board authorization prior to subletting. The leases stated: “The Lessee shall not sublet the whole or any part of the apartment or renew or extend any previously authorized sublease, unless consent thereto shall have been authorized by a resolution of the Directors ... Any consent to subletting may be subject to such conditions as the Directors ... may impose. There shall be no limit on the right of Directors ... to grant or withhold consent, for any reason or for no reason, to a subletting.”

A document that had been signed by Bregman and the sponsor specifically addressed Bregman’s purchases. The document, dated April 14, 1972, acknowledged that Bregman would be permitted to sublet “provided the consent of the Board ... is obtained.” The document further stated that the owners of the building would use their “best efforts” to have the board “not unreasonably withhold” its consent to subletting. The court noted, however, that the agreement did not contain a provision that altered or diminished the board’s authority to grant or withhold consent.

The court reviewed correspondence from the time of Bregman’s purchase. The owners of the building explicitly rejected language that would have required that the board could not unreasonably withhold its consent to Bregman’s subletting her apartments. A letter dated May 1, 1972, stated that sponsor was returning Bregman’s checks in connection with the purchase because the proprietary leases did not provide that consent would not be unreasonably withheld and that since the owners of the building could not bind future boards, they would not agree to the inclusion of such language. A second letter, dated June 1, 1972, from the sponsor’s co-op coordinator to Bregman’s attorney confirmed Bregman’s purchase of the apartments and documented that Bregman’s attorney had agreed to the final form of agreement, in which the phrase “which consent shall not be unreasonably withheld” was deleted. This phrase was added instead: “The owners will use their best efforts to have the Board of Directors not unreasonably withhold their consent to subletting [by plaintiff].”

Importantly, the final signed document, dated April 14, 1972, did not contain any language in which the board promised to “not unreasonably withhold its consent” to sublets; nor did it have any language that stated Bregman would have the unfettered right to sublet.

After Bregman purchased in 1972, she lived in Apartment 6C for two years, during which time she renovated Apartment 10A. During the next 30 years, Bregman sublet both apartments. Bregman claimed that she “occasionally” submitted information about her subtenants to the board “as a courtesy,” but she did not include any provision in any sublease making the co-op’s consent a condition of the sublease. Bregman asserted that this was because she believed that her arrangement with the board made its consent unnecessary.

On September 16, 2003, the board adopted a resolution stating that “no lessee shall be permitted to sublet the whole or any part of an apartment or renew or extend any previously authorized sublease for more than two years during any four consecutive year period unless consent thereto has first been duly authorized by a resolution of the Directors.” This resolution was allegedly adopted after a board member learned the amount of rent Bregman charged her subtenants.

A sublease for Apartment 10A was submitted to the board for approval in August 2003. The board okayed the sublet, conditioned upon Bregman’s delivery of an executed copy of a document: “Shareholder Acceptance of Corporation’s Sublet Policies.” This required Bregman to acknowledge that the right to sublet was governed exclusively by the co-op’s bylaws, including resolutions adopted by the board that restricted the shareholders’ rights to sublet to two out of every four years. The document also stated that “the undersigned agrees that the board’s decision to waive the production of certain documents normally required during the sublet application in no way creates precedent or requirements for any future waivers or exceptions with respect to the corporation’s then current sublet policy and application process.”

Two years later, Bregman submitted an application for another sublease on the same apartment. On November 21, 2005, the managing agent rejected the sublet application with a message saying, “I am not to accept any sublet packages” for 10A. On February 10, 2006, the board president wrote that under the new sublet policy, the apartment would not be eligible to be sublet again until September 2007. The letter explained that, while there were exceptions made to the new sublet policy, “a shareholder must demonstrate that there are extenuating circumstances surrounding the sublet.” The letter then requested that, if Bregman felt there were such circumstances, she should contact the board. Bregman asserted that she had special rights. The board requested that she provide documentation in that regard. Bregman’s counsel responded and questioned the board’s reliance on the resolution for its rejection of the application.

The board took no further steps. Bregman brought this action. The complaint alleged that the board’s denial of Bregman’s right to sublet was arbitrary and capricious, was not a proper exercise of any legitimate business judgment, and that it had the effect of creating two classes of shareholders – those who could sublet and those who could not. Bregman alleged economic harm in lost rental income and sought an injunction preventing denial of her sublease applications. The co-op made a claim for attorneys’ fees and expenses in accordance with the terms of the proprietary lease.

In July 2010, Bregman retained new counsel, who sought to amend the complaint. Bregman now claimed that the co-op and managing agent were attempting to divest her of her rights as a shareholder. Bregman claimed the co-op refused to permit her to sublet either of her two apartments, and that the managing agent had systematically interfered with her ownership rights by preventing or unreasonably delaying access into her apartments by her contractors. Bregman’s proposed amended complaint included a claim that the original board assumed the contractual obligations of sponsor and confirmed her perpetual subletting rights at its first meeting. Bregman offered a letter dated February 2, 1983, from the board’s counsel stating that, “In view of the arrangements made at the time the building went cooperative and you purchased two apartments on condition that you ... be permitted to sublet same, we have investigated your proposed subtenant ... and find him suitable.”

Bregman also submitted an affidavit on May 8, 2007, from the same counsel, now deceased, stating that he was a principal of sponsor at the time of the conversion and that, “As I recall, at one of the early Board meetings, the arrangements which we had made with Mrs. Bregman at the time of the purchase were acknowledged by the co-op’s Board, the intention being that it would not simply be an agreement with the sponsor but also an agreement which would be understood to be followed by the co-op, and the minutes should reflect the foregoing.”

Bregman sought to add the managing agent and individual board members as parties, with claims for breach of contract and breach of fiduciary duty against the co-op and members of the board and to add a claim of tortious interference with Bregman’s proprietary lease, as against the managing agent. The co-op moved for summary judgment.

The court found that nothing in the documents submitted supported Bregman’s position that she had the unfettered right to sublet. According to the proprietary leases, the right to sublet always required board consent and there was no protection against consent being withheld.

Even if the court could have relied on the 1983 letter and the 2007 affidavit by the now deceased former principal of the sponsor, the documents did not sufficiently support Bregman’s claims. In fact, the court noted, they lacked any indication that the sponsor had the ability to bind the board.

The court also reviewed an applicable statute, Business Corporation Law Section 501(c). The statute provided that “each share [issued by a corporation] shall be equal to every other share of the same class.” Thus, the statute precluded any special subletting rights.

The court discussed a 2003 appellate level case. In that, a shareholder challenged a managing agent’s denial of a request for consent to a sublet. The same court deciding Bregman invalidated the portion of the co-op’s proprietary lease that gave preferential treatment to those who purchased directly from the sponsor, i.e., “original purchasers.” Bregman tried to distinguish the 2003 case; however, the court noted that it was the same issue based on two different situations in which shareholders tried to claim rights beyond those of other shareholders. The court stated that BCL 501(c) precluded a shareholder from obtaining special rights that could not be granted in the lease and bylaws.

Bregman also argued that the 2003 resolution was enacted in bad faith, since its sole intent was to discriminate against her. The notice of meeting at which the resolution was passed specifically stated that the meeting was to discuss “the sublet issue” of Bregman. Thus, Bregman claimed that the adoption of the resolution at that meeting demonstrates that it was about her and that because it was “targeted,” it shows the co-op’s bad faith. The court found that the record failed to support Bregman’s claim.

The court referred to a case decided by New York’s highest court in 1990 –Levandusky v. One Fifth Avenue Corporation. There, the court of appeals stated that a co-op board owes its duty of loyalty to the cooperative – “that is, it must act for the benefit of the residents collectively.” The Levandusky court set out the Business Judgment Rule, which stated that “so long as the board acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board’s.” The court explained that the rule protected the board’s decisions from indiscriminate attack while at the same time allowed review of improper decisions.

The court held that the board at 111 Tenants Corp. was prompted by a legitimate interest in the welfare of the co-op to maximize owner occupancy and therefore the value of the shares. It was authorized to adopt a resolution in furtherance of that interest.

The court also explained that boards could not single out a shareholder for disparate treatment; however, if it became aware of a situation that was contrary to the interests of the co-op, it had the right to adopt a policy to address that situation.

Even though the board’s new policy, adopted in 2003, may have prevented Bregman from subletting her apartments as she had for the prior 30 years, adoption of the resolution was not the type of deliberately abusive treatment that would have justified allowing a legal challenge to the board’s decision.

Moreover, even if Bregman were the impetus for the decision to pass the resolution, she was not the only shareholder affected by the resolution. Rather, the resolution applied to all shareholders. That Bregman more immediately felt the impact did not render the board’s action discriminatory.

Finally, the court affirmed that leave to amend the complaint was properly denied as well as the lower court’s decision to dismiss the complaint.

Comme

nt: This decision addresses myriad issues concerning the rights of boards and shareholders who have engaged in a course of conduct over many years. Factually, the plaintiff could not demonstrate that she was given additional rights when she purchased at the time of conversion in 1972. Although the court addressed this point, it is not clear that it would have made a difference in the outcome. Earlier appellate cases held that, where sponsors of co-op conversions gave special rights to “original purchasers,” i.e., those who purchased from the sponsor, those rights were invalidated based upon the Business Corporation Law’s provisions requiring that all shares be treated equally. (We note that the Business Corporation Law does not apply to condominiums.)

The Bregman court explained that, even if the sublet resolutions were passed in light of the prior treatment of plaintiff, the resolutions were applicable to all shareholders who wished to sublet. The fact that the plaintiff may have been the reason the issue came to the board’s attention was of no moment and did not serve as a basis to invalidate the resolution.

Attorneys

For Plaintiff

Stiefel & Cohen

For Defendants

Hoey, King, Epstein, Prezioso & Marquez