Sublet Policies

Q

Can my co-op make a rule to stop new shareholders from subletting, but keep the old policy for current shareholders? We will make sure that all new shareholders are aware of that before they purchase their apartments. And do we need to get shareholders to approve before we change the sublet rule?

A

Let’s take the easier question first. The standard co-op proprietary lease provides: “Any consent to subletting may be subject to such conditions as the Directors... may impose. There shall be no limitation on the right of Directors... to grant or withhold consent, for any reason or for no reason, to a subletting.”

That language means that a co-op board can adopt a new sublet policy without shareholder approval. That ranges from limiting sublets to a certain amount of years during a longer span to barring it outright. It also includes imposing sublet fees.

The questioner’s co-op is on shaky grounds, however, in adopting a different sublet rule for existing and new shareholders.

The law’s current state on this has evolved from case law to statute and back to case law, first restricting and then salvaging the imposition of certain transfer fees (i.e., flip taxes), and then expanding into – and then stepping back somewhat from – restrictions on subletting. A recent case seems to presage expansion beyond subletting, to threaten the right of boards to govern co-ops under the Business Judgment Rule (BJR). Another recent case seems to signal a retreat even from subletting restrictions. So the questioner’s co-op needs to consider this evolution.

In Fe Bland v. Two Trees Management Co. (1985), a seminal co-op decision, New York’s highest court held that a co-op cannot impose flip taxes, even if by way of a shareholder-approved amendment to its governing documents, unless all shareholders are charged in proportion to their shareholdings, and thus treated with the equality that the court deemed applicable to co-ops under New York Business Corporation Law (BCL) Section 501(c). That case barred a flip tax that varied per share based on the term of ownership of the shares. Its rationale also would bar a flip tax set at one fixed amount for apartments with varying share allocations, or at a percentage of the net profit realized from the sale of an apartment.

Fe Bland left co-ops in shock because so many had and wanted to continue flip taxes that did not meet this standard and feared that the decision would lead to demands and lawsuits for the refund of flip taxes improperly imposed. The state legislature quickly came to the rescue with the adoption of a 1986 amendment to BCL Section 501(c), applicable retroactively, that exempted a co-op’s imposition of flip taxes from the equality of treatment requirement provided that it treated shareholders equally with regard to the paying of maintenance and assessments, a few other financial matters, and voting. Although it saved flip taxes from BCL Section 501(c)’s equality of treatment requirement, the legislature failed to close the Pandora’s Box that Fe Bland opened.

The appellate court governing Manhattan and the Bronx first held, in Wapnick v. Seven Park Ave. Corp. (1997), that the special sales and subletting preferences that a co-op sponsor conferred on the original purchasers of apartments constituted unequal treatment under Fe Bland’s interpretation of BCL Section 501(c), and noted that the legislature’s amendment to that statute exempted just the flip taxes imposed on sales of apartments.

Fe Bland applied BCL Section 501(c)’s equality of treatment requirement to flip taxes, however, because they involve financial matters, which, along with voting matters, are typically associated with stock ownership. Subletting is more closely associated with the real estate aspects of co-ops. So, when it rescued unequal flip taxes from Fe Bland, the legislature had no reason to conclude that it also might need to exempt sublet or other real estate-based policies of co-ops.

Then the appellate court governing the rest of New York City, Long Island, and Westchester, in Lescht v. Concord (1999), held that a co-op might have violated BCL Section 501(c)’s equality of treatment requirement by freely subletting apartments that it acquired through foreclosure while subjecting shareholders to its restrictive sublet policy; and that this might dictate, under Wapnick, the invalidation of the policy. The court felt so bound to impose the equality requirement that it expressly refused to accept the co-op’s explanation that it was, in fact, leasing, and not subleasing, those apartments; or, apparently, to sympathize that the co-op was doing so out of financial necessity.

One month later, the Manhattan/Bronx appellate court, in Susser v. 200 East 36th Owners Corp. (1999), exercised some restraint in this regard, by holding that BCL Section 501(c)’s equality of treatment requirement does not bar a sponsor’s reservation of special subletting rights because they are permitted under the New York attorney general’s regulations governing co-op offerings, and also because a sponsor’s unsold apartments typically are inhabited by rent-regulated tenants, who are entitled to renewals of their leases (actually subleases) from the sponsor. The court looked askance at the shareholder’s attempt there to use BCL Section 501(c)’s equality requirement to turn sponsor exemptions “into devices for stripping residential cooperative corporations of their essential managerial prerogatives” regarding, in that case, subletting.

When it next confronted this, in Krakauer v. Stuyvesant Owners, Inc. (2003), that same appellate court sought to further defuse the abuse of its application of BCL Section 501(c)’s equality of treatment requirements to subletting. It held unenforceable a provision granting preferential rights (presumably to original purchasers) but left intact “the corporations [sic] authority with respect to the regulation of subtenancies.” That put an end to shareholders evading subletting rules, as in Wapnick and Lescht, by asserting the invalidity of a whole policy rather than just the preference that created the inequality.

Later that year, in Spiegel v. 1065 Park Ave. Corp. (2003), that same court confronted a shareholder claiming special rights to sublet that the sponsor granted to an original purchaser. The court reaffirmed the unenforceability of those rights because they violated BCL Section 501(c)’s equality of treatment requirement. But here, for the first time at the appellate level, a co-op was the proponent and beneficiary of the application of that requirement to subletting.

In Bregman v. 111 Tenants Corp. (2012), that same court, also at a co-op’s behest, also held illegal under BCL Section 501(c) special subletting rights that a shareholder allegedly received from a sponsor. There, co-ops also received a huge boost for their regulation of shareholders generally. “Although the board’s new policy, adopted in the 2003 resolution, may prevent plaintiff from subletting her apartments in the same manner as she had done for the first 30 years,” wrote the court, “adoption of the resolution does not qualify as the type of deliberately abusive treatment that would justify allowing a legal challenge to the board’s decision. Assuming that plaintiff’s situation was the impetus for the board’s decision to restrict subletting, and that plaintiff is, as she claims, currently the only shareholder affected by the resolution, nevertheless the board’s adoption of a restrictive resolution applies to all shareholders. The fact that plaintiff will be more immediately affected by the resolution does not render defendant’s act discriminatory or applicable solely to her.”

So, in the end, Bregman, following Spiegel, should give great comfort to co-op boards, to complement the comfort already given by Susser and Krakauer. But Bregman also reaffirmed the love affair, first sprouted in Wapnick and fertilized in Lescht, with applying BCL Section 501(c)’s equality of treatment requirement to subletting, and kept the door open to its broader application.

Sure enough, in White v. Gilbert (2012), a shareholder claimed that she was unfairly treated by a co-op board with regard to alterations that she was undertaking. Citing Bregman, as well as Wapnick, the trial court held that “Contrary to defendants’ assertion, the [BJR], Section 501(c), each share issued by a corporation ‘shall be equal to every other share of the same class.’ In accordance with that provision, a cooperative corporation is required to treat all shareholders of the same class of stock equally, and the failure to do so is sufficient to overcome the protections afforded under the [BJR].”

This raises the specter of courts judging actions by co-op boards not just by the fairly “hands off” but also by BCL Section 501(c)’s equality of treatment requirement, which seems far afield from what New York’s highest court intended almost 30 years ago in Fe Bland.

On the other hand, there might be some hope that the application of BCL Section 501(c)’s equality of treatment requirement to co-op subletting might not be rock solid. In another recent case, Razzano v. Woodstock Owners Corp. (2012), a shareholder purchased a co-op apartment in 2007 with knowledge of a policy that restricted subletting for those purchasing after 2002. The trial court rejected her claim that the policy violated BCL Section 501(c)’s equality of treatment requirement even though certain shareholders could sublet and others could not. The court was content that the board had good reason to adopt the policy under the BJR.

In the end, Razzano might seem to give the questioner’s co-op some comfort in enacting a sublet policy similar to the one there. But I question whether that decision would be upheld if appealed, especially in light of Bregman’s resolve – however misguided – to continue the application of BCL Section 501(c)’s equality of treatment requirements to subletting.