Fees for An Illegal Sublet

May a board enforce a provision set forth in its “shareholder’s handbook”? That was a question in Cohan v. Board of Directors of 700 Shore Road Waters Edge, Inc.

Shareholder Marla Cohan brought what is known as an “Article 78” proceeding against the cooperative corporation’s board of directors because it assessed a $3,000 fee against her for an alleged illegal sublet. Cohan purchased her shares in 2002. Near the end of 2009 and into 2010, many shareholders complained that she apparently no longer lived in her apartment and that it seemed to be occupied by someone who made excessive noise.

Assessed for Subletting

In August 2010, the board assessed a sublet fee of $3,000 against Cohan. Her counsel wrote to the board president, objecting to imposition of the fee and asserting that Cohan had not sublet the apartment but was living there with her sister. Counsel cited paragraph 14 of the proprietary lease, which permitted occupancy by a shareholder and certain family members, including sisters.

The board refused to rescind the sublet fee and informed Cohan that it would assess additional fees until the noise issue was resolved. Cohan started the Article 78 proceeding to annul the board’s determination, to rescind the sublet fee, and to seek reasonable attorneys’ fees, arguing that the board violated the proprietary lease and bylaws by assessing the sublet fee.

The court discussed the Business Judgment Rule (BJR), which provides that a court should defer to a board’s determination as long as the board acts “for the purposes of the cooperative, within the scope of its authority and in good faith.” The court explained that the BJR did not apply when a cooperative board acted outside the scope of its authority or if it violated its governing documents.

No Authority to Assess

The court found that the board did not have the authority under its governing documents to assess a fee against a shareholder for illegal subletting. The proprietary lease, the bylaws, the “shareholder’s handbook,” and the house rules did not substantiate the board’s claim that the sublet policy, which was set forth in the handbook, was an enforceable house rule that had been incorporated into the proprietary lease. Because the board acted outside the scope of its authority, its action in charging the $3,000 fee and additional fees was not protected by the BJR. Accordingly, Cohan did not have to pay those sums.

Owed Attorneys’ Fees

The court also found that Cohan was entitled to an award of attorneys’ fees under the statute (Real Property Law Section 234), which provides that if a lease allows a lessor to collect if it is successful in an action, a lessee has a reciprocal right to receive attorneys’ fees if the lessee is successful. In this instance, the proprietary lease required the lessee to pay lessor’s expenses, including attorneys’ fees, in connection with any action or proceeding. The board had argued that, had it prevailed in this action, it would have been entitled to collect attorneys’ fees. Consequently, because Cohan was the prevailing party, she was entitled to an award of fees and the case was returned to the trial court for a determination of what those fees should be.

The Takeaway

While seemingly uneventful, this decision by the Appellate Division Second Department addresses an issue that we come across with surprising frequency. It is not sufficient for boards to adopt a “handbook” setting forth the rules of the building. Any rules must be adopted by the board as a house rule in accordance with the terms and requirements of the proprietary lease and – importantly – must be presented to the shareholders as “house rules.”

We understand that many buildings believe that the format of a handbook is user-friendly; however, the handbook entries should refer back to the proprietary lease or house rule authority (e.g., “a lessee must keep their dog on a leash at all times, see House Rule 12”). Anything less and the board runs the risk that the handbook provisions will not be enforced if there is no corresponding lease section or house rule to justify the provision. As we see in this case, not only did the board lose the right to impose the fee for an illegal sublet, but it was also required to pay its lessee’s attorneys’ fees because the lessee was the prevailing party.

We recommend that boards review any shareholder handbook with management and counsel to make sure that any provisions requiring future enforcement are properly adopted in accordance with the co-op’s governing documents.

Attorneys

For plaintiff: Rappaport, Hertz, Cherson & Rosenthal

For defendants: Steven Camparano

When Your Contractor Sues

Does a contractor that claims it is owed money for work performed have the right to demand arbitration? That was the question asked in Southgate Owners Corp. v. KNS Building Restoration, Inc.

KNS, a contractor, and Southgate, a cooperative housing corporation consisting of several buildings on East 52nd Street east of First Avenue, contracted for work. The firm entered into a standard form American Institute of Architects agreement that did not include the arbitration provisions and made the courts the selected forum for resolution of disputes. Southgate asserted that KNS breached the AIA agreement and, ultimately, terminated the contract. It refused to pay the balance of money allegedly owed to KNS, about $79,000.

Contractor Seeks Arbitration

KNS sought to arbitrate under the Prompt Payment Act (PPA) contained in New York’s General Business Law; Southgate began an action to stay arbitration based on the AIA agreement. The Prompt Payment Act had been amended in 2009 to build in protections for contractors and subcontractors. One such amendment stated that in the event of a dispute, upon notice, the parties would be required to engage in an expedited arbitration before the American Arbitration Association.

Thus, the issue became whether, under the circumstances of this case, the PPA or the negotiated terms of the AIA agreement were to be enforced. KNS asserted that the PPA mandated arbitration. Southgate claimed that the PPA only concerned payment of “undisputed amounts” and that the amount KNS sought in this instance was disputed and therefore not subject to the PPA.

Contractor’s Alleged Sins

Southgate claimed that KNS defaulted under the terms of the agreement in several respects: it failed to provide adequate labor, equipment, and materials to finish the job on time; it misrepresented the use of its contractors; it did not obtain prior approval for its contractors; it failed to pay its contractors in accordance with the lien law and PPA; it did not properly supervise the project; it did not provide required documents, including proof of the subcontractor’s insurance, warranties, lien waivers, and the like. Finally, KNS failed to provide project close-out documents. Southgate noted that, during the course of the project, it had found it necessary to issue five separate notices of breach of contract to KNS, none of which had been cured.

KNS argued that the question of whether the matter should be arbitrated was for the arbitrator to decide. The court explained that although there are certain issues that indeed are decided by an arbitrator – such as whether a demand to arbitrate was timely or whether provisions of an arbitration agreement were waived – the question of whether the parties agreed to arbitrate, or are otherwise bound by an arbitration provision, was up to the courts.

The court discussed the PPA. It explained that the act was intended to encourage the prompt payment of undisputed amounts owed to contractors and subcontractors. The court explained that the statute stated its purpose as follows: “...to expedite payment of all monies owed to those who perform contracting services pursuant to construction contracts.” The PPA was not intended to trump the terms of any agreement entered into between the parties and, in that regard, the PPA stated that “except as otherwise provided ... the terms and conditions of a construction contract shall supersede the provisions of this article and govern the conduct of the parties.”

The court found that, in this instance, Southgate objected in a timely manner to certain payment applications submitted by KNS and therefore declined to approve payment for specific items of work. By these objections, the items were not “undisputed” and therefore, the arbitration provisions of the PPA were not applicable. The PPA did not require those who had signed construction contracts to lose their choice of a forum for resolving disputes if the amount claimed to be owed was at issue. Accordingly, the court held, the terms of the AIA Agreement prevailed and stayed arbitration.

The Takeaway

We believe this is the first case to interpret the 2009 amendments to the PPA. AIA agreements are extremely important, yet rarely understood. This is particularly true when there are statutes that may modify the rights and privileges of the parties, but that may not be reflected in the form agreements. Construction projects may cost substantial sums of money and all shareholders/owners pay the cost. Whether the project is small or large (and with “change orders,” even a small job can become costly), boards should consider having counsel review the AIA agreement (a) to ensure that the contractor has not modified it in a way that is adverse to the interests of the building; and (b) to modify the form agreement, as needed, to include provisions that will help protect the building and its interests.

In addition, post-contract follow-up is imperative. AIA agreements, and the PPA, require specific – and often stringent – time periods within which to object to an action or an invoice. It is important that the board, its manager, and its architect or engineer strictly adhere to these time frames and that objections be made in writing.

The case may be appealed to the interim appellate court.

Attorneys

For plaintiff: Stiefel Cohen & Foote

For defendant: Farrell Fritz