The Wake-Up Call

It was a few years ago – when Michael Williams was board president at the 190-unit co-op on Wallace Avenue in the Bronx – that he got “the call.”

It was from a vice president at Marine Midland Bank, the holder of the building’s underlying mortgage. The banker had grim news: he reported that “the sponsor was not paying the mortgage and the building was in trouble.” For Williams and the rest of the board, it was “a wake-up call.” Indeed: if the building defaulted on its mortgage and went into foreclosure, shareholders could end up losing their only assets and still be responsible for their personal mortgages. It would be, in the words of a veteran real estate lawyer, “the worst of all possible worlds.” As one distraught shareholder at the co-op put it: “You don’t want to lose your investment, your future, your children’s future.”

After bruising negotiations with officers from Marine Midland, a solution was reached and disaster avoided. The term of the mortgage was extended; the sponsor agreed to auction off his apartments, and any that failed to sell would become the property of the co-op; the sponsor gave up his seats on the board and his role as managing agent; the sponsor paid the mortgage arrears and agreed to contribute $300,000 to the co-op’s reserve fund. A new management company was brought in and new board elections were held. Some of the sponsor’s apartments sold. Shareholders were hopeful that a new day had dawned.

Then, some time later, Williams got “the call” – again. It was a vice president from Marine Midland and what he told Williams this time was tantamount to a sentence of death for the troubled co-op. Many of the former sponsor-held units had gone into serious arrears, forcing the board to foreclose on a large number of apartments with unpaid maintenance. That had swelled the corporation’s holdings to 63 mostly unsalable units. A co-op has the right to rent foreclosed apartments – which generates much-needed income – but that doesn’t advance the campaign to become a building with a majority of owner-occupied apartments.

The bank, claiming the building had too much debt and too few resident-shareholders to pay it off, had decided to sell the co-op’s underlying mortgage to a new “sponsor” – actually an investor – who was buying it with the intention of eventually turning the property into rental apartments. That was a nightmare on a par with foreclosure – the end for any co-op.

How the building got into this fix – and how it got out – is an object lesson in what happens when a board becomes complacent, a sponsor has too much power, and circumstances work against you. How do you find your way out?

Ordinary People

The Wallace Avenue co-op is filled with ordinary people who just wanted to have a home of their own. Michael Williams is typical. In 1990, Williams, a contract administrator for the city, moved into the recently converted co-op with his bride. He was elected to the co-op’s board, on which he would serve in various positions over the next dozen years. He felt right at home in a building that’s solidly middle class. His neighbors didn’t have bottomless pockets, but they were working people – teachers and nurses, with a few lawyers and doctors as well.

“When we moved in, it seemed like everything was working well,” Williams recalls. “The sponsor was the managing agent, and he was selling off apartments.”

There were three red flags that a more experienced board might have noticed: (1) the sponsor doubled as managing agent; (2) the sponsor held nearly half of the shares in the corporation; and (3) the sponsor controlled the board of directors.

With the sponsor doubling as the agent, the board lacked an independent voice advising it on financial matters; with the sponsor in control, it would have been tricky for the board to initiate tough actions against him; and with nearly half the shares in his possession, the sponsor was in a nearly impregnable position. That led to the first crisis – the potential default, which the board had resolved.

Now it was facing the threat of being downgraded to a rental. The problems went back to the original sponsor’s unwillingness to pay for routine maintenance. These four pre-World War II, six-story brick buildings now needed immediate work – on the chimney, roof, boilers, elevator, and exterior bricks. But the arrears had a ripple-down effect. Strapped for cash, the board couldn’t afford to fix the apartments the co-op owned, and because they couldn’t fix the apartments, they couldn’t sell them. This created a double bind: every unsold unit meant one less shareholder in the co-op, and one less monthly maintenance check in the co-op’s coffers. Between the empty apartments and the increasing amount of back maintenance due, the revenue stream turned into a trickle. Put another way, the co-op was apartment-rich, but cash-poor.

So the bank wanted to sell the mortgage to an investor who, in turn, would return the property to rental status.

Conversion Back to Rental: A Death Blow?

To forestall the threat to the co-op’s continued existence, the board decided to seek bankruptcy protection. As the workout progressed over the course of two years, the shareholders decided to cast their fate with an investor named Jacob Selechnik. In exchange for the corporation’s 63 former sponsor apartments, Selechnik agreed to refinance the $6 million mortgage, put money into the reserve fund, and pay off back taxes and legal bills. In return, he became the managing agent and gained control of the board.

The face of the board changed – and with that change came a new insight into the situation, which seemed to some to be history repeating itself. As the co-op was coming out of bankruptcy, Williams left the board and Trudy Tejado was elected. She had immediate misgivings about the new sponsor.

“He was a very charming and shrewd man,” Tejado, the board’s current vice president, says of Selechnik. “I liked him but I didn’t like what he was doing. He allowed some shareholders to not pay their maintenance, then he bought them out for very little money. He was controlling the building. I didn’t like the idea.”

Key Lesson: Get a Lawyer

Tejado decided the shareholders had to do something besides reacting to one crisis after another. They had to be proactive. One of the shareholders suggested she call Abbey Goldstein, a partner in the law firm of Goldstein & Greenlaw, who eventually agreed to help Tejado and her fellow insurgents in their efforts to wrest control from Selechnik.

The problems with the investors running the board could have been resolved years earlier, says Goldstein, if the shareholders had examined – or had hired someone to examine – the co-op’s offering plan. “It had language saying that the sponsor may not elect the majority of the board. So if the non-sponsor shareholders had been aware of this language, they could have elected a majority of the board members – meaning three out of five – without the sponsor voting. They didn’t know this. We went to court and eventually got a court order saying that the sponsor couldn’t vote his shares.”

Trudy Tejado and the other shareholders on the board took control, Goldstein explains, and sued the sponsor for various infractions. Eventually, they prevailed in the high-stakes court battle. The new board set out to collect damages from Selechnik. But just before that case went before an arbitrator in early 2009, Selechnik offered a cash settlement. The co-op made a counter offer: it asked Selechnik to surrender his 96 units and walk away from any financial liability. Selechnik took the deal, relinquishing any ownership claim to the apartmetns. There was speculation in the co-op that Selechnik had done so to avoid possible prosecution for the misuse of corporation funds.

Lesson: Vigilance Is the Watchword

What’s to be learned from this nightmare? “Don’t take anything on faith,” says Goldstein. “A lot of it depends on the language in the bylaws and the offering plan, what it says about the rights of the sponsor. Some plans don’t limit the number of seats the sponsor can cast his votes for. If the sponsor holds half of the units in the building and is the managing agent in the building, you need to have heightened vigilance.”

The co-op shareholders might also have turned to the attorney general’s office for relief, says Arthur Weinstein, an attorney not connected with the case who is a vice president at the Council of New York Cooperatives & Condominiums. “If the sponsor controlled the board for more than five years, the AG [may have been] able to help. The sponsor may be ignoring his obligations under the plan to relinquish control. It depends on how the original offering plan was written, what the time periods are, and precisely how many shares the sponsor owns.

“All of these things are covered in the offering plan,” continues Weinstein. “Unfortunately the sponsor-controlled board is not willing to act, and what will have to be done is that some members of the board, or even a group of tenant-shareholders, can either hire an attorney to help them, or could go to the attorney general’s office and say, ‘Here’s our situation, will you help?’ But seeing the sponsor’s obligations under the plan would be helpful.”

Weinstein adds that is possible to win a case like this without going to court. In a recent dispute that is similar to the one at Wallace Avenue, Weinstein reviewed the original offering plan documents, and then “wrote a couple of nasty letters to the original sponsor’s attorney. When they ignored me, I then wrote to the attorney general’s office saying. ‘Here are my letters to the sponsor, here are my complaints, and I’ve had no response.’ Eventually, the attorney general’s office contacted the sponsor’s attorney and in effect put pressure on the sponsor to come forward and honor his obligations. We subsequently worked out a settlement. And this was all short of legal action, which gets expensive. So there are things the individual can do.”