Who’s on the Hook for Attorneys’ Fees?

Every lawyer and manager and many board members have had to deal in recent years with the issue of short-term rentals – those apartment owners who decide to rent their apartments for a month, a week, or just a night. The case of Osberger v. 18 Mercer Equity Inc., a lower court case, discusses what happens when a co-op shareholder accused of renting improperly seeks to recoup attorneys’ fees.

Backstory

Bonnie Soon Osberger is a shareholder in the co-op located at 18 Mercer Street in Manhattan. Her husband, Mark Osberger, resides in the apartment with her. In April 2011, a former member of the corporation’s board of directors dialed 311, the city’s help line, to ask the city to investigate whether the Osbergers were illegally renting their apartment on a short-term basis. The city inspected and no violations were issued. However, the former board member was told by the city inspectors to call 311 again if he thought there were transient visitors in the apartment.

That same former board member called 311 again in November 2012, and this time the New York City Fire Department issued violations relating to illegal transient occupants. The violations, however, were actually against the building and not the Osbergers, even though it identified their apartment. The board of directors agreed with the Osbergers that the board would defer sending a notice to cure, as long as the Osbergers agreed to retain counsel to appear at the hearing at which they hoped to get the violations dismissed.

The Osbergers retained counsel to attend the hearing. However, the administrative law judge assigned to the matter would not allow the Osbergers to intervene or be heard. The co-op also had an attorney there, who made a presentation. The violations were, in fact, dismissed.

The Current Action

The Osbergers then brought this action to recover the roughly $13,000 in attorneys’ fees they had spent to retain counsel for the hearing. They denied any wrongdoing or illegal use of the apartment and claimed that the former board member had made false accusations that had resulted in violations being issued against the building owner – the cooperative corporation. The Osbergers alleged that were it not for this wrongful conduct, they would not have had to incur legal fees.

But the former board member submitted an affidavit setting forth the basis for his good faith belief. That included the Osbergers’ internet advertisements offering to rent the apartment for as little as a week. In addition, he observed people entering and leaving the apartment, and spoke with them about their status. Given this and the fact that the city inspectors who came in April 2011 told him to call 311 if he believed there were transient occupants, he called again in November 2012.

The Osbergers asserted four different theories upon which they should recover attorneys’ fees. The first was a theory of common law indemnification. This is a restitution concept that allows a loss to be shifted from one party to another based on equitable considerations – fairness, in other words. The Osbergers claimed in essence that, because the claim that they engaged in short-term rental activity was falsely made, they should be reimbursed.

The court, however, explained that the evidence submitted was sufficient to show that the board and the complaining former board member acted at all times in good faith and to further cooperative purposes.

The court noted that the records submitted by the board not only included copies of the Osbergers’ advertisements, but of the fire department violations saying the Osbergers’ apartment was being used by transient occupants. In any event, the court noted, under the Business Judgment Rule, even if the board turned out to be wrong or ill-advised in its determination, its decision to require the Osbergers to retain counsel to fight the violation was still protected.

The court also found that the board was not unjustly enriched at the Osbergers’ expense. Both the board and the Osbergers retained counsel to appear at the hearing; however, when the Osbergers’ counsel was not permitted to participate, the co-op’s attorney argued and caused the violations to be dismissed. The Osbergers had a vested interest in this outcome and therefore could not subsequently complain about it.

The Osbergers next claimed that they were entitled to attorneys’ fees on the theory that such fees were for consequential damages. Under the “American Rule,” all parties pay their own attorneys’ fees unless otherwise stated in a contract or statute. But when damages are a result of a defendant’s acts, which require a plaintiff to defend an action, there is an exception to the rule.

The court found that because the board’s action was taken in good faith, the Osbergers could not recover fees on this basis. Further, the Osbergers were not technically a “defendant” in the administrative proceeding, and therefore not required to defend themselves.

As for the Osbergers’ breach-of-fiduciary-duty claim, the law is settled that a corporation does not owe a fiduciary duty to its shareholders. The court then looked to the Osbergers’ contractual indemnity claim. The Osbergers asserted that the proprietary lease permitted the co-op to recover attorneys’ fees, and that based on Real Property Law Section 234, that provision is reciprocal. The court found, however, that because the lease provision required the shareholder to be in default before the board could recover fees, the board could not have recovered its fees and thus the Osbergers had no reciprocal right.

Finally, the Osbergers claimed that they should be entitled to fees based on the implied covenant of good faith and fair dealing implicit in every contract, including the lease. The court found that this claim was no different than the attorneys’ fees claim under the lease and rejected it. The Osbergers’ demand for fees was denied.

The Takeaway

Although incidental to the issue of legal fees, this case raises a point we have seen many times. When a city agency issues a violation, it is often (if not always) issued against the building and not the offending apartment owner. In some situations, an administrative law judge will allow an apartment owner to intervene or to take over the defense; in some instances he or she will not. It is important for a building, upon receipt of a violation, to be clear that the responsibility both for defense and to cure a violation and pay fines or penalties rests with the apartment owner.

The court’s analysis of the Osbergers’ claim for attorneys’ fees under the co-op proprietary lease is noteworthy. The cooperative would not have been able to assert a claim for fees since the Osbergers were not in default, and a default was required under the lease. Our experience has been that, in situations like this, most boards would in fact demand its fees be paid by the shareholder.

Attorneys

For the Osbergers: William A. Thomas

For the Cooperative: Smith, Gambrel & Russell