Sponsor Obligations

WHEN A CO-OP’S sponsor owns a large number of units, it’s possible that independent sharehold-ers will never have effective voting control. Additionally, in an under-sold building, lenders are sometimes unwilling to provide loans to raise money with a mortgage or to refi-nance an existing mortgage. This issue can also affect loans on individ-ual apartments, which can be a drag on salability and values.Complaints about board control and stymied financing were the founda-tion of a 2002 Court of Appeals deci-sion in 511 West 232nd Owners vs. Jennifer Realty. The board in that case complained that the co-op could not function as an independent purchaser might expect and that the co-op was not viable. The tactical approach in this case was to assert that the original offering plan stated that the sponsor intended to sell apartments, and there-fore there was an actual obligation for the sponsor to do so and not keep apartments as profitable rentals.The sponsor asserted that this claim was extrapolating language into a promise that wasn’t there. The sponsor also asserted that the offer-ing plan and corporate documents had explicit provisions that the spon-sor could rent apartments without any right of approval.The Court of Appeals ruled in 2002 that there is not per se a promise to sell in an offering plan. All the court said was that it is possible that, in some circumstances, there might be a prom-ise to sell. To figure that out in a given instance would require the determina-tion of a fact at a trial. Incidentally, that matter was settled without trial, and I am not aware of any trial going to a conclusion on this issue; the lawsuits that have been brought subsequently were settled.One other change to the landscape since the Jenniferdecision is that it has become customary for offering plans to include additional explicit language that the sponsor reserves the right to rent rather than sell units. These offering plans also discuss the repercussions of that fact on corporate governance. Because of that fact, it would be more difficult to mount the Jennifer-type challenge based on such an offering plan.On the other hand, you have to look at each offering plan because some do have specific representations that the sponsor agrees to sell. Those would have been negotiated by a sponsor, or they might have been inserted at the time of the review of the offering plan at the Attorney General’s office.There is a recent recorded document that might give insight to a typical post-Jennifer sensibility – a 2015 case called Frost Equities vs. Frost Owners Corp. What is distinctive is that the case led to a settlement that is on the public record because it was ordered by the court. (Full disclosure: my firm represented the sponsor in this matter.)According to the Frost settlement, the sponsor owned 49 of 163 apart-ments in the building. In the settle-ment, the sponsor agreed to sell 15 of its 49 apartments over time as vacancies occurred, and the co-op paid an incentive fee to the sponsor of $125,000. In addition, the corporation agreed to pay an additional incentive fee of 19 percent of the sale price of each apartment. In exchange, the co-op got a commitment that at least 15 of the sponsor’s apartments would be sold to independent purchasers.Briefly, some lessons to be learned from the corporate governance point of view: in a low-sold situation, make sure there are real damages, such as an inability to finance, Check the cor-porate documents and the offer-ing plan to see if there is a promise requiring the spon-sor to sell, or if there are provisions that enable the sponsor to continue leasing out apartments without con-sent of the board.There is always the oppor-tunity to negotiate, and it’s usually less expensive than litigation. If there are too many rental units, discuss placing limits on all owners, not just the sponsor, in con-tinuing to lease apartments.