Flip tax

When co-op boards try to make major changes in their operations, there are key things they need to consider. Let's talk about a flip tax. Before they impose one, what should they keep in mind?

The fundamental thing they should be considering is the specific provisions in their proprietary lease, bylaws and certificate of incorporation. The governing documents of the co-op will determine exactly how you should proceed.

Seems like a simple formula. Follow the procedure laid out in the governing documents, and there won’t be a problem.

Not unless there is an unusual provision in these documents, which there was in this co-op. To impose a flip tax, you often have to amend the proprietary lease, which takes a supermajority vote, typically two-thirds of shareholders. In this co-op though, the bylaws allowed a simple majority of shareholders at a meeting where there was a quorum to approve the amendment. Doing the math, a quorum could be half of the shareholders, and a majority of that half would be just around a quarter.

A much easier threshold to cross than one for an amendment to the proprietary lease.

Yes. And the courts have not dealt directly with situations where the board itself didn’t impose an amendment to the bylaws but gave it to shareholders to do with a plurality vote and not a supermajority.

Sure enough, this made somebody unhappy.

Very unhappy, and we’re not sure exactly why. This individual wasn't in the process of selling, so the flip tax wasn’t a personal matter. I don’t know what motivated them, but they commenced a shareholder's derivative action against the co-op and demanded that the board rescind the amendment. They eventually sued the board, and I must admit that I was guarded in terms of our chances at the beginning, because I was relying on the typical standard that imposing a flip tax would be a proprietary lease amendment.

Then you went and looked at the governing documents.

I did. It turned out they didn’t include the boilerplate provisions I assumed they would, and the amendment had been done legally. As a result, the court refused to issue a restraining order against the co-op and denied the relief sought by the shareholder. So the co-op is now free to impose a flip tax of 2 percent at the time of each sale, which is a significant amount of money.

So what did you learn, and what can other boards and lawyers learn from the experience?

This case involved a flip tax, but it applies in other areas as well. In other words, read your corporate documents. While provisions tend to be standard, they are not absolutely so, and the responsibility of a co-op vis-a-vis its shareholders – especially when it concerns voting rights – depends on the precise language.

And not only the boards but their lawyers need to pore over those documents.

Yes. You won't find me acknowledging in the future that I didn't read them immediately.