Modernizing the Proprietary Lease: A Challenging Task for Co-op Boards

Getting co-op shareholders to agree on amending the proprietary lease can be even more challenging than settling disputes over lobby paint colors. You need a supermajority of shareholders to vote on any new amendments, and it takes persistence and education to pull this off. This is all complicated by the difficulty in understanding the legal language in the first place and then explaining why it needs updating.

The board at 65-unit 6300 Riverdale Avenue in the Bronx tackled this problem and was able to pass an ambitious four-item lease update requiring shareholders to carry apartment insurance, to hold the co-op harmless for certain damage to apartments, to formally define what “sublease” meant and to establish the right of the co-op to levy fines.

“Many shareholders will not be very quick to want to approve amendments,” explains Carl Borenstein, president of Manhattan’s Veritas Property Management, who manages the seven-story building. “For example, why would you want to give the board carte blanche to give you fines? Or if I’m looking to move to Florida and have my son move into the apartment, why would I give them the OK to tell me that this is a sublet?” 

Some buildings tie a proprietary lease update to extending its expiration date. “If it expires in less than 30 years, a bank won’t give you a mortgage,” Borenstein notes. “The simplest thing is for anybody in the building to not be an idiot and of course approve an amendment to extend the lease. Some boards throw in a couple of other changes and make it all or none so that anybody who votes against the updates are basically voting against the extension of the proprietary lease.”

In the case of 6300 Riverdale Ave., though, the board bundled several amendments — none of which were tied to the proprietary lease extension — and said to the shareholders: You pass all of these changes, or none of them.

KEEP IT LEGAL

“Most proprietary leases are probably 40 years old,” dating from the 1980s co-op conversion boom, “and most of them are cookie-cutter,” says the building’s attorney, Domenick Tammaro of Smith Buss & Jacobs. “Nobody was reinventing the wheel. Everyone just kept plugging [the same language] into different offering plans.”

For any board set on updating the proprietary lease, the first step is to make sure the amendments you are proposing are legal. That’s not a particularly high bar, notes attorney Eric M. Goidel, a senior partner at the Manhattan firm Borah, Goldstein, Altschuler, Nahins & Goidel, who has no involvement with the building. “A co-op is a corporation,” he says, “and under the business judgment rule, a corporation is generally free to chart their own course,” so long as the board’s decisions are consistent with the governing documents and fiduciary duty, comply with the law and further a legitimate corporate purpose.

BATTLE PLAN

The board knew going in it would have to work hard to achieve the required supermajority to pass the four amendments. Its first task was to not overreach, while keeping things as simple as possible. “They didn’t want to put out 25 amendments and inundate people,” says Borenstein. “They said, let’s pick the most important ones.”

The second task was to decide whether to have shareholders vote for the amendments individually or as a bloc. “They could have done these as one-offs: ‘Let’s vote on item one. Let’s vote on item two.’ So they might have passed two and lost two,” the manager says. “What they did was they put it through together and gambled on all or none.”

The gamble required an education campaign “because there wasn’t anything so outlandish or over the top in these amendments that would turn people off,” board attorney Tammaro says. The riskiest part “was the fines. It’s hard to get people to give someone else, a board in this case, the ability to impose fines. It’s human nature. You either think, ‘Well, I abide by rules. What do I care if we give the board the ability to impose fines?’ or ‘No, I’m not giving anyone that ability.’”

“They didn’t do a town hall,” says Borenstein, “but they put out mail and email with a blurb showing, ‘This is what it currently says. And this is what we want it to say, and let’s explain why we want it that way.’ And they asked for questions or concerns before they held a meeting so that people had an opportunity to look at it. And at the meeting itself, they had the attorney attend so that before they put it to the vote, the attorney could address anybody’s concerns or questions.”

Other boards of buildings he manages have similarly put word out “and then had a town-hall meeting with the attorney there,” Borenstein says. “So there’re two different ways of doing that.” Because of this co-op’s relatively small size — 65 units — the board “canvassed [informally, not door-to-door], they spoke to people and they got proxies for people who couldn’t come to the meeting.”

Ultimately, “I think the convincing arguments were that you live in a community and you want to have the power to be able to make everybody own up and be responsible for their actions,” says Borenstein. “I think it came down to how you would want to be treated and the way you’d want to act.” Even so, “this just eked through by, like, a percentage point. This wasn’t a landslide.”

SUCCESSFUL AMENDMENTS

Sublets. Subleases are pretty common occurrences in co-ops, but 6300 wanted to clearly define what the board considered a sublet. And that’s because courts in New York’s various boroughs define “use of premises” differently, which means that when a sublet problem occurs, it is a judge or jury that defines what a sublet is, rather than the co-op. 

In the case of 6300, says Borenstein, the board wanted to make it clear that a shareholder’s relative could live in the apartment and that would not be considered a sublet, as long as the shareholder also resided in it. “They wanted to more clearly spell it out,” Borenstein continues, “so that everyone knew that they could have their son, daughter, mother or father live with them.”

Insurance. While many co-ops require that shareholders carry homeowner’s insurance, it’s not necessarily in the proprietary lease. Not only did 6300’s board want this requirement in the proprietary lease, but it also wanted to ensure that the homeowner’s policy named the co-op as an additional insured.

“The problem is that insurance companies are hiding behind old proprietary lease language,” says Borenstein. “Homeowner’s policies are very good at kicking back and saying the building should be submitting damage repairs through its policy.” Doing so, particularly for every leak caused by an overflowing bathtub or leaking dishwasher, is causing building policy premiums to increase and loss ratings to linger. 

Such water and occasionally fire damage are the most common issues, says Jason C. Schiciano, co-president of Levitt-Fuirst Associates in Tarrytown, New York, an insurance brokerage unrelated to this co-op’s property and liability coverage. But “you could have a contractor doing work within a unit and the contractor may slip and fall and get injured in a common area,” he says by way of example. “And then that contractor can sue the building even though they were doing work for the homeowner.”

This is why the amendment specifically required that the homeowner’s policy name the co-op as an additional insured. Perhaps more importantly, it also required what’s called “a waiver of the insurer’s right of subrogation against the lessor.” That means, says attorney Goidel, that the homeowner’s insurance company agrees not to go after the co-op’s insurance company to pay for all or part of the damage.

All of this informs a second, related amendment the board got passed. This one makes the shareholder “responsible for any water damage to any apartment or the building caused by a sink, tub or shower overflow within the apartment or the [shareholder’s] negligence or the failure of the [shareholder’s] appliances or plumbing fixtures or equipment including, but not limited to a flushometer and other exposed pipes, tubes, and shut off/air valves in the apartment, sink faucet and return, toilet, toilet ring, grout/caulk, and any pipes, tubes, and valves installed by the [shareholder] or their predecessor.”

Clarifying a proprietary lease’s insurance requirements is important, says Schiciano, because “a lot of times the language of the proprietary lease has just been cut-and-pasted by attorneys. And so a lot of times there are either conflicts in the wording between different sections— for instance, the insurance section and the repair-and-maintenance section — or there’s wording that’s subject to interpretation.”

Fines. The board’s final amendment was to formalize that the co-op has the right to levy fines when shareholders break building bylaws and house rules. Odd as it seems, virtually no proprietary lease specifically allows that.

“Seriously,” says Goidel, “if I had to give a percentage of the co-ops my firm represents — and I’d bet other attorneys would say the same — I’d say less than 2% of the proprietary leases that I’ve come across have any power to fine.”

The reason is fairly simple, says Goidel. “I think either it was inadvertent or it was sponsors not wanting to have a system of fines in the offering plan,” which would have made sponsors liable for fining themselves if one of their rent-stabilized tenants — now technically the sponsor’s sublessees, for which the sponsor is responsible — broke rules.

Goidel says some co-ops have gotten around this by levying administrative fees. “So if people don’t curb their dog, you don’t fine them $500, but maybe you impose an administrative fee of a hundred dollars for the cost of cleanup.”

BOTTOM LINE

There’s a host of reasons why your co-op might want to amend the proprietary lease, but most importantly these old documents need to be updated to reflect current laws and practices. Doing so ensures that any financial considerations or governance challenges can be clarified, and ultimately will provide legal protection to your board.

SIDEBAR

Proprietary Lease 101

The proprietary lease governs all aspects of the relationship between the co-op and each shareholder. It spells out the rights and privileges associated with share ownership. Unlike the bylaws, which dictate how the co-op is organized and managed, stipulate how elections are held, and indemnify officers and directors, the proprietary lease is more focused on the contractual relationship between shareholders and the co-op corporation and the rights and responsibilities of each party.