FLIP TAXES: COURT CONFUSION OVER IMPLEMENTING THEM LEGITIMATELY, PART 1

The annual shareholders meeting of the corporation had been held the month before these closings, immediately followed by a meeting of the new board of directors. At that gathering, according to minutes distributed later by the managing agent, the board resolved that, "Effective immediately, a flip tax of three percent of gross sales price will be levied on all apartment resales … at closing." The clients were already in contract at the time of the board resolution.

The clients' attorneys contacted the corporation immediately following the closings and requested proof that the transfer fees were validly implemented. (The issue of the clients having already been in contract at the time of the resolution was never raised, although it certainly could have been prior to any settlement.) Toward the end of August, the corporation's attorney responded with a copy of those July minutes and noted, "There is nothing in the bylaws or the proprietary lease prohibiting the imposition of a flip tax. The board has amended the bylaws to provide for a flip tax." The attorney did not specify, however, when the board amended the bylaws and provided no proof that it had.

Would it have made a difference? Doesn't every cooperative attorney know that a valid transfer fee requires an amendment of the proprietary lease — requiring a shareholder vote — unless otherwise provided in the offering plan or a pre-conversion amendment to it?

Last Year's Surprise Ruling

On May 2, 2008, Judge Cynthia Kern of the New York County Civil Court rendered her decision in Andrew Weigel vs. 30 West 15th Street Owners Corp. In that case, Judge Kern concluded that "the cooperative … was allowed to impose the transfer tax by properly amending its bylaws as there was nothing in the proprietary lease or offering plan which prohibited the imposition of a transfer tax or was inconsistent with the imposition of a transfer tax."

Judge Kern's conclusion — that a transfer tax (or "flip tax"), commonly charged by a cooperative to raise revenue, can legally be put into effect merely by amending the bylaws — came as a surprise, not only because it flies in the face of the cooperative legal community's general understanding of the New York State Business Corporation Law (BCL), but also because most bylaws can be amended by the board of directors alone (in some cases, by as few as two or three individuals).

Controversy over how a valid transfer fee could be enacted took shape with the seminal December 19, 1985 Court of Appeals case Fe Bland vs. Two Trees Management Co., et al.  and its companion case, 3 30 West End Apartment Corporation vs. Kelly. This case is still the highest authority in New York state on the matter.

These boards had imposed transfer fees based on a percentage of profit. First, the court looked to the corporate documents for specific authority for such an imposition. It looked at language that is extremely common in cooperative bylaws and leases authorizing the collection of "a reasonable fee to cover actual expenses and attorneys' fees of the Corporation, a service fee of the Corporation and such other conditions as it may determine" in the case of a transfer, as well as "cash requirements" of the cooperative generally.

The court determined that the standard general language of these (and most) bylaws and proprietary leases do not provide authority for a transfer fee so easily. And even if the lease provision authorizing collection of a shareholder's pro rata portion of the cooperative's "cash requirements" had been such authority, the transfer fees imposed here were not proportional based on the number of shares held by that shareholder.

One Class Only

Secondly, in FeBland, the court determined that the format of the flip tax, which varied based on whether the selling shareholder was an original purchaser or not, created more than one class of cooperative shares. It noted that, under the Internal Revenue Code, a corporation is entitled to tax benefits as an eligible "cooperative" only, among other requirements, if it has but one class of shares.

Further, these cooperatives were authorized by their certificates of incorporation to have only one class of shares. And BCL 501(c) applied, which requires each share to be equal to every other share of the same class. The court felt that when the flip tax was not proportional to the number of shares owned by the shareholder, BCL 501(c) was violated.