Why Are Sponsors and Boards Often at Odds? Attorneys, Others Offer Insights

According to bylaws and court cases, this control was supposed to be relinquished after five years (or earlier if a certain percentage threshold was reached). By that time, sponsors had frequently resold their units to other investors; hence the name "holder of unsold shares" (which can refer to the sponsor or its successor). But even after the five-year point, some abusive sponsor / holder behavior did not change.

"Sponsors would use building materials and building staff for sponsor apartments. Very often, that could be tens of thousands of dollars," says Steven Birbach, chairman of Carlton Management. "And it used to happen a lot."

Conversions would get extremely contentious. Once the shareholders gained control of their board, they would enlist a third-party managing agent to analyze the maintenance and building logs — known as forensic accounting — to bill back to the sponsor. Some cases went to court and took years to settle.

Bye-Bye Bylaws

Even after relinquishing control, sponsors irritated boards because they were largely exempt from building bylaws and rules as a part of the conversion agreement. One of the sponsor exemptions was that they could rent out their units at market rates for an extended time (and sometimes in perpetuity). Boards preferred that all units be owner-occupied, because banks frowned on loaning money to buyers into properties with a large percentage of rentals. This further added to friction between the two parties. Sponsors did not have to get board approval for their renters or buyers.

Take, for example, the 72-unit White Plains, N.Y. co-op that has renters and owners living in the same building — although they might just as easily be living in different worlds. The board spent a number of frustrating years dealing with two holders of unsold shares.

"They don't have to answer to anybody, and they put whoever they like in these apartments," recalled the board secretary when the situation was at its worst. "We have one apartment now where we know at least seven adult males live." The board became aware of their presence only when a fire broke out in that unit and the fire department reported six beds in a two-bedroom apartment.

The other holder of unsold shares was equally "horrible," noted the secretary. "He owns the apartment above me. People have been there for 15 years, and he hasn't painted once. He hasn't fixed the fixtures and, because of that, a fixture beneath the sink broke and I woke up at six in the morning to water pouring through my living room ceiling. He reimbursed me for out-of-pocket expenses, but he wouldn't reimburse the co-op. He said they had insurance that would cover it. He's not responsible."

Dynamic Tension

Ultimately, "Sponsors and boards have adverse interests, and therefore there is a lot of natural tension," explains attorney Bruce Cholst, a partner in Rosen, Livingston & Cholst. 

"Sponsors typically want one thing and one thing only: short-term profit," he says. "So they want to maximize resale and rental value in the short term. That means keeping maintenance and assessments to a minimum whether or not they are going to finance legitimate long-term building needs, and they want cosmetic improvements rather than capital improvements that benefit the building long term. Sponsors want non-restrictive sublet and pet policies because they facilitate resales, whereas boards tend to be more concerned with the long-term quality of life implications of these policies."

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