RIGHT OF FIRST REFUSAL, P.2

Time is very short for exercising it –usually 20 to 30 days after an application is made to sell. And since the board must hold both a board meeting and a unit-owner meeting before the ROFR can be exercised, this uses up 15 to 20 of those days. The managing agent should be alerted to move quickly whenever an application is submitted. The delay of a week may be fatal, as is failure to follow the precise requirements of the bylaws or the terms of the contract of sale.

Co-ops, on the Other Hand…

Co-ops, however, can use their power to reject buyers to leverage into a purchase. Indeed, they have an obligation to protect shareholder investments by blocking a low price sale.

Why? One sale will affect shareholder values for up to a year after closing. It affects appraisals, the amount banks are willing to lend, and future sales prices. If one of the primary obligations of a board is to maximize shareholder values, buying back undervalued shares is not only a legitimate corporate activity, it may be imperative

The ability to finance and the method of securing funds also differ between co-ops and condos. A point in common, however, is: Never exercise a ROFR unless the funds to buy are absolutely available. Common available sources of money are as follows:

• Reserve Funds (provided they are not restricted by Local Law 70 or some other legal impediment)

• Lines of credit from a lender

• Refinancing the first mortgage on the building (co-ops only)

• Using the apartment as collateral to borrow funds

• Special assessment

• Using the building’s cash flow and deferring payment of vendor bills. One thousand-unit building with the opportunity to buy 300 sponsor apartments for $700,000 – less than $2,500 per unit! – had no reserves and or line of credit, and could only secure a $450,000 loan. So to bridge the financing gap, it "borrowed" the water and sewer taxes ($250,000) by not paying it at the time. While it eventually did so, with a late-payment penalty, it proved worth it: In the last 13 years, it has reaped more than $10 million profit, tax-free, on its initial $700,000 investment – and still owns half the units.

Dealing with Foreclosures

Some of the best opportunities for profiting from ROFR occur when a lender forecloses on an apartment. Banks routinely stop bidding at the foreclosure auction when the amount due on the mortgage has been reached. Since many loans represent only a tiny fraction of the current apartment value, matching a successful bid could produce a windfall. However, the provisions of the foreclosure contract usually require quick closing on terms which were not negotiated with the buyer.

First, the board must examine the language of its ROFR. Are bank foreclosures exempted? Second, it must keep tract of troubled transactions and scheduled auctions. Third, it should act decisively: Immediately after the auction, notify the foreclosing lender and the successful bidder that ROFR will be exercised. Do not wait for an application. Also, notify the lender that the board is ready, willing and able to close immediately. When the lender’s representative starts screaming, don't back down – the lender is only entitled to receive the proceeds of the auction, not a windfall on resale.

The use and exercise of a ROFR is controversial. A board is risking its funds to flip apartments. A wrong decision could be costly to the building. There is also criticism that the board is "stealing" a deal from a third party. This argument ignores the real damage that low sales prices cause to other owners and the entity. The board owes a duty to its owners to protect value. If the selling owner really wants to transfer an apartment at a below-market price, he or she should be permitted to do so. The only question is into whose pocket should the windfall profit go if the sale proceeds.

James Samson is a partner at Samson, Fink & Dubrow. James Goldstick is vice president of Mark Greenberg Real Estate.

Adapted from Habitat February 2008. For the complete article and more, join our Archive >>

Art by Liza Donnelly