FINING CO-OP SHAREHOLDERS: HOW TO DO IT LEGALLY

The board of directors at Castle Village, a 585-unit co-op on the Upper West Side, decided several years ago that it was being hamstrung by outdated governing documents. "Our corporate documents were from the 1980s," says Jerry Fingerhut, an accountant who joined the co-op's board in 2005 as treasurer and is now president. Amid other problems created by the dated documents, "[T]he only fine we could levy was for late payment of monthly maintenance, a flat fine of $25."

But a co-op board can't simply start imposing fines. You must rewrite your proprietary lease, which requires approval by a supermajority of shareholders, a percentage that's spelled out in your lease. That number at Castle Village was 75 percent — so rather than simply rewriting the lease, the board chose to overhaul all of its corporate documents at once, including its bylaws and its articles of incorporation. The board's attorney, Theresa Racht, a partner at Racht & Taffae, came up with drafts of the three documents, which were the full board and its legal committee reviewed.

The proposed overhaul gave the board power to levy unspecified fines for violations of house rules, as well as a $500 fine if a shareholder failed to carry homeowner's insurance; it also specified that the fine for late payment of monthly maintenance would rise from $25 to either $50 or 1 percent of the maintenance, whichever was greater. Among other updates, the board also established a 3 percent transfer fee, a storage fee, and a sublet fee; instituted staggered terms for directors; and reduced the required supermajority to 67 percent.

"Any lease or [set of] bylaws from the '80s needs to be updated," says Racht.

First Step: Explain

The board sent out regular memos explaining the rationale for the changes, and held several informational meetings that Fingerhut describes as "wide-open." At those meetings the board listened to shareholder concerns and explained the potential benefits of such sweeping changes.

As for the toothless $25 fine for late payment of maintenance, Fingerhut says, "We had become a popular lending institution, which is not what we wanted to be. We didn't want to be punitive, but we didn't want to have to borrow money when people failed to pay their maintenance."

Once the proposed changes were made final, the board faced what Fingerhut calls the "Herculean" part of the process — getting the necessary votes. The board convinced 30 sympathetic shareholders to serve on a steering committee and brought in the Honest Ballot Association to oversee the election. To get out the votes, the steering committee members were assigned to specific shareholders and told to knock on doors, prodding residents to show up for the election or return proxies in sealed envelopes. The secrecy eliminated intimidation and cheating.

It worked. The changes were separated into six items on the ballot, and every one of them passed with a plurality of anywhere from 75 to 90 percent.

The new fines have already made a difference. Half a dozen shareholders who neglected to renew their home-owner's insurance policies were fined $500 — and warned that a second fine would be levied if they failed to get coverage within 30 days. If they still failed to get coverage, the board would buy a policy and bill them. The shareholders promptly bought the insurance.

"So far, the fines have been largely psychological," Fingerhut says. "The threat of a fine has changed people's behavior. But we're nearing the point with some people — people barbecuing, letting air conditioners leak rusty water, letting their dogs use the lawn as a toilet — there are a few nagging situations we're going to have to address. Our role is not to be behavioral psychiatrists. The fact that we have to use this club is distasteful to us."

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