UNDERFUNDED CONDO RESERVES, P.2

The reserve fund law provides sponsors of conversion projects with two different methods of funding the reserve fund of a condominium: (1) funding the entire reserve fund within 30 days of the first closing, or (2) funding the reserve fund over the course of five years with a "mandatory initial contribution." The mandatory initial contribution must be established as a minimum of one percent of the total price. 

However, sponsors who choose to use the second method can fund less than the minimum one percent mandatory initial contribution by taking credits against it. Sponsors may take a credit for the cost of "capital replacements," which means a "building-wide replacement of a major component of any of the following systems: (1) elevator; (2) heating ventilation and air conditioning; (3) plumbing; (4) wiring; (5) window; or a major structural replacement to the building; provided, however, that replacements made to cure code violations of record shall not be included." They begin after an offering plan is submitted for filing, but before it's declared effective. These credits are not to exceed the lesser of: (1) the actual cost of "capital replacements" during the applicable period, or (2) one percent of the total price.

What to Investigate

In order for a sponsor to take a credit against the mandatory initial contribution, it must set forth in the offering plan or amendments thereto its intention to take such a credit, and what capital replacements it will make/have made together with the actual or estimated costs thereof.

To investigate a questionable credit disclosed in the offering plan or amendments, board attorneys should research the Department of Buildings job filings. These filings, easily accessible online, can indicate start dates, job descriptions, and estimated costs for the claimed work.

The Department of Buildings website also lists violations against each property, thus enabling board attorneys to determine whether a credit was impermissibly taken to cure a violation. Board attorneys should also hire engineers and/or architects to inspect the capital replacements to (1) determine whether the work was actually completed, (2) determine if the work was actually a replacement, and (3) compare their findings with the inspection report commissioned by the tenants in occupancy before the offering plan's acceptance for filing.

It is relatively rare that a condominium conversion takes place without any report prepared by engineers or architects employed by the tenants in occupancy, but in those unusual cases, boards should avail themselves of whatever inspection reports were gathered by purchasers of particular units in the complex.

Enforcement: One Fine Day

The reserve fund law provides for civil and criminal penalties for violations. Criminal penalties include criminal liability and fines — up to two times the amount required to be funded by the reserve fund law, which was not funded, and civil penalties — $1,000 per day for each day the reserve fund was not fully funded, with a maximum civil penalty equal to the full amount of the statutorily calculated reserve fund.

Thus, a sponsor who short-funds the reserve faces potentially quadruple liability: the amount of the reserve, plus that same amount again as a civil penalty, plus double that as a criminal fine. The reserve fund law empowers the Department of Housing Preservation and Development to enforce it on behalf of the City of New York. Further, the New York State Office of the Attorney General, under the Martin Act, has the power to start litigation on behalf of the state against sponsors who fail to fulfill their reserve fund obligations.

In addition, the statute specifically provides that "nothing contained in this section shall impair any rights, remedies or causes of action accrued or accruing to purchasers of…condominium units," meaning that unit-owners and boards may privately begin ligation directly against sponsors. Therefore, individuals and/or boards may be able to make out causes of action for breach of contract, fraud, and/or negligent misrepresentation.

When choosing enforcement mechanisms, it is important to realize that governments at every level are currently facing serious funding problems, depriving them of the ability to meet needs at even the most basic levels. Since the governmental agencies have the discretion but not the requirement to act against conversion sponsors, in many scenarios governmental assistance may be a vain hope and the only real relief may be for boards that hire outside counsel to enforce the law through the courts.

In New York City condominium conversions, unit-owners and boards should scrutinize their reserve funds to ensure that the condominium's sponsor complied with the reserve fund law, because discovering and prosecuting underfunding can result in the recovery of substantial dollars to the condominium.

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