Sublet Loophole: Even When Allowed, Boards Can Refuse … for No Reason

The case was DeSoignies v. Cornasesk House Tenants' Corp., in which the court upheld a board's absolute right to control subletting as provided in the co-op's proprietary lease — while also noting that the board's new rules limiting the amount of time one could sublet and imposing a surcharge constituted an impermissible de facto amendment to the proprietary lease, something that requires shareholder approval.

In 1972, 1973 and 1980, DeSoignies purchased co-op apartments 1B, 2B and 5A at 238 East 84th Street. She never lived in any of those apartments and had subleased them for over 25 years. Before this litigation began in 2002, DeSoignies had routinely sought and received approval from the board of directors before subletting.

On August 1, 2001, the board adopted new subletting rules, effective January 1, 2002. Among other things, the rules restricted subletting to two of every four years and imposed a 10 percent surcharge on every sublet. In May 2002, DeSoignies was served with 10-day notices to cure for the three apartments, alleging she was now in violation of the proprietary lease.

DeSoignies began the action in June 2002, seeking a declaration that she had an unconditional right to sublet based on a December 11, 1972, letter she received from the chairman of the co-op board. That letter stated: "This will confirm our conversations whereby we stated that the shareholders of the Cornasesk House Tenants Corporation are allowed to sublet unconditionally their apartment(s) for the duration of their ownership."

"For Any Reason or No Reason," Unless...

The co-op argued that the actions of a board are protected by the Business Judgment Rule. It also asserted that the 1972 letter conflicted with the provisions of the proprietary lease, and violated Business Corporation Law, Section 501(c). Paragraph 15 of the proprietary leases states: "... the Lessee shall not sublet the whole or any part of the Apartment or renew or extend any previously authorized sublease, unless consent thereto shall have been duly authorized by a resolution of the Directors … or, if the Directors shall have failed or refused to give such consent, then by lessees owning at least 65% of the then issued shares of the Lessor.... There shall be no limitation on the right of Directors or lessees to grant or withhold consent, for any reason or for no reason, to a subletting."

The court determined that the new rules' time-limits and surcharge were invalid, since the proprietary lease stated that it could not be amended without 65 percent of the shares voting for approval. The court noted, for example, that Article 5.04 of the lease, "Fees on Assignment," stated that the board may impose "the proper fees of its attorneys and managing agent for services in connection therewith," but made no provision for a surcharge.

However, paragraph 15 of the proprietary lease accorded the co-op board discretion to withhold consent to any sublease " for any reason or no reason." This language afforded the board unfettered rights with respect to consideration of sublet applications and, unless there was a showing of a breach of fiduciary duty, the Business Judgment Rule precluded judicial inquiry into the reasonableness of its decisions. According to paragraph 15 of the proprietary lease, any tenant whose application had been denied by the board had the right to obtain approval of a sublet by seeking the consent of "lessees owning at least 65 percent of the then issued shares of the lessor." This option was not pursued.

This case illustrates the ongoing conflict between a board's power to enact house rules and shareholders' rights to control fundamental changes that amount to a proprietary lease amendment requiring shareholder approval. It suggests that rule-making may be counterproductive when subletting requests can be reviewed and approved on a case-by-case basis without a lease amendment.

Richard Siegler is a partner in the New York City law firm of Stroock & Stroock & Lavan.

Adapted from Habitat November 2005. For the complete article and more, join our Archive >>