The Business Judgment Rule and an Unreasonable Board

The Del Terzo family had lived in the building since the mid-1950s. They purchased their apartment when the building was converted to cooperative ownership in 1985 and, at the time of Helen's death (her husband had died earlier), owned a three-bedroom combined apartment. Her son Robert moved back into the apartment in 2004 to care for her. He lives in the apartment with his wife, two college-age children, and a cousin. Michael, Helen's other son, has a thriving medical practice in Pennsylvania, where he lives with his family.

The Applications

Michael and Robert inherited the shares of the apartment. The proprietary lease states: "If the Lessee shall die, consent [of the board] shall not be unreasonably withheld to an assignment of the lease and shares to a financially responsible member of the Lessee's family…"

Michael and Robert submitted an application to the board, but included only Michael's financial information (allegedly at the instruction of the managing agent). When it was determined that this was insufficient, Michael and Robert submitted a second application together with a cover letter that explained that Robert and his wife (and their cousin) would continue to live in the apartment, as they had done before Helen's death, and that Michael — who may move to New York in the future — would not live there but would guarantee payment of maintenance and all other expenses.

They requested that the shares be issued to Robert and Michael. Even though Michael said that he would not live in the apartment, the application identified both brothers and both of their families (as well as their cousin) as "proposed occupants."

There was no dispute that Michael was financially responsible. Robert, on the other hand, was retired; he last held a job in 1992. His only assets consisted of the apartment and money from a trust set up by his mother. A fiduciary of the estate explained that Robert had not earned money in recent years because he had moved back to New York to take care of his mother.

The fiduciary's letter acknowledged that Robert's income alone would not be sufficient to support the apartment, but that Michael's income would supplement. Robert, the court noted, had a good credit score with all accounts (including those with balances) being "satisfactory."

The Rejection

Eight of the nine board members met and voted unanimously to deny the application made by Michael and Robert. According to the court's written opinion, no one on the board thought the application was credible — among other things, Michael said he was not going to be a resident of the building. And if he did move from Pennsylvania, the brothers would be in violation of the lease because the co-op lease allows only one family to live in an apartment.

When the board refused to reconsider its decision to reject the assignment, Michael and Robert began their legal action.

The court discussed that the Business Judgment Rule is typically applied to acts of co-op boards, but that because there was a proprietary lease provision that stated that consent "shall not be unreasonably withheld," the rule did not apply in this case.

This was one basis for Michael and Robert's claim that the board acted improperly — their application should have been, but was not, treated differently from other applications even though the Business Judgment Rule did not apply to them because of the "not unreasonably withheld" language in the lease.

The court discussed the "real issue" — the prohibition that no more than one couple can occupy the apartment, which is contained in the proprietary lease. The court concluded that there was no question that Michael lives in Pennsylvania, where he has a medical practice, so that only Robert and his family (and their cousin) would live in the apartment. The court also acknowledged the board's "strong preference" that apartments be occupied by their owners, but was not troubled that Michael would live there because Robert would make the apartment his primary residence.

Given that there was no dispute that Michael was financially qualified — all the lease required – the court directed that the shares be transferred to Michael and Robert. Notably, the court did not grant the request (presumably made by the estate) for attorneys' fees.

The Takeaway

This decision gives us a view into how courts may treat board actions differently if the Business Judgment Rule does not apply. The court considered the board's determinations:

• that the finances of the occupant son (Robert) were insufficient (and apparently did not even allow him to meet the debt service on the apartment);
• that the son who did have sufficient assets (Michael) would not live in the apartment, violating the board's "strong preference" for occupant-owners; and
• that if Michael did live in the apartment, he and Robert would be in violation of the lease provision that only one family can live in an apartment.

The court did not say how it would have ruled had the Business Judgment Rule been applicable. However, in deciding that Michael and Robert were entitled to the shares, the court looked beyond BJR considerations (whether the board acted in good faith, for the purpose of the cooperative, and within the scope of its authority).

The court, it appears, considered the merits of each reason the board gave for its decision to reject Michael and Robert as purchasers and rejected those reasons. Ultimately, it concluded that all the lease required was that a proposed assignee be financially responsible, which Michael clearly was.

Richard Siegler is a partner in the New York City law firm of Stroock & Stroock & Lavan. Dale J. Degenshein is a special counsel for that firm.

Illustration by Liza Donnelly. Click to enlarge.

For more, see our Site Map or join our Archive >>