Case Notes: Going, going… Not So Fast!

Auctioning Off Closets and Bathrooms

The co-op building located at 911 Seventh Avenue in Manhattan has, within it, three closets and two bathrooms that are accessible through common halls. The closets and baths are common areas, not part of any apartment. The board was leasing these areas to shareholders, but decided that it would sell them instead to the shareholder who was the "highest bidder." It appears as if the board had the areas appraised (according to the amended complaint, one hall closet was valued at $28,500) prior to solicitation of bids. At the time the auction was announced, one of the spaces was leased by plaintiff Martin Newman. Another was leased by a member of the board.

Newman submitted a sealed bid for one of the closets and one of the bathrooms, which exceeded the appraisal amount. The board rejected the bids and called for another round of bidding. Newman again bid and the managing agent told him, in an e-mail, that he was the highest bidder for two of the spaces. Sharon Bronte, another plaintiff, was the high bidder for other spaces.

Two months after the second round of bids was received, the board cancelled the sale, announcing that it was economically better for the co-op to continue to rent the closets and bathrooms.

Newman and Bronte sued, claiming that the board and certain of its members breached their fiduciary duty and their contract to sell the areas to the highest bidder.

Charges of Bad Faith in Cutting Off the Sale

On this claim, defendants argued that their actions were protected by the Business Judgment Rule, which prohibits judicial inquiry into the actions of a board when they are taken in good faith, in the exercise of honest judgment, and in the lawful and legitimate furtherance of the corporate purpose. The plaintiffs said no — that the rule could not protect the board, because when it decided to cancel the sale after the second round of bids, its members acted in bad faith and not in the best interest of the co-op. The plaintiffs claimed that the defendants were motivated by self-dealing and were retaliating because plaintiffs — both former board members — had criticized them in the past.

The court looked at the fiduciary duty claims, and discussed the elements (the burden for which is on the plaintiffs): (1) the existence of a fiduciary relationship; (2) misconduct by the defendant; and (3) damages directly caused by the defendant's misconduct.

Falling Short on Breach of Duty Claims

Because this was an early motion (one to dismiss the complaint before discovery), the court had to accept the allegations of the plaintiffs as true. Even so, the court decided that the plaintiffs' claims fell short of establishing a claim for breach of fiduciary duty. Although there was no question that the board had a fiduciary relationship with the plaintiffs, the court determined that the plaintiffs did not allege any misconduct that could be construed as a breach of that duty. There was nothing to substantiate the plaintiffs' claim that the co-op's loss of immediate revenue was detrimental to the co-op. The court also decided that the fact that one board member would be able to continue to lease one of the spaces did not rise to the level of a breach of fiduciary duty — particularly because plaintiff Newman was also leasing a space, and he could continue to do so.

Breach of Contract: The Elements

The court set out the elements of breach of contract — (1) a contract; (2) the plaintiff's performance of the contract; (3) the defendant's breach; and (4) resulting damages. There must also be an objective meeting of the minds with respect to the material terms of the agreement.

Here, the plaintiffs submitted a bid to purchase common area space; that is, they offered to pay a specific amount for something that — according to the court — might or might not be for sale. Solicitation of bids is a request for offers, nothing more — the one soliciting the bid has the right to accept or reject any or all of the offers.

The court found that, at best, the facts established only that there was a solicitation of bids. There was no valid and binding contract. Although the plaintiffs received e-mails that their bids were the highest (e-mails can, under certain circumstances, constitute a contract), it was conceded that these e-mails did not constitute board approval for the sale.

Because there was no meeting of the minds, there was no contract. As to damages, the court found that plaintiffs could not point to any actual damage suffered as a result of the board's failure to consummate the sales after bids were issued.

The court dismissed the action.

The Takeaway

The board's actions here raise questions that the court never addresses. The decision refers to the board's conclusion — after the second round of bids were received — that the co-op would be better off financially if it leased, rather than sold, the areas. However, there can be no question that the board considered these issues prior to its announcement that bids would be solicited; indeed, it even had the spaces appraised. The court never discusses the board's stated reason for this change of heart (if it stated a reason).

This was a motion to dismiss — early in the proceeding, before any discovery took place. The court's decision, however, indicates that even given this seeming lack of explanation, the plaintiffs simply could not demonstrate the elements necessary to sustain a breach of fiduciary duty or breach of contract cause of action. In a situation like this — where a board acted within the bounds of the law but, perhaps, in a manner disagreeable to certain apartment owners — the owners may be best served by seeking relief not from the courts but by running for the board or campaigning against the reelection of the board members to cause a change to the lease/sale policy. 

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.