A Sponsor Hanging On Too Long Chills Progress at Frost House
July 2, 2013 — Sponsor. An innocuous little two-syllable word. But in the roughhouse world of New York real estate, the sponsor — the party who creates a co-op or condo either by converting a rental building or erecting a new structure — is often seen as a villain. Sponsor, in the eyes of many co-op shareholders and condo unit-owners, is one very dirty little word. in part two of our three-part special report on sponsors retaining control past the deadlines set by law, we look at how owning even less than one-third of a co-op's apparent can thwart progress and change.
Frost House, at 1160 Third Avenue in the Lenox Hill section of Manhattan, is a 163-unit co-op built as a rental in 1965. When the building was converted in 1988, the sponsor controlled 60 apartments. Today, he still owns 51 of them — 30 percent of the building.
"It's not a viable co-op," says Steven Sladkus, a partner at the law firm Wolf Haldenstein Adler Freeman & Herz, the lawyer who has represented the board for the past 15 years. "The sponsor has a profit center going on in the building," Sladkus adds. "Fourteen of his apartments are rent-stabilized and 37 are free market. And rental tenants put extra strain on the building because they don't care about a building the same way that shareholders do."
Which brings us to a highly problematic downside of so-called sponsor units. In cooperatives, they can be rented to tenants who are not required to pass the board's entry requirements for prospective buyers — effectively robbing the co-op of one of its prime attractions: the ability to control the building's makeup. Apartments rented by the sponsor also bypass the annual sublet fees, which can potentially deprive the co-op of considerable income.
Town Hell
The Frost House co-op board called an informational "town hall" meeting in late April, which attracted several dozen shareholders, to discuss the progress of a complaint the board had filed against the sponsor in New York State Supreme Court last November, seeking an injunction that would force the sponsor to sell unsold apartments in a timely fashion. The landmark 2002 case 511 West 232nd Owners Corp. v. Jennifer Realty Co. established that a co-op sponsor must yield control of the board after 50 percent of the apartments are sold or five years after the first closing, whichever comes first.
Many shareholders expressed concern about the potential cost of moving forward with a lawsuit, according to Sladkus. But the board appears to be out of options.
"The shareholders have been asking the sponsor to sell his apartments for years and years," Sladkus says, "and they've finally gotten fed up. The sponsor has refused to enter into any reasonable schedule to sell. He essentially said, 'Screw you.' The only recourse after that is to sue."
The sponsor currently holds one seat on the seven-member board. The board's legal filing notes that the sponsor cannot elect a majority of the board once it owns fewer than half the shares or after two years from conversion, whichever comes first. Both of those conditions were met long ago.
"Nonetheless," the complaint states, "the sponsor's continued ownership of unsold apartments entitles it to vote the share of co-op stock appurtenant to the unsold apartments, which amount to nearly one-third of the co-op's outstanding shares. This necessarily reduces control that resident shareholders of the co-op have over the building that should be their space."
Bye-Bye Bylaws
There's yet another drawback to such a strong sponsor presence, according to the legal complaint: "As long as the sponsor retains ownership of the unsold apartments, it thus has veto power over virtually any amendments that the co-op shareholders might want to make to the co-op's bylaws."
"Thirty percent is still powerful enough to make a difference," says attorney Steven Anderson, a partner at Anderson & Ochs, who has represented many boards in their effort to wrest control from sponsors. Such conflicts, he says, have deep roots. "Sponsors have financial interests that are embedded," Anderson says. "They may have a sweetheart lease on commercial property, they may still own apartments. They're not precluded on voting just because they don't control the majority of the board. As a practical matter, they still have some control. You can try to negotiate with a sponsor, but it's hard to do. Unfortunately, it's not uncommon to have to start litigation to get a sponsor out."
For two more tales of sponsor conversions, and lessons to be drawn from them, read part one and watch for part three on Thursday, or pick up the June issue of Habitat.
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Photos by Tom Soter