Protecting Against Criticism During Refinancing
Dec. 11, 2015 — We have represented many boards that have refinanced their existing underlying mortgages. Several have been faced with challenges from shareholders who believe that the expenses of refinancing, primarily the cost of prepaying the existing mortgage, do not warrant refinancing. The boards in question have carefully studied the refinancing market, the risks of rising interest rates, the ability to lock in favorable rates to build a reserve for future capital improvements, and the costs to be incurred if refinancing occurs. In the boards’ judgment, the benefits of refinancing far outweigh the burden of paying a prepayment penalty.
Therefore, some of the boards decided that it was in the best interests of all shareholders to move ahead with the refinancing. In one building, a small minority of disgruntled tenant-shareholders began litigation to stop the board from refinancing the mortgage. They also attempted to pass shareholder resolutions restricting the board’s ability to incur debt unless approved by the tenant-shareholders, and wrote letters to the proposed lenders objecting to the refinancing and threatening suit against the board.
The lawsuits were defended, invoking New York’s Business Judgment Rule, which provides that a court will uphold the decisions of a board of directors and not substitute its belief as to the proper decision on a particular business issue, provided it acts in good faith and in the interests of the shareholders as a whole. The proposed resolutions were ruled out of order, as they violate the terms of New York’s Business Corporation Law, which invests business decision-making authority in the cooperative’s board of directors and not in the shareholders. Finally, our firm worked with the board to explain its decision-making authority to the lenders and their title companies so they would not be intimidated by the shareholders’ actions and would close the mortgage refinancing.
Takeaway
When there are important financial decisions to be made by a board, such as refinancing an underlying mortgage, it should carefully study the benefits and costs of the transaction. The board should keep all shareholders informed of the steps it takes when making the study, and should advise them of the reasons why it decides to move forward with a transaction. It is wise for a board to involve counsel at this stage to help it craft clear communications to all shareholders explaining the process and listing the benefits to be achieved by refinancing. In many buildings, there may be some shareholders who do not agree with a board’s actions. By carefully explaining the benefits to be achieved, a board is likely to prevent extreme actions by shareholders, which might delay or upset the transaction. If, despite the board’s best efforts and intentions, some shareholders take actions to stop the transaction, it should have counsel defend its decision-making with the cooperative’s prospective lenders and title companies and, if needed, in court.