Condo Boards Can Get Burned by Inadequate Bylaws

Purchasing an apartment in a small condominium presents unique problems. Perhaps the most common is the issue of self-management. Often, unit-owners believe that independent management is unnecessary – or too expensive considering the size of the building. But that leads to one of two scenarios: either every unit-owner has to play a large role in governance, or the unit-owners depend on one of their fellow unit-owners to take care of business. In many cases, however, the “manager” is not a real estate professional and, worse, is filling the role for his/her own benefit rather than for the good of the building.

Case in point: At 28 Cliff Street Condominium in Lower Manhattan, problems began when a fire broke out in the ale house on the first floor in 2010. Philomela Maguire, the president of the condo board since 2005, operated the ale house. Although the first floor was commercial, the other condo units on the three floors above were all residential, and the fire resulted in extensive damage to the entire building. The residents were not able to occupy their units for over a year. The board filed a claim with its insurance carrier and was paid $1.2 million. It then began to restore the building. 

About a year and half after the fire, Maguire was removed as president by the other board members. Then in 2014, the board and other unit-owners filed a lawsuit, alleging that Maguire misappropriated the insurance proceeds by improving and expanding the ale house while commandeering the boiler room for the ale house’s sole use. The plaintiffs also claimed that the repairs made to the rest of the building were “substandard.” The plaintiffs asserted 12 causes of actions, both individually and derivatively on behalf of the condominium. On the other hand, Maguire asserted 10 counterclaims, the most important of which was her claim that she was entitled to indemnification — that is, reimbursement — for the legal fees she expended in defending herself from the plaintiffs’ claims.

The state Supreme Court dismissed all but two of the plaintiffs’ claims. It also held that Maguire was entitled to reimbursement and that the condominium must pay Maguire’s legal fees, which were in excess of $350,000. The court held that condominiums are subject to the Real Property Law (which includes the Condominium Act) rather than the Business Corporation Law (which applies to corporations, including housing cooperatives). According to the court, where the Real Property Law is silent, as is the case with respect to reimbursement for unsuccessful claims brought against the officers, the Business Corporation Law should govern. This being the case, the court reasoned, the condominium should be governed by Section 722, which states: “A corporation may indemnify ... a director against amounts paid in settlement and reasonable expenses, including attorney’s fees ... incurred by him in connection with the defense ... if such director ... acted in good faith...” The court further held that a special referee must be appointed to determine if Maguire executed her duties in good faith and, if so, what was the reasonable amount of attorney’s fees expended to defend the 10 causes of action that were dismissed. 

The parties appealed the decision. As noted by the appeals court, the Appellate Division had never decided the issue of the relation between the Business Corporation Law and the Real Property Law as it applied to condominium associations. The court pointed out that the Condominium Act regulated the formation, management, powers and operation of condominiums. There is nothing in the Condominium Act about indemnifications of this sort. The court also noted that governance is guided by the bylaws adopted by the condo unit-owners, which may contain provisions regarding legal fees and indemnification of board members. 

Interestingly, the bylaws of 28 Cliff Street did indeed provide for certain indemnification, but only that the unit-owners would “indemnify and hold harmless each member of the board of managers against all contractual liability to others arising out of a contract signed by the board of managers on behalf of the condominium…”

The appeals court reversed the lower court’s decision. It held that Maguire was not entitled to reimbursement, since the Business Corporation Law does not apply to condominiums; in addition, the condo’s bylaws provided for indemnification only for contractual liability, which was not at issue in the case. 

The Lesson. This case should serve as a warning to condominium board members. There are many issues that are unresolved by looking at the Condominium Act (or the bylaws of a condominium), and quite often the courts will look to the Business Corporation Law since cooperative law and condominium law often parallel one another and function similarly. But it is now clear that this cannot be taken for granted. For condo board members, it is now more important than ever to review the indemnification and other protections that may be in their bylaws, and if none exist, they may want to reconsider their position on the board until such reimbursement provisions are added.

Andrew P. Brucker is a partner at the law firm Armstrong Teasdale. The statements and views in this article are his own and not necessarily those of the firm.