Can't We All Just Get Along?
War and Peace between Boards and Sponsors

Each year, CNYC presents a day-long housing conference featuring dozens of workshops and seminars that cover virtually every aspect of managing and operating housing cooperatives and condominiums. In 2004 and again this year, attorneys Walter Goldsmith, Esq., a partner with Sonnenschein, Sherman & Deutsch LLP and Douglas P. Heller, Esq., a partner in the firm of Friedman, Krauss & Zlotolow, will conduct a workshop offering advice on how to turn around adversarial situations between the board and sponsor, with insights for understanding the sponsor’s point of view and clues to improving communications.

The relationship between boards and holders of unsold shares can been a bit strained, to say the least. While many board members are inclined to think of the sponsor as someone who is difficult to work with, many sponsors might think of board members as unreasonable amateurs that nobody can work with at all. According to attorneys Doug Heller and Walter Goldsmith, however, both parties can do more to reduce or eliminate the miscommunication that many times results in litigation.

While the primary objective of many board members is to create a quality environment that maximizes each shareholder's individual investment, the sponsor’s objective is to maximize its own profit. As Mr. Heller and Mr. Goldsmith explain, these interests do not have to be mutually exclusive. Both board members and holders of unsold shares must resist any temptation to deviate from their fiduciary duties. Mr. Heller says, "Your number one, two, three, and hundredth priority is to act in the best interest of the building." Says Mr. Goldsmith, "It's the toughest job you'll ever have."

Suspicious Minds
There are a number of scenarios that can create ill will between a board and its sponsor. Holders of unsold shares do not need board approval for selling their units, nor are they bound by the board's sublet restrictions. Also, unlike other shareholders, they're generally exempt from paying flip taxes and fees for subletting, alterations and transfers. Many offering plans also grant the sponsor veto power over the board's management decisions, and in some cases disproportionate voting power. This can leave board members feeling powerless to control the quality of life of the shareholders.
The sponsor may hold on to free-market units in perpetuity; boards complain that this results in transient, trouble-making tenants. Sponsors, however, say they're holding onto these market rent units to offset costs of maintaining the rent-regulated units.

Other conflicts arise over building maintenance. While boards want to make improvements, sponsors may not want to put money into the building that they cannot recover because of fixed rents. Shareholders might feel the building was in poor condition when it was converted, and thus consider repairs to be the sponsor's responsibility. The suspicion that a sponsor didn't disclose everything at the time of the conversion and that he doesn't have the building's best interests at heart can also cause significant rifts.

Conflicts are almost inevitable in mixed-use scenarios. According to Mr. Heller, "The holder of unsold shares has a whole different point of view in this situation." Where the sponsor wants to maximize the rent for that ground-floor supermarket, residents complain about smell and noise.
Another potential for conflict: building employees working in sponsor units for extended periods of time. “If the super or handyman is always painting the sponsors' apartments,” notes Mr. Heller, “there's a problem.”

In one case, Mr. Heller says, a board decided to enact a rule to prevent any director from profiting from the building, such as brokering units, representing the building as attorney, or acting as a contractor in the building. The impetus for this rule was that the building treasurer (voted in by the shareholders) was also the broker for the holder of unsold shares.

The Role of
the Attorney General
As stated in article 23-A of the Business Law, known as the Martin Act, anybody who makes or takes part in a public offering of cooperatives is subject to the Attorney General's jurisdiction with respect to the offering plan. Says Mr. Heller, "That means, for example, that if the sponsor has lied in his offering plan, buyers can complain to the Attorney General's office. But, if he votes in a way you don't like at a board meeting (assuming he's there legitimately), you can't complain."

According to Mr. Heller, the AG's office carved out a specific function for itself since the 1970’s: mediating co-op/sponsor disputes in the hope of avoiding litigation. “This has been extremely helpful; unfortunately, it has now been suspended, hopefully temporarily.”

In response to bulk transfers of unsold shares, in 1982 the New York State Attorney General promulgated regulations clarifying the distinction between a sponsor and a holder of unsold shares. The sponsor is the original person who submitted the offering plan. Subsequent investors are legitimate holders of unsold shares, according to these regulations, only if they've been designated as such by the original sponsor. This protects the original intent of the offering plan, legitimizing the new individual's entitlement to all the benefits (and obligations) in the original offering plan, such as the right to sell and/or sublease apartments without board consent. If that designation cannot be proven, the board can challenge the legitimacy of the holder of unsold shares. (However, see page 5 for a 2005 Court decision that disallows the distinctions in the AG's regulations.)

Know the Law
Many board members don't realize that proxies exist only for shareholder meetings, not board meetings, in the State of New York. Says Mr. Heller, "If the sponsor doesn't show up, he doesn't vote." The law says you can have meetings via telephone, but "if the sponsor shows up and says I represent the two absent board members, tell him he doesn't," Mr. Heller explains. Only directors present at a board meeting can vote, and they each have one vote only.

Mr. Goldsmith explains that class action lawsuits arise when groups of shareholders with a sufficient number of similar problems/issues bring an action against a sponsor. There are cases where courts have protected the rights of minority shareholders who were trampled on by the majority. This is particularly relevant in low-rise buildings, where some units may be affected and others not, such as those with fireplaces or balconies. The pressure is to resist spending money on items that benefit some shareholders and not others.

It's also important to understand the implications of the Jennifer Realty case, where the sponsor sold very close to the minimum amount of units and then sat on the remaining 80% of shares for many years, refusing to sell when inquiries were made. Shareholders were left to wonder if they really had a co-op under these circumstances and filed suit against the sponsor for failure to create a “viable cooperative”. While the Court of Appeals did not make a definitive decision on what to do in such cases, in a landmark decision, the court refused to dismiss the cause of action and referred the case back to the lower court for trial. And, according to Mr. Goldsmith, at least one appellate court cited Jennifer in its own decision.

Be Reasonable
When dealing with your sponsor, say Mr. Heller and Mr. Goldsmith, one cannot emphasize enough the importance of acting professionally. Attempt to understand the other side's intentions so you can take a reasonable approach. Many times, says Mr. Heller, both sides "are totally missing each other and there actually could be a meeting of the minds, but they have no basis to understand one another and they don't communicate well enough to ever get there." At that point, he says, both sides have simply “made lawyers rich, because you litigate for reasons that probably wouldn't be necessary if both sides had taken a better view at the beginning."

When you approach the holder of unsold shares, present a united front; don't show division."If you do," says Mr. Goldsmith, "he'll take it as a sign of weakness." According to Mr. Heller, when the sponsor "asks you for something and you say no as a reflex action because you basically hate the guy, it starts the dynamic where everybody is at war."

A good way to avoid litigation is to take a strong stance. Hire a good team of professionals — accountant, managing agent, good counsel — to sit at the table with you, as necessary. Mr. Goldsmith says, "An ounce of prevention is worth a pound of cure. Don’t be penny wise and pound-foolish. Spend the extra money and hire a good managing agent."

Mr. Goldsmith says he works with several cooperatives "where 20 years ago we all basically had our M-16s pointed at each other. And now the holder of unsold shares and the board are the best of buddies. Now why is that? They switched the dynamic. Other than the fact there's been some board turnover; they gradually got to the point where they started to treat each other as professionals rather than personalizing everything."

Be aware that a lot of sponsors and holders of unsold shares might be inexperienced in dealing with boards. According to Mr. Heller, "Everybody assumes the holder of unsold shares is this big, bad guy with a ton of money who came down just to mess up their lives. But a lot of these guys basically borrowed a lot of their money, and are operating by the skin of the teeth. And they might know a lot less about co-ops than you!"

The bottom line, they say, is that somebody's got to be the adult in these situations. Sometimes a board turns down a request because they don't understand it. Don't neglect to consult your professionals about this. The first person to ask is your managing agent. If the agent tells you he doesn’t have time, Mr. Heller cautions, "call his boss. He will respond because the firm won't want to lose you."

Stay Focused
Boards and sponsors that can keep their efforts focused on their fiduciary duties have the best chance of keeping the peace. Mr. Heller and Mr. Goldsmith say some kind of “ritual”at the beginning of each board meeting might be in order to keep everything in perspective. Says Mr. Heller, "Have everybody swear they'll uphold what is in the best interest of the building before the meeting starts. If everybody did that, I think you'd have much more reasoned meetings."

With this, they hope you'll never cross the line from peace into war. The outcome of any litigation is unpredictable."The ultimate goal with litigation," Mr. Goldsmith says, "is to avoid it."