In a recent decision, New York's second highest court ruled that the Hotel Des Artistes coop-erative did not have the authority
to impose a 30 percent sublet fee on its shareholders. In Zimiles v. Hotel des Artistes, Inc., the judge required the co-op to return $300,000 in sublet fees collected since 1990. Although the case remains in litigation, it should serve as a warning to all boards that unless they have the proper authorization written into their governing documents, they may be open to challenges on sublet fees, especially if those fees go beyond the usual reasonable amount charged of five to ten percent of the rent.
Sources of Authorization
The board gets its authority to regulate subleasing from the proprietary lease and by-laws. The scope of the board's authority depends on the exact language of the building's documents. It is not enough that either the proprietary lease or the by-laws contain the proper language; both documents must include the right authorizations for the co-op to comply with the court's ruling.
The proprietary lease (usually Paragraph 15) commonly provides that co-op consent to a sublease is subject to such conditions as the board may impose. Twelve years ago, in Zuckerman v. 33072 Owners Corp., the Appellate Division ruled that this broad language in a proprietary lease grants to the board wide-ranging authority to impose a reasonable sublet fee as a condition to consenting to a sublease. What is reasonable, though, depends on what the by-laws say.
The proprietary lease used by the Hotel Des Artistes cooperative allowed the co-op board to reject a sublease at its discretion, but did not give the board the authority to impose additional qualifications as a condition for giving its consent. Thus the board could not require payment of a substantial additional fee as a condition of consent.
The by-laws usually contain variations on the following language:
The board of directors shall have the authority, before permittingM-a sublettingM-to fix a reasonable fee to cover actual expenses and attorneys' fees of the corporation in connection with each such proposed transaction...
Courts have determined that by-law language specifying the types of fees that can be charged acts as a limit on permissible sublet fees. Thus, since the by-laws quoted above specify that the co-op can charge a reasonable fee to cover actual expenses, as well as attorneys' fees, the co-op would be barred from charging another type of fee in addition. Even if the proprietary lease grants broad authority to the board to impose conditions, such authority may be restricted to non-monetary conditions only.
Amending the By-Laws
Provided your proprietary lease passes the initial test of authority, you can make sure that your by-laws give the board a more comprehensive mandate to impose conditions on subletting. The following suggested clause contains appropriate language:
Before permitting the sublease of an apartment, the Board of Directors shall have the authority (a) to fix such fees and charges as it may determine to be appropriate, including (but not limited to) a surcharge for permitting any sublease, a fee to cover actual expenses and attorneys' fees of the corporation in connection with each proposed sublease, and a fee for conducting a lien search and credit search ag ffb ainst the parties; and (b) to impose such other conditions as it may deem appropriate. There shall be no limitation on the Board's right to accept, reject, or impose conditions in connection with any proposed sublease other than as required under the Proprietary Lease or applicable law.
By-laws can usually be amended by a vote of the board of directors, but it is wise to check your by-law provisions for the proper procedures. If board approval is all that is required, the amendment can be proposed at any regularly scheduled meeting of the board. Notice of the proposed by-law change should be given if you call a special board meeting. If your by-laws do not allow amendments without a shareholder vote, you should consider placing the change on the agenda of the next annual meeting.
Permitted Types of
Most co-ops charge one of five different types of sublease fees in addition to reasonable expenses and attorneys' fees: a flat fee based on monthly maintenance; a flat fee based on the sublease rent; an arbitrarily determined flat fee; a fee based on an amount per share; or a percentage of the difference between the maintenance and sublease rent.
Courts have upheld almost all types of sublease fees in connection with shareholder challenges. In McCabe v. Hoffman, for example, a shareholder who was charged a fee equal to five percent of his profit claimed that the fee resulted in unequal treatment from other stockholders, in violation of state law. The Appellate Division disagreed, stating that sublease fees based on a percentage of rent received have nothing to do with a stockholder's share ownership, and thus do not result in discriminatory treatment under state law.
While no court has ever rejected a sublease fee merely because of its size, it seems as though unreasonably high fees are more likely to be overturned. For example, in Zuckerman, the court upheld a reasonable sublease fee, but never specified what would be considered reasonable. In the Zimiles case, the Hotel Des Artistes had imposed an extraordinary 30 percent sublease fee (it was originally 100 percent!), and the court ruled that such a substantial fee had to be expressly authorized in the lease.
The Appellate Division also rejected a 30 percent sublease surcharge in 1993, in Bailey v. 800 Grand Concourse Owners, Inc. The Grand Concourse by-laws restricted the co-op to charging a reasonable amount to cover actual expenses and attorneys' fees of the corporation. The court determined that the 30 percent sublease fee was unreasonable under the by-laws.
Even if your co-op fails the Zimiles tests, it may escape the fate of that co-op depending on the size of the sublet fee. Most by-laws allow the imposition of a reasonable sublease fee to reflect actual expenses of the cooperative. Doubtless your cooperative has increased rent collection, security, and quality of life concerns during the term of the sublease. While it is difficult to quantify the cost of such increased vigilance, a fee of ten to 15 percent of rent or maintenance would not seem unreasonable.
Of course, if your by-laws and proprietary lease meet the Zimiles standards, your co-op board continues to have broad discretion over the amount of your sublease fee. In light of the courts' discomfort with a 30 percent surcharge, however, we recommend that you keep your own cooperative's fee substantially below that level unless both your proprietary lease and by-laws give your board explicit authority to impose a sublet fee.
Mr. Jacobs is a partner in the law firm of Smith, Buss & Jacobs. He has more than 15 years experience in leasing, financing, partnerships and syndications, sales and acquisitions and all areas of commercial real estate.
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