From the Court to the Board Lessons from Recent Decisions

Several interesting court decisions regarding co-ops and condos were made during the latter part of 2005. The decisions received some commentary, but perhaps not the attention that they deserve. In a condo case, the Appellate Court that oversees the trial courts in Manhattan and the Bronx made a decision that clarifies when a condo unit owner may be subject to liability in connection with the condo’s common elements. And New York’s highest court issued a decision changing how one determines whether a co-op shareholder is a holder of unsold shares (i.e., a shareholder who typically has special privileges, such as being able to transfer and sublease without board approval). Some other notable decisions provide valuable lessons.

Ira Pekelnaya, as Guardian Ad Litem for Michael Taratuta v. Jerri Allyn. Lesson: Condo unit owners are not liable individually for injury or damages that result from common elements, which they do not control.

This Appellate Division, First Department, decision may be one of the most significant court decisions regarding condos in recent years. The question was whether condo unit owners could be held individually liable for injury caused by a defect in a common element. In this case, a common element chain link fence on a parapet-wall fell and struck plaintiffs. The plaintiffs sought money from the condo unit owners who they argued were liable for the condo board’s decisions with respect to the fence. In a well-reasoned decision by Judge Tom, the court held that there is no liability imposed upon individual unit owners based solely upon their ownership in the common elements.

According to the court, it is control, not common interest that is the operative criterion upon which liability is predicated. “In the absence of such control by the individual unit owners over the common elements alleged to be defective, this court concludes that the individual defendants cannot be held answerable in damages.”

The court found that the condo form of ownership was a creature of statute and subject to strict construction. There is no provision in the law governing condos that imposes liability on unit owners for injury caused by a defect in the common elements. The court was impressed with plaintiffs’ point that a condo is not required to maintain liability insurance which may cover damages. The court went so far as to “urge legislation to require a condominium to obtain a minimum amount of liability insurance coverage in such amount as may be deemed adequate to protect the public.”

Ronald Yatter v. Continental Owners Corp. Lesson: According to the New York courts whether a shareholder is a “holder of unsold shares” depends solely upon how the shareholder’s relationship with the cooperative is defined in the relevant offering plan and the proprietary lease.

The Appellate Division, Second Department, just applied the June 2005 Court of Appeals decision in George Kralik v. 239 East 79th Street Owners Corp., in deciding whether a co-op shareholder was a holder of unsold shares. One of the greatest values of being a holder of unsold shares typically is being able to transfer shares or sublet with board approval and without transfer or sublet fees.

Prior to the Kralik decision, the question of whether a shareholder is a holder of unsold shares was answered by examining whether the shareholder complied with certain regulations promulgated by the New York Attorney General’s Office to govern the conduct of holders of unsold shares.

Now, whether correct or incorrect, the operative question is how the co-op’s governing documents define the shareholder’s relationship with the co-op. The courts see the question as one of contract interpretation rather than compliance with the Attorney General’s regulations. Unless there is a change in legislation or the New York Court of Appeals changes its mind on another appeal dealing with this issue, the question must be answered by considering the offering plan and proprietary lease provisions.

Inwood Park Apartments, Inc. v. Coinmach Industries Co. Lesson: Make sure your agreements are always clear and unambiguous. Right of first refusal provision in favor of laundry services company is declared invalid.

At least a few times a year a co-op or condo seeks advice with regard to a contract that they signed without legal guidance. Laundry service agreements, signed without counsel’s advice, come up every now and then.

It is not clear whether Inwood Park Apartments signed the laundry service agreement with the laundry company without first obtaining legal guidance. The agreement contained a right of refusal provision which was so broad that it gave the laundry company the right of first refusal even after the agreement with the laundry company expired. If upheld, such provision would effectively have required the co-op to retain the laundry company’s services indefinitely irrespective of whether the co-op wanted to continue with the company. For example, once the laundry company’s contract expired, a new laundry company might have reached an agreement with the co-op. Under the contract provision, the laundry company could match the agreement terms and force the co-op to enter into that same agreement with them.

The Appellate Division, First Department, however, unanimously decided that the provision was invalid because it was considered an unreasonable restraint upon the alienation of the co-op’s property. This right of refusal provision probably should never have been in the contract in the first place.

Lorenza Machado v. Clinton Housing Development Co. Lesson: Whether the co-op or its shareholder is responsible for a particular maintenance or repair may not always be clear.

This case involved the question of whether the Clinton Housing Development Co. co-op or its shareholder Lorenza Machado is responsible for the maintenance and repair of a hot water valve for a bathroom sink. Machado called the co-op’s managing agent when she saw a leak coming from the sink’s hot water faucet and hot water valve next to the sink. The agent told her to turn the water off. She turned the valve for about five minutes and it exploded scalding her.

The most interesting aspect of this case is the difference in opinion between the judges on the Appellate Court panel (3 judges in the majority saw it one way, and 2 judges in the minority saw it another way).

Whenever faced with a question like the one in this case, the first place to look is the proprietary lease. The Clinton Housing proprietary lease provides that the maintenance and repair of exposed plumbing (pipes not “within the walls”) and fixtures to which they are attached are the shareholder’s responsibility. Thus, the co-op is responsible if the valve is “within the walls.” Otherwise, the shareholder is responsible. This is a typical proprietary lease provision.

The majority of the court dismissed the case holding that there was no question that the valve was not “within the walls” and thus, the shareholder was responsible. The minority of the court dissented stating that there was no question that the valve was “within the walls.” The minority felt that the “mere fact that the valve stem protruded through the wall does not change the valve body’s location” and the co-op’s obligation under the proprietary lease.

Simon Schwarz & Theresa Otto v. Dorchester Apt. Corp. Lesson: The business judgment rule is a powerful defense for a board of directors.

The business judgment rule is a powerful defense for a co-op or condo board. Dorchester Apartment Corp. adopted a rule preventing any shareholder from having more than one parking space while shareholders are on a waiting list for a parking space. Two shareholders commenced this suit challenging the board’s decision regarding the rule.

The Supreme Court in Brooklyn decided in the co-op’s favor because of the business judgment rule. The court decided that the business judgment rule applies because the shareholders did not meet their burden of proving that the co-op board “acted in bad faith or outside of the scope of their authority, or in a way that did not legitimately further the corporate purpose.” The court rejected the shareholders’ argument that the board acted in bad faith toward them because they were the only two shareholders who currently occupy two parking spaces. According to the court that alone is insufficient to establish bad faith.

Michel Brasseur v. Joe Speranza. Lessons: In order for board members to be sued in their individual capacity they must have committed a tortious act that is separate and apart from their decisions as board members.

Even though it is well established in New York that suits against board members in their individual capacity cannot be maintained unless the board members committed an independent tortious act that is separate and apart from their decisions as board members, plaintiffs still sue individual board members without meeting that criteria. This still happens unfortunately and courts should impose stiff sanctions against plaintiffs who lodge baseless claims.

This case is yet another example of a baseless claim against individual board members who serve, for free, as board members. The Appellate Court dismissed the claims against the individual board members on the ground that plaintiffs did not meet the strict standard to maintain such a claim. Unless plaintiffs are regularly and consistently sanctioned for inappropriately naming individual board members in lawsuits, the practice of including individual board members in lawsuits as an apparent “scare tactic” will continue.

Joyce Kwiecinski v. Sea Breeze II Condominium Association. Lesson: Condo boards must make sure that they have the authority to borrow before they borrow.

This case is a classic example of a condo board deciding to borrow money to pay for a construction project without first confirming that the board itself has authority to borrow the money. A condo’s bylaws typically provide the answer. The Sea Breeze II Condominium’s board was faced with a $52,296 construction project and signed a note to the contractor for that amount to be paid over a two-year period. The questions were whether the note constituted borrowing money (it did) and whether the condo board had authority to borrow the $52,296 without bringing the decision to the unit owners for a vote (it did not).

The condo’s bylaws provide that at least two-thirds of unit owners, both in number and in aggregate common interest, must vote to approve borrowing of any sum in excess of $50,000 in any one fiscal year. The court held that there are issues of fact regarding whether the board had authority itself to proceed with the $52,296 worth of construction work in view of the borrowing requirement in the bylaws.

Borrowing authority is a common issue for condos. A condo’s bylaws typically provide the extent of a condo board’s borrowing authority without obtaining approval by a certain vote of unit owners. Condo boards must make sure they have authority to borrow before committing themselves to any project.

Joseph G. Colbert is a partner with Kagan Lubic Lepper Lewis Gold & Colbert, LLP specializing in the representation of cooperatives and condominiums. He also is an adjunct professor at St. John’s University School of Law.

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3 Comments

  • I would still like to know if the Board of Managers can be sued individually because they instituted major projects without the approval of a majority of the unit owners. Also, the president of the Board is an employee of the management company. Can she be sued individually for conflict of interest in her capacity as fiduciary oversight of the mangement company. She also had two trees planted on the sidewalk in front of her unit at condo expense and did not apply for a permit to do so. Also, without approval or even knowledge of the planting until the Dept. of Forestry in Queens was called and asked about it. Patios were enlarged onto common area and imported tile was installed without the approval of the majority of owners. These patios are restricted to half of the owners. The other owners have terraces and had to pay for the installation of floors on their terraces.
  • @Jan: In a normal situation, when you elect your Board of Managers, you are doing so on the understanding that they can make decisions on behalf of the unit owners and for the unit owners without the prior approval of a majority of the unit owners. In order for you to sue them individually, and for their D&O coverage not to kick in, you would have to show that they did something so against the health and well being and completely out of better business judgement. It is probably a bad idea that the President of the Board is an employee of the managing agent, although if such a conflict is addressed in meetings with her being recused from items that have to deal with sensitive subjects, such as the discussions on the management company, it could be construed as ok. She is (I'll assume) an owner in the building, and she should be able to serve the Board freely with regards to items that are not dealing with her conflicts. You have a case against the common area being used, since this would need the approval of the owners at large, but you don't have any wiggle room on the tile, albeit expensive tile. It's part of the joys of living in a building with a Board. They do have leeway in making those types of decisions.
  • One of the most important questions about Co-ops is that of the Sponsor. I see very little comment in your magazine about making a Co-op a "True Co-op' or a 'Viable Co-op'. I know it is tricky, but to important not to be commented on in every issue in one way or another.