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Q&A: Sponsor Control over the Board

Q&A: Sponsor Control over the Board
Q I serve on the board of a Brooklyn co-op which is only 52 percent shareholder  owned. Shareholders now have the simple majority on the board. Our sponsor owns  the management company (which is non-responsive), has a relationship with our  CPA and we share his attorney. It makes many shareholders and board members  uncomfortable having the sponsor associated with every entity we depend on for  loyalty. What are the pros and cons of using a sponsor-owned management  company, a CPA with possible sponsor loyalties and an attorney who has worked  for the sponsor for decades?”  

 —Concerned Cooperator  

A “Your questions highlight a fascinating challenge that is faced by co-op (and  condo) boards when they make the transition from control by the sponsor to  control by the non-sponsor owners,” says Stanley M. Kaufman of the New York law firm of Kaufman Friedman Plotnicki & Grun, LLP.  

 “At such time, all of the co-op’s existing relationships, including its relationship with its managing agent and  outside professionals, should be examined and carefully considered. With respect to the management company, the first order of business should be to  look at any existing contract between the co-op and the management company,  which may provide for a specified term or which may limit the grounds upon  which the contract may be terminated before the end of its prescribed term.  

 “Your management company is an agent that owes a fiduciary duty to your co-op as  a whole, and it should not favor any shareholder over another. If it is  contractually free to do so, your board may be well advised to retain a new  management company that does not have a divided allegiance. On the other hand,  your sponsor-owned management company may be very professional and competent;  its principals obviously have a proprietary interest in the co-op (as owners of  48 percent of its shares), and they may possess a unique and very useful (if  not invaluable) knowledge of the property, its history and its construction. These “pros and cons” should be weighed by the board in arriving at a decision on whether to look for  a new management company.  

 “In the case of professionals, such as the co-op’s accountant and attorney, it is probably more appropriate that the board retain  professionals who possess undivided and unquestioned loyalty to the co-op. While accountants are required to adhere to certain practices, it certainly  would be unfortunate if it were ever discovered that your sponsor-owned  management company had mismanaged or misappropriated corporate funds, that such  conduct was not uncovered by the accountant who audited the corporation’s books, and that the accountant had a relationship with the sponsor.  

 “The relationship that would appear to most clearly cry out for a change is that  with the attorney who represents both the co-op and the sponsor. An attorney  owes his or her client the highest duty of loyalty and confidentiality. Having one attorney represent both entities is fraught with peril, both from the  perspective of the co-op’s interests and the attorney’s ethical obligations. That attorney most likely would have two clients with very differing interests,  which would constitute a conflict of interest or a serious potential conflict  of interest. This very issue was addressed in an ethics opinion issued by The Association of  the Bar of the City of New York (Formal Opinion 1990-1) which concluded, after  discussing various conflicts that might arise and that might require the  attorney to withdraw from both representations, “that the preferable course in general” would be for the sponsor’s lawyer to decline “at the outset” to represent the co-op as well. At the very least, that attorney should have disclosed to the board the nature  of this conflict or potential conflict (under ethical rules governing the  conduct of attorneys, even such disclosure alone sometimes is not sufficient to  allow the “conflicted” attorney to represent both entities).”      

 

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Comments

  • We are a coop incorporated in the state of New York. Our coop by-laws contain language to the effect that the holders of unsold shares cannot control a majority of the Board after 5 years or when unsold shares reach less than 50%, whichever comes first. Both of these criteria have now been met with about 30% of the shares currently owned by the Sponsor. My question is how would the Sponsors vote be counted if there are 7 board seats, with two vacancies, and 9 candidates. The Sponsor is one of the five incumbents. Do the Sponsor’s vote count the same as any other shareholder? Or can the Sponsor have a majority vote for only three of the seven candidates? Or something in between? Please advise