On June 11, 2002, in one of the most significant court decisions affecting co-op and condo owners in recent years, the New York State Court of Appeals issued a ruling in the well-publicized case of 511 West 232 Street Owners Corp. v. Jennifer Realty Corp.. The court held that offering plans are in fact a kind of contract - and legally oblige buildng sponsors to act in good faith and timely sell "at the very least" enough shares to create a "fully viable cooperative." The Court ruled that by keeping a majority of shares in a cooperative, a sponsor defeats the purpose of the contract.
In order to understand the Jennifer dispute - whether a sponsor of a non-eviction conversion to co-op or condo ownership of an existing residential building has an obligation to complete the offering plan by selling all of the unsold apartments within a reasonable time after they are available for sale - a little history is necessary. Although the concept of a cooperative apartment building goes back over a hundred years, the creation of a co-op by converting an existing rental building to owner-occupancy seems to have caught on after World War II and gradually picked up steam during the 1960s and the latter part of the 1970s.
By the early 1980s, the only statutorily authorized method of converting a building into a co-op was through an eviction plan, by which the sponsor - upon selling 35 percent of the apartments to tenants-in-occupancy - could evict the remaining tenants if they did not buy their apartments. This threat of eviction generated opposition to the co-oping process. While conversion of a building to cooperative ownership was generally viewed as a good thing, bringing the benefits of home ownership into an urban setting, and helping to stabilize and improve neighborhoods, the opposition to the co-oping process from those tenants threatened with eviction created a political problem.
Accordingly, the New York State Legislature enacted a political compromise between the benefit of rapidly converting buildings to cooperative ownership, and tenant opposition to possible eviction and dislocation. The result was the creation - in 1982 - of the "non-eviction cooperative conversion," legislatively embodied in Section 352-eeee of the General Business Law, which allowed a sponsor to declare a co-op conversion plan effective upon sale of only 15 percent of total units. In return, however, the sponsor was prohibited from evicting any of the non-purchasing tenants. The compromise was expressly intended to facilitate conversions to cooperative ownership by reducing the opposition from existing tenants. The non-eviction conversion soon became the standard form of conversion. For most of the 1980s, sponsors sold apartments as soon as the rent regulated tenants moved out and the apartments became available to be sold on a free market basis.
During the economic downturn of the early 1990s, however, many sponsors were unable to sell apartments for several years, and were forced by economic conditions to rent out apartments when they could not be sold. After the economy picked up in the early-to-mid-90s, some sponsors continued to rent apartments rather than resume selling them. By 1995, a controversy began to erupt as to whether sponsors had a right to continue renting free market apartments indefinitely, or whether they had an obligation to sell the apartments as they became available, in order to complete the offering plan.
The facts of this case, as stated in the decision of the Court of Appeals, are typical of many other co-ops. The subject co-op was a 66-unit, rent-regulated apartment building located in the Bronx. In 1987, the sponsor filed to convert the building to cooperative ownership under a non-eviction plan. On May 16, 1998, after selling 15 percent of the apartments, the sponsor declared the plan effective and the closing took place soon thereafter. The New York State Court of Appeals stated that the sponsor had sold no apartments since 1990, and kept ownership of 41 of the 66 apartments - constituting more than 62 percent of the shares of the building. The sponsor ceased updating its offering plan in 1996, and thereafter refused to sell apartments even though - as the complaint alleges - it received bonafide purchase offers.
The complaint also alleges that the plan did not disclose that the sponsor intended to make a substantial profit by renting out apartments at free market rates, or the risk that the sponsor would keep most of the apartments for itself. The complaint alleges that as a result, the sponsor frustrated plaintiffs' ability to resell apartments, interfered with the refinancing of the building's mortgage, and caused maintenance payments to increase. The complaint further claimed that because the majority of the apartments are still rented - rather than owner-occupied - many transient tenants live in the building, causing an increase in wear-and-tear and additionally increasing the maintenance.
The complaint alleges causes of action for fraud, breach of fiduciary duty, breach of contract, and deceptive advertising. In response to the complaint, the sponsor moved to dismiss the case, alleging that the complaint did not state valid causes of action. In March 2000, Bronx County Supreme Court Justice Jerry L. Crispino dismissed the cause of action for breach of contract, but sustained all of the other causes of action against the sponsor. The trial court took the position that there was nothing in the plan that contained any promise by the sponsor to sell apartments within a particular time frame, although the court believed that the allegations of fraud had been sufficiently pleaded.
On appeal, the Appellate Division took exactly the opposite position. In August 2001, the court ruled that there was an implied contractual promise in the offering plan to sell the unsold units within a reasonable time - on the ground that while the parties understood that all of the apartments would not be sold initially, it was intended that all would evidentially be sold. However, the court dismissed the fraud-based claims on the ground that they were duplicative Martin Act claims that could only be prosecuted by the Attorney General.
The Appellate Division's decision was a landmark ruling, causing enormous interest and divergent opinion to be focused on this case. When the sponsor appealed the case to the Court of Appeals, the Real Estate Board of New York (REBNY), the Community Home Improvement Program (CHIP), and the Rent Stabilization Association (RSA) filed amicus briefs on behalf of the sponsor, while the New York State Attorney General's Office and the Council of New York Cooperatives & Condominiums (CNYC) filed amicus briefs on behalf of the cooperative.
For all of its potentially sweeping implications, the Jennifer decision is carefully limited. For procedural reasons, the court did not address the issues of whether the complaint stated a valid cause of action for fraud, or whether the co-op and the purchasing shareholders had standing to prosecute such claims, and left in place the dismissal of those claims by the Appellate Division. The court expressly declined to rule on the merits of the contract cause of action - that is, whether there was sufficient proof in the record to show that the plaintiffs had proved their case. The court was very careful to confine its holding to the point that the complaint did state a valid cause of action, and thus that the offering plan did include an implied covenant to sell apartments beyond the 15 percent minimum within a reasonable period of time.
While the decision affirming that the co-op can require the sponsor to sell apartments is a substantial step forward, it leaves the extent to which the apartments must be sold - and in what time frame - to be determined by the lower court. The court expressly did not address the issue of whether the sponsor impliedly promised to sell all of its unsold shares, holding only that "at the very least," the offering plan was a contract that obligated the sponsor to sell sufficient shares to create a "fully viable cooperative," and that by retaining a majority of the shares of the co-op, the sponsor had defeated the purpose of the contract.
The court also declined to discuss the applicability of this decision to holders of unsold shares who are not the sponsor. One has the sense that the court was feeling its way slowly through unfamiliar territory.
There is no current statute or court decision which defines a "fully viable cooperative," and the Court of Appeals did not undertake to do so. Accordingly, on remand the lower court will have to determine what constitutes "a fully viable cooperative," whether the facts in this case show this particular co-op is not, and how many and when apartments will have to be sold until that standard is reached.
As in most court decisions, this decision will provide ammunition to advocates of both the broad and the narrow interpretation of the decision. Advocates for sponsors - asserting that the decision should be read narrowly - may point to the statement of the court that the wrong was that the sponsor kept most of the shares, and that the factors mentioned by the court to show that the co-op was not viable were all economic factors. This might suggest that viability would depend on selling only 51 percent of the shares, or that viability had been achieved as soon as purchasers of existing apartments could obtain bank financing.
Advocates for co-ops and tenant shareholders seeking a broad interpretation will point to the fact that the court's decision stated that "at a minimum," there was a duty to create a "fully viable cooperative," and thus selling shares until "viability" had been achieved was only the start of the sponsor's obligation - not the end of it. In addition, the court expressly cited the obligation imposed by the Attorney General's regulations not to abandon the plan before it had been completed, and left open the question whether all apartments had to be sold. This might suggest that the court will ultimately rule that all or virtually all of the apartments would have to be sold before the sponsor had complied with its obligations.
It is clear that this decision is a solid victory for the legal profession, because there remains much litigation to be undertaken in order to resolve all of those issues in this case or in future cases. While the decision is a substantial step forward on behalf of co-ops and tenant shareholders who have been victimized by the failure of sponsors to carry out their offering plans, it is not - to paraphrase Winston Churchill's famous statement - the end of the battle over sponsors failing to carry out their offering plans, it is certainly the beginning of the end of that battle.