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LEGAL CORNER: Recent Co-op Decision: Stromberg v. East River Housing Corp. and a Review of Co-Op Disclosure Legislation
Recently, the decision in Stromberg v East River Housing Corp. brings to light some of the issues that exist with regard to the co-op approval process and the restrictions that burden purchasers and sellers in co-op transactions.
Over the past several years significant headway has been made in the area of Co-op Disclosure legislation in various areas in New York State, and particularly in Westchester County. While similar co-op transparency legislation has been introduced in New York City and at the state level, those measures have yet to be enacted.
Recently, the decision in Stromberg v East River Housing Corp. [see https://bit.ly/3HkWDPs] brings to light some of the issues that exist with regard to the co-op approval process and the restrictions that burden purchasers and sellers in co-op transactions. This article will review the decision in Stromberg, revisit some of the key requirements under the Westchester Co-op Transparency legislation, and discuss the state of the legislation introduced in New York City and at the state level.
Stromberg v. East River Housing Corp.
In Stromberg, the plaintiffs owned shares in a residential cooperative apartment building located in Manhattan and were lessees under the proprietary lease for their apartment. One of the defendants is East River Housing Corporation, which operates through its Board of Directors. Another individual defendant named in the lawsuit was the Board's vice president, Shulie Wollman, who was also the general manager of another named defendant, Cooperative Village Management, East River’s management company. The plaintiffs sued the defendants “claiming that defendants improperly and arbitrarily refused consent to a proposed sale of plaintiffs’ apartment.” The defendants counterclaimed against the plaintiffs for “declaratory relief” and reimbursement of legal fees.
The Facts of Stromberg
The plaintiffs entered into a contract of sale in January 2022 for the sale of the co-op apartment for the sale price of $520,000. The price was based on an appraisal obtained by the plaintiffs from “a disinterested third-party appraisal service. The appraisal service valued the unit at $525,000. The appraisal was based, in part, on comparable properties in the area that were sold for $514,500-$528,000.” The plaintiffs and purchaser submitted the purchase application to the Board, which was rejected. The plaintiffs “appealed to the Board to change its mind, but the Board did not do so.”
The plaintiffs’ real estate broker then asked the Management Company if the “Board would approve the sale with an increased sales price.” According to the facts of the case, the parties amended the contract purchase price and increased it to $540,000, however, the Management Company indicated that the “amended purchase price ‘was still too low’ and that ‘the Board would not approve a sale with a purchase price lower than $600,000.00.’’’ The purchaser ultimately cancelled the contract because the Co-op Corporation did not provide the approval within the “reasonable” time frame as required under the contract. The plaintiffs then filed a lawsuit against the defendants, suing them for the following claims: (1) a breach-of-contract claim against East River and the Board, (2) a breach-of-fiduciary-duty claim against the Board, (3) an aiding-and-abetting claim against the Management Company, and (4) an unreasonable-restraint-of-alienation claim against the Board.
In April 2023, while motions were pending, the plaintiffs entered into a new contract of sale with a new purchaser for a purchase price in excess of $600,000. A new sale application was submitted to the Board. In May 2023, the Management Company and the Board required the plaintiff and the new purchaser to submit an amended application and requested additional information relating to the finances of the purchaser.
As a result of the additional demands made by the defendants relating to the new application, the plaintiffs believed that these actions were being made in retaliation because the plaintiffs had filed the lawsuit. The plaintiffs then amended their complaint to include an allegation of an “additional breach-of-fiduciary-duty against the Board for its alleged retaliation with respect to the April 2023 sales application, and an aiding-and-abetting claim against Wollman.”
The defendants filed two counterclaims against the plaintiffs. One counterclaim “seeks a declaratory judgment that the Board may properly consider an apartment's proposed sale price when determining whether to grant or refuse consent to a sale of the apartment's shares and lease.” The second counterclaim “seeks an award of attorney fees under the proprietary lease.” The plaintiffs, in their answer, raised “the affirmative defense that the lease's attorney-fee provision is unenforceable as unconscionable to the extent that it ‘require[s] reimbursement of the Lessor's professional fees and disbursements in a legal action brought by Lessee against Lessor based on Lessor['s] default.’”
Breach of Contract Claim in Stromberg
And the Business Judgement Rule
In connection with the plaintiffs’ claim that East River and the Board “breached the co-op's governing documents and acted contrary to applicable law by failing to approve plaintiffs’ application,” the defendants claimed that their denial was in compliance with and protected by the “business judgment rule,” which “protects its ‘good faith, rational decision to withhold consent to the 2022 application based on the proposed sale price for that unit.” The court denied the defendants’ motion to dismiss based on this argument.
The ‘Business Judgment Rule Based on
The Value of Co-Op Apartment
The court in Stromberg, citing a well-known New York Court of Appeals decision in Levandusky v. One Fifth Avenue Apartment Corp. [see https://bit.ly/3vBHx5q], explained that “under the business-judgment rule, a court may not inquire ‘into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.’” The court in Stromberg further points out that “unless there is ‘illegal discrimination, the respondent members of the board of directors of the respondent cooperative corporation have the right to withhold their approval of petitioners’ purchase for any reason or no reason.’” The “Business Judgment Rule” would not protect any Board or Cooperative Corporation against illegal discrimination, but a Board would seemingly be permitted to withhold the approval of a purchaser for “any or no reason” based on the Levandusky decision.
The court in Stromberg further points out (citing another First Department Appellate Division case, Singh v. Turtle Bay Towers Corp. [see https://bit.ly/4aZcZus]) that it was “proper for a co-op board to reject a purchase application when ‘the decision to deny the purchase application was based upon the determination that the purchase price for the subject unit was significantly below market value.’” The decision in Stromberg, however, does seem to place some limitations on the broad corporate discretion espoused in the Levandusky and Singh decisions. The key distinction, and limitation, provided for in Stromberg is not whether a co-op board may use value as a determining factor in approving or disapproving an application, but the method or means by which the value is determined and considered by a board is important and value also cannot be the only factor.
Contract Rights in the Proprietary Lease
The court points out that the proprietary lease for the apartment which was entered into by the plaintiffs and East River provides that “There shall be no limitation, except as specifically provided therein, on the right of the Board of Directors to grant or withhold consent to an assignment, for any or for no reason.” The court further points out that East River argues “that its decision to withhold consent was based on the fact that the 2022 application's proposed sales price for plaintiffs’ unit was lower than the prices of previous sales—not because East River set an arbitrary minimum price floor that is materially above market value.” According to the contract (i.e., Lease) terms and the Business Judgment Rule, the defendants argue that they have the right to deny the application based on the fact that the value of the subject apartment is significantly below market value.
The plaintiffs, however, claim that the “arbitrary” price of $600,000 set by East River did not accurately reflect market values and argued that their appraisal established an accurate value based on comparable sales. The plaintiffs also argue that the previous sales data relied on by the defendants was “faulty because it included the sales prices of units that [were] not comparable to plaintiffs’ unit and that this sales data did not reflect [other] sellers’ concessions, which assertedly inflated the nominal sales price of the unit without changing the post-concessions amount that [other] sellers actually received from buyers.” The plaintiffs provided the defendants with a copy of the appraisal obtained by them from an independent third-party and also submitted an affidavit to the court from their broker establishing that their limit price of $600,000 was not in line with market values, and argued that other factors were not taken into account by the Board when setting this price threshold and denying the purchaser’s application.
Court’s Ruling Regarding the Co-op’s Determination
Ultimately, with respect to the issue relating to the denial of the plaintiffs’ and purchaser’s application, the defendants were seeking a declaratory judgment establishing that they may “consider the apartment’s sale price in determining whether to grant or withhold consent to the Prior Application.” The court points out that plaintiffs were not disputing whether the co-op Board could “consider the purchase price; rather, [the plaintiffs] contend[ed] it cannot be the sole criterion considered in approving or denying an application and plaintiffs allege[d] that East River abused its discretion by considering only whether the sale price satisfied an arbitrary price floor unrelated to the unit's market value.” The court agreed with the plaintiffs and provided that “the only question is whether the particular manner in which East River considered the unit's sales price was legally impermissible.”
The court ultimately denied the defendant’s request for a declaratory judgment and dismissal of the plaintiff’s claim, and ordered that the lawsuit must proceed at trial with respect to these open issues. The court’s holding seems to place additional restrictions on a co-op board’s fairly broad discretion to make decisions “for any or no reason” under the guise of the Business Judgment Rule. It will be important to follow this case carefully to see what ultimately is decided.
Are Legal Fees Recoverable by the Co-op
In an Action Brought by an Owner?
The decision in Stromberg also provides important guidance with respect to attorney fee provisions in contracts and proprietary leases. In Stromberg, the court points out that the proprietary lease provides as follows: “‘in connection with any action or proceeding brought by the Lessee against the Lessor that is based on any other matter or thing relating to the lease or to East River's ‘Bylaws, Certificate of Incorporation, House Rules, or regulations duly adopted by the Board of Directors, the lessee must pay East River's fees.” The defendants in Stromberg filed a motion for summary judgment establishing that they were entitled to legal fees from the plaintiff based on the above-cited provision. The plaintiffs, as an affirmative defense, argued “that the attorney fees provision in the lease is unenforceable as unconscionable.” The court agreed and dismissed the defendants’ claim for reimbursement of legal fees.
The court cited another First Department decision in Krodel v Amalgamated Dwellings Inc., which “held that a proprietary lease provision requiring the lessee to pay the co-op’s legal fees incurred in connection with an action brought by the lessee against the co-op, which relates to the lease ‘or to any alleged failure by the lessor to perform any act which the lessor is required to perform’ is unconscionable and, therefore, unenforceable.” The court pointed out that the reasoning in Krodel provided that the enforcement of “such a provision would produce an unjust result because it would dissuade aggrieved parties from pursuing litigation and preclude tenant-shareholders from making meaningful decisions about how to vindicate their rights in legitimate instances of landlord default.” The court in Stromberg, therefore, held that the attorney-fee provision would be unenforceable under the Krodel decision.
Westchester Co-Op Disclosure Legislation Revisited
The decision in Stromberg seems to provide a limited expansion of an owner’s and purchaser’s rights in connection with the sale and transfer of a cooperative apartment, and a limitation of the broad discretion of co-op boards when denying a co-op purchase application. While we will need to wait to see what the ultimate resolution is in Stromberg, several counties (i.e., Westchester, Rockland, Dutchess, Nassau and Suffolk) have been successful in passing co-op transparency and disclosure legislation.
In Westchester County, the co-op transparency and disclosure laws passed in 2018 and amended in 2021 [see https://bit.ly/4aZ1AuA], afford owners and purchasers significant protections. The Westchester County Fair Housing Law requires co-op corporations to “adhere to certain time frames and report rejections to the Westchester County Human Rights Commission.” [See https://bit.ly/3RQzyJa]. The amendment passed in 2021 also now requires the co-op corporation to provide a reason for the denial to a purchaser. Important provisions are outlined by the Human Rights Commission in its informational flyer, which should be reviewed and utilized by all real estate professionals [see https://bit.ly/3RQzyJa]. The flyer provides details on application requirements, rejection notice requirements (as well as providing forms of the Model Rejection Form [see https://bit.ly/3u2Fwi2] and a completed one [see https://bit.ly/48Kv6CM] for reference purposes), critical deadlines, fair housing training requirements for co-op board members, and a list of fines for non-compliance.
The Human Rights Commission informational flyer also points out that Westchester County’s Fair Housing Law “requires cooperative housing corporations that have minimum financial qualifications to disclose those qualifications in their applications. Section 700.21-a (A)(2)(b), however, states in relevant part:
If a cooperative housing corporation does not have stated mandatory minimum financial qualifications the [cooperative must at least disclose its] preferred minimum income, total assets, and credit score, and preferred maximum debt-to-income ratio and percentage of purchase price being financed, noting that these criteria may vary in the discretion of the governing board weighing these factors when it makes a decision on an application.”
The FHL also makes clear that a co-op board does retain the “discretion” to consider and weigh the factors they set in connection with the required minimum financial qualifications if the co-op does not have any in place.
Legislative Initiatives to Track in 2024:
New York State and New York City
There has also been proposed legislation introduced in New York City (Int. 0915-2023) and in the New York State (NYS Assembly Bill No. A02685) level relating to co-op transparency and disclosure obligations, but these laws have yet to be passed. [See Co-op Transactions: Unmasking Hidden Discrimination, National Association of Realtors at https://bit.ly/3HjxBQB and reprinted in Real Estate In-Depth]. It will be important to keep track of the progress of these legislative initiatives in 2024 as well as developments in the Stromberg case, as they will possibly expand the protections afforded to purchasers and owners with respect to co-op transactions.
The foregoing article is for informational purposes only and does not confer an attorney-client relationship and shall not be considered legal advice. The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the views or positions of HGAR, its affiliates, or any other entity.