By Robert J. Braverman

Robert J. Braverman is a member of Braverman & Associates, P.C., specializing in cooperative and condominium housing law. He represented 200 East 36th Owners Corp. in the Susser case.

RECENT RULINGS CREATE UNCERTAINTY FOR HOLDERS OF UNSOLD CO-OP SHARES

In the last several weeks two decisions have been handed down which significantly affect the rights of holders of unsold shares in cooperative housing corporations to sublet their apartment units. The impact of these decisions may very well be felt within the residential housing industry for years to come.

In the first case, Justice Sheila Abdus-Salaam of Supreme Court, New York County reconfirmed the traditional right of a holder of unsold shares to sublet and transfer the apartments appurtenant to their shares without having to obtain the consent of the cooperative's board of directors---a right which, according to some commentators, was cast into doubt last year by the Appellate Division, First Department's decision in Wapnick v. Seven Park Avenue Corp., 240 A.D.2d 245 (1st Dept. 1997).¹

In the second case, Parkoff v. Harris, a Kings County Housing Court judge virtually created an entire new class of protected tenants when he found that the "non-eviction protections" of the Martin Act² are properly extended to tenants who after conversion rent unsold units from sponsors or holders of unsold shares.

This article analyzes how these decisions affect holders of unsold shares and the cooperative housing industry.

In Susser v 200 East 36th Owners Corp., NYLI QDS #22209181, plaintiff, a tenant shareholder of a cooperative housing corporation, was refused permission from the co-op's board of directors to sublet his apartment. The co-op's proprietary lease contained a standard clause which exempted the holder of unsold shares from having to obtain the consent of the corporation in connection with assignments and sublets.³

Plaintiff filed an action claiming, among other things that the co-op had violated § 501 (c) of the Business Corporation Law (BCL) by requiring shareholders other than holders of unsold shares, to obtain board approval to sublet, transfer, or assign their apartments.

STRETCHING "WAPNICK"

In support of this 501(c) claim, the plaintiff in Susser unsuccessfully attempted to extend the First Department's 1997 decision in Wapnick v. Seven Park Avenue Corp., 240 A.D.2d 245. In Wapnick, the court found that a proprietary lease provision which exempted an original purchaser (i.e., the contract vendee of the sponsor or holder of unsold shares) from the co-op's restrictions on transferring and subletting violated BCL § 501 (c). The court held that since the exemption for original purchaser was not in the form of a flip tax, the exemption was outside the statute's sole exception, as set forth in the 1986 amendment.

Ruling in Susser, Justice Abdus-Salaam expressly noted that "at first blush", the holding in Wapnick might lead one to conclude this case to the holder of unsold shares with respect to subletting is violative of BCL 501 (c)," However, the court stopped short of extending the holding in Wapnick to the facts of Susser, noting that there is "an important distinction" between a holder of unsold shares and an original purchaser.

Specifically, the court examined the legislative history generated in connection with the 1986 amendment to BCL § 501 (c). That history addressed the fact that holders of unsold shares in cooperative housing corporations have traditionally enjoyed exemptions from certain obligations imposed upon other shareholders of the corporation (such as the right to sublet, assign and transfer their shares without having to obtain consent form the co-op's board of directors) and that the amended statute was not intended to eliminate those benefits. The court also looked to the fact that the Appellate Division, First Department, had cited to this legislative history with approval in its decision in Mogulescu v. 255 West 98th Street Owners Corp., 135 A.D. 2d 32 (1st Dept. 1988).

The obvious reasoning behind the legislative history is that, unlike an original purchaser, the benefits afforded to a holder of unsold shares are consistent with certain statutory obligations a holder must carry out. For example, § 352-eeee (2)(c)(ii) of the General Business Law (GBL) prohibits a holder of unsold shares from evicting any non-purchasing tenants in a building which is converted to cooperative ownership pursuant to a non-eviction offering plan.⁷ Many of these non-purchasing tenants are protected by the Rent Stabilization Law (RSL) and Rent Stabilization Code (RSC) promulgated pursuant thereto.

Among a host of other statutory benefits, rent stabilized tenants must, in the absence of material violations of their lease and/or the RSC, be provided with renewal leases for one year or two year terms (at the tenants option).⁸ Although rent controlled tenants are to subject to the same "lease renewal rights" as their rent stabilized counterparts, they are, nevertheless, afforded protection from eviction. Thus, a holder of unsold shares has no choice but to sublet apartments occupied by rent regulated tenants.

The legislative history clearly evidences the desire of the drafters of the amended version of BCL § 501 (c) to preserve the ability of holders of unsold shares to carry out these obligations without interference from the statute's prohibitions. The outcome of Susser merely follows this desire.

The decision in Susser will, no doubt, allay any fears and concerns that may have been created in the wake of Wapnick. Indeed as pointed by other commentators there was a belief among some members of the real estate bar that the decision in Wapnick threw "into question both the ability of cooperatives to control sales and sublets by the traditional approval process and the exemptions from approval of sales, sublets, alterations and so forth presently enjoyed by holders of unsold shares.⁹

REMEDY APPLIED

By far, the most critical question arising from Wapnick concerned the remedy to be applied in connection with a "BCL § 501 (c) violation." This is because the Appellate Division in Wapnick merely reversed the lower court's "3211 dismissal" of the plaintiff's 501 (c) claims. Accordingly, the court did not address the proper remedy for a tenant shareholder aggrieved by discriminatory conduct in violation of the statute.

For instance, would so-called privileged shareholders, such as the original purchaser in Wapnick simply lose their benefits---benefits which were specifically bargained and contracted for between the sponsor or holder of unsold shares and the original purchaser or, would all shareholders obtain the benefits enjoyed by the privileged shareholder. Of course, this latter remedy would serve to eliminate many of the restrictions now imposed by cooperative housing corporations on tenant-shareholders; including the requirement to obtain consent of the corporation in connection with subletting, transfers and alterations of apartments.

These restrictions have, for years, been a cornerstone of cooperative living and the principle that tenant-shareholders of cooperative housing corporations may decide for themselves with whom they wish to share their elevators, their common halls, and facilities, their stockholders' meetings, their management problems and responsibilities and their homes. Weisner v 791 Park Avenue Corp., 6 NY.2d 426, 434 (1959). Indeed, even the mere possibility that these sacred rights could be lost because of the decision in Wapnick was cause for concern among some members of the co-op bar.

Notably, there is some question as to whether or not the Wapnick court was even correct in applying BCL § 501 (c) to the exemptions afforded to an original purchaser. Upon closer examination, a question arises as to whether affording certain benefits to all original purchasers of shares really constitutes disparate treatment of shareholders owning the same class of chares. At the time of their issuance, all of the shares of the corporation provided a "one time benefit" to original purchasers. The mere fact that subsequent owner elected to purchase shares which had already "used up" this benefit should not necessarily give that shareholder a right to action under BCL § 501(c) since the allegedly aggrieved shareholder's stock enjoyed the very same benefit the only difference being that the benefit was already "cashed in."

Regardless of the soundness of Wapnick, its holding clearly should not, and thankfully for the cooperative housing industry, was not extended to the facts of Susser. Accordingly, the coveted right of a co-op's board of directors to regulate subletting and oversee apartment transfers and alteration at least for the time being, fully intact.

In addition, holders of unsold shares have successfully preserved their right to operate outside the confines of these restrictions. Unfortunately, the claming effect created by the holding in Susser was short-lived.

BROOKLYN BOMBSHELL

At approximately the same time that Susser was handed down, Judge Marc Finkelstein of the Kings County Housing Court sent shock waves through the residential real estate industry when he handed down his decision in Paikoff v. Harris, NYLJ. Sept. 30, 1998. P. 28. Col. 1.

Paikoff was a summary holdover proceeding brought by the sponsor of a co-op building in Brooklyn against a tenant who rented one of the unsold units after the co-op conversion.

At issue in Paikoff, was whether the tenant/shareholder should be considered a "non-purchasing tenant" under the Martin Act and, as such protected from eviction.¹⁰

Traditionally, only those tenants who were in possession of their apartments at the time of the cooperative conversion and who elected not to purchase their apartments were considered protected under the Martin Act. Subsequent renters of co-op units held by either the sponsor or holder of unsold shares were considered "free market tenants" who could be lawfully evicted after the expiration of their leases. However, Judge Finkelstein examined the applicable section of the Martin Act and held otherwise. Specifically, CBL § 352-eeee(1)(e) provides "non-eviction protection" to:

A person who has not purchased under the plan and who is a tenant entitled to possession at the time the plan is declared effective or a person to whom a dwelling unit is rented subsequent to the effective date

The court found that the language italicized above expressly afforded Martin Act protection to "post conversion renters" of unsold units.

In further support of its decision, the court relied upon a 1993 affirmation the then Director of Regulatory Compliance in the state Real Estate Financing Bureau stating:

The Director concludes that a tenant who is already living in a conversion [sic] cooperative at the time the plan becomes effective is a non-purchasing tenant. However, the term "non-purchasing tenant" also includes a tenant who rents a vacant unit after the effective date of the plan, as long as the tenant does not sublet the unit from a purchaser under the plan. The position of the Office of the Attorney General is that a sponsor or holder of unsold shares is not a "purchaser under the plan." Therefore, the position of the Attorney General is that a tenant who rents a vacant unit after the plan's effective date from a sponsor or holder of unsold shares is a "non-purchasing tenant" under GBL 352-eeee.

In essence, this decision creates an entirely new class of tenant---one which is not as heavily regulated as a rent stabilized or rent controlled tenant (i.e., there are no administrative registration requirements; limited ability to increase rents; statutorily imposed renewal periods, etc.); but, nevertheless, a tenant who cannot be evicted absent of material breach of the lease.

For sponsors and holders of unsold shares, the decision in Paikoff is, for the most part, bad news. With a revitalized real estate market in the New York metropolitan area, many sponsors who have been renting unsold units to tenants who were not in occupancy at the time of conversion (i.e., free market tenants) have finally, thanks to the favorable market, started to sell these units at the expiration of the free market leases. The decision in Paikoff undoubtedly will hinder these efforts insofar as many of these free market tenants may elect to stay in possession of their units even if their rent is significantly increased. Indeed in the currently tight rental market, there is a greater possibility than ever that tenants will elect not to relinquish their apartments.

Moreover, although the Martin Act only prohibits a sponsor or holder of unsold shares from imposing "unconscionable increases" on its non-regulated tenants, there is sure to be a rash of costly litigation between owners and renters affected by Paikoff over what constitutes an unconscionable rent increase.¹¹

In addition, sponsors and holders of unsold shares in buildings that have still not felt the effects of the favorable real estate market---many of which are located in the outer boroughs---also will be faced with a difficult dilemma. They could sell their apartments as soon as they become vacant, but they might suffer a loss. They also could re-let their units but would run the risk of winding up with a tenant in perpetuity.

Another ramification of Paikoff is that it virtually eliminates the ability of a sponsor or holder of unsold shares to recover high end apartment units under the luxury decontrol provisions of the rent regulation laws.

Under the Rent Regulation Reform Act of 1997, rent regulated apartments renting for $2,000 or more per month and which are occupied by persons who have a total annual income in excess of $175,000 per annum for each of the two preceding calendar years may, upon application of the owner to the Division of Housing an Community Renewal, be deregulated.¹²

The 1997 Act was already a somewhat watered-down version of its predecessor statute, which was enacted pursuant to the 1993 Rent Regulation Reform Act. Although the income threshold was decreased from $250,000 to $175,000, an owner who has obtained an order of deregulation must now "offer the housing accommodation subject to such order to the tenant as a rent not in excess of the market rent."¹³

The new requirement "to offer the housing accommodation" is woefully vague as to such critical issues as whether the housing accommodation must be offered through a written lease; and, if so, for what period of time and under what terms. Nonetheless, it was presumed that inasmuch as the apartment was no longer subject o rent regulations, that the owner was not required to offer the housing accommodation to the deregulated tenant ad infinitum.

However, in light of the decision in Paikoff, this no longer seems to be the case. Accordingly, although owners of high-end unsold co-op units may finally, throughout luxury decontrol, be able to rid themselves of the undesirable financial effects suffered when there is a shortfall between the owner's maintenance obligations to the co-op and the rent regulated rent (negative carry), these owners will, as a result of Paikoff, be unable to sell these units unless a steep discount is offered due to the fact that there is a tenant in possession.

The decision in Paikoff has various ramifications for cooperative housing corporations. Whereas some holders of unsold shares and sponsors will be more eager to sell their shares so as to avoid the result of Paikoff---a development that most co-op's will welcome---there are those sponsors and holders of unsold shares who will, because of Paikoff, be unable to sell units whose tenants have availed themselves of their newfound Martin Act protection---a result directly contrary to most co-op's unabashed desire to obtain a "sponsorless" building.

In addition, the decision in Paikoff has the potential to drive down prices of apartments owned by other shareholders. For instance, shareholders seeking to sell their apartments may be forced to lower their sales price to meet or beat the price offered by a panicked sponsor or holder of unsold shares who decides, as a result of Paikoff to quickly liquidate any unit which becomes vacant.

Paikoff has been sharply criticized by members of the real estate bar who have pointed out that, in reaching his decision that post-conversion renters were "non-purchasing tenants" under GBL § 352-eeee (e), Judge Finkelstein seemed to ignore the Martin Act's definition of "Purchaser under the plan," which is found in GBL § 352-eeee (d). That definition provides that a purchaser is "[a] person who owns the shares allocated to a dwelling unit or who owns such dwelling unit itself."

Taking into account the above-cited definition of "purchaser under the plan," the detractors of Paikoff claim that there is no reason to believe that a post-conversion sponsor or a holder of unsold shares is not a "purchaser under the plan" pursuant to GBL 352-eeee (d).

In the absence of a basis for removing a post-conversion sponsor or holder unsold shares form the statute's definition of "purchaser under the plan," it is questionable as to whether or not Paikoff would be affirmed on appeal.

Without doubt, the last few months have been incredibly tumultuous for all holders of unsold shares. And their judicial roller-coaster ride is not over. Both Susser and Paikoff have been appealed and it remains to be seen whether they will be affirmed by the appellate courts. Accordingly, holders of unsold shares should continue to hold onto their hats, if not their apartments.

END NOTES

1. See Schechter. "Major Changes in Management and Operation of Cooperatives" 3/23/98 NYLI. 54. Col. 4.
2. See General Business Law (GBL) 352-eeee et.seq.
3. The proprietary lease provisions at issue in Susser provided that "Neither the subletting of the apartment from time to time nor the assignment of the lease by the holder of unsold shares allocated to the apartment shall require the consent of the directors or shareholders."
4. For a co-op's tenant shareholders to obtain "pass through" tax advantages (similar to a private house owner). § 216 of the Internal Revenue code requires that all shares of the co-op be of the same class.
5. Business Corporation Law § 501 (c).
6. In Febland, the offending flip tax differed depending upon whether the assignor was an original purchaser from the sponsor and whether he or she had been an owner for five years of more.
7. GBL § 352-eeee (2)(c)(ii) provides in pertinent part that "No eviction proceedings will be commenced at any time against non-purchasing tenants for failure to purchase or any other reason applicable to expiration of tenancy.
8. See RSC § 2502.5(b)(1).
9. See Schechter, "Major Changes in Management and Operation of Cooperatives 3/23/98 NYLI. 54. Col. 4.
10. See GBL § 352-eeee (2)(c)(ii). Supra.
11. General Business Law § 352-eeee (2)(iv) provides in pertinent part, that "[N]on purchasing tenants shall not be subject to unconscionable increase beyond ordinary rentals for comparable apartments.
12. See RSL § 26-504.3 (b). Emergency Housing Rent Control Law (EHRCL) § 2-a (b); Emergency Tenant Protection Law (ETPA) § 5-a (b); City Rent and Rehabilitation Law (CRL) § 26-403.1 (b).
13. See RSL § 26-504.3(e); EHRCL § 2-a (e); ETPA § 5-a (e); CRL § 26-403.1(e).



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