By Edward T. Braverman and Kenneth s. Grau

Edward T. Braverman and Kenneth S. Grau are partners at Braverman & Associates, P.C., a Manhattan law firm that specializes in cooperative and condominium housing law.

Julius Blumberg has been printing forms for the general practitioner for some 100 years. The new and improved "Contract of Sale --- Cooperative Apartment" (M-123) has greatly simplified life for the practitioner representing as co-op purchaser. The revised form goes far in creating a fair transaction between purchaser and seller, and covers substantially all of the important aspects of a cooperative transaction. However, the general practitioner must remain vigilant as to the many other important aspects of a cooperative transaction, lest his client consummate an ill-conceived purchase.

Of course, the initial consultation with the client should include the pertinent details of the transaction such as purchase price, amount to be financed, address, apartment number, closing date, maintenance, flip tax liability, assessments, etc. However after the basics are on paper, the practitioner's important work begins---due diligence.

It will be up to the practitioner to hone in on the important aspects of the cooperative that interest his client:

• The physical condition of the property
• The financial condition of the property
• The restrictions placed on the use and occupancy and subsequent transfer of the apartment unit; and
• The quality of life to be expected.

Investigation (due diligence) should start with a pre-arranged visit to the building's managing agent to review co-op minutes and financial statements. Other documents which should be reviewed by counsel include the cooperative's proprietary lease, bylaws and certificate of incorporation, as well as any amendments to these documents. If the building in which the client is interested was recently converted to the cooperative form of ownership, the attorney should also focus attention on the cooperative offering plan and all its amendments.

In reviewing these documents, the attorney should focus on any information pertaining to the physical condition of the building, the financial condition of the cooperative, and restrictions governing use, occupancy and transfer of apartments.

The minutes of at least the three most recent years of board meetings and annual shareholders meetings should be read and reviewed, with special attention directed to comments that would impact on the advisability of purchasing the apartment in question or, for that matter, any apartment in the subject building. Attention should be focused on such items as roof, façade, window replacements, security systems, mechanical systems, asbestos removal, elevator replacements and problem tenants (especially those surrounding the apartment to be purchased).

If the minutes make reference to any engineering reports, the practitioner should review these reports to the extent they are available. Close attention should also be paid to financial problems which the co-op may be experiencing, such as substantial maintenance arrears or problems under § 216 of the Internal Revenue Code (the Code provision providing pass-through deductibility of real estate taxes and mortgage interest).

In reviewing the minutes, the practitioner should bear in mind that these documents actually contain signposts for what may be happening or restrictions which will be enacted by the co-op in the future. For example, the minutes may very well indicate whether or not the board is considering the imposition of an assessment, maintenance increase or "flip tax" (transfer fee and/or sublet fee. Substantial increase in carrying costs for the apartment typically diminish the value of the unit.

As previously noted, the practitioner should also review the proprietary lease which sets forth the respective rights and obligations of the cooperative corporation and the shareholder. Special attention should be paid to those provisions pertaining to the sale, subletting and alteration of units as well as those provisions dealing with the scope of repaid obligations imposed on the parties.

The attorney should review and forward to the client a copy of the house rules for the building which are almost always annexed to the proprietary lease. The attorney should also briefly review the bylaws and certificate of incorporation to ensure that these documents do not contain any unusual conditions which would impact upon a prospective purchaser.

FINANCIAL DOCUMENTS

The practitioner should obtain and review at least the last two years financial statements. These documents can provide invaluable information as to present and future expenses. Attention should be paid to any tax incentive which the co-op is currently enjoying: its commercial income; the amount of reserve funds; and the principal amount, interest rate and maturity date of the underlying mortgage. Dramatic increase in the cost of building system repairs, such as plumbing, boiler, roof and façade, are a clear indication of the need to replace major portions of the building with its concomitant expense and the possibility of an assessment for the client.

Budgets should be carefully examined as well to ensure that the building is not keeping maintenance charges at an artificially low level by using reserve funds or yearly assessment to cover day-to-day building operations.

The attorney should be particularly cognizant of any indication that the building does not qualify as a "cooperative housing corporation" under § 216 of the Internal Revenue Code. Failure to so qualify results in significant adverse tax consequences to the shareholders of the apartment corporation, including loss of deductibility of the building's mortgage interest and real estate tax deduction, loss of tax-free rollover treatment under Code § 1034; loss of the personal interest deduction on the end loan mortgage; loss of the $125,000 exclusion for shareholders 55 and older pursuant to Code § 221; and the possible imposition of substantial interest and penalties.

Such quality of life issues as the commercial tenancies in the building must be examined. The client may not wish to reside in a building which will also house food vendors, high-volume retail outlets, dry cleaners and those who use x-ray equipment. The issue of the personal security of each tenant should also be explored.

If the conversion to cooperative ownership has not yet been fully completed, special attention should be paid to the most recent amendments to the plan to determine the extent of sponsor and/or investor ownership, and the number of units that are not currently owner-occupied. The practitioner may have to obtain some of this information from the managing agent.

If the building is one in which the sponsor or investor still has substantial holdings, the attorney should focus on the financial condition of the sponsor and investor entity, and what control, if any, he has over the operation of the building, as well as special rights reserved to such entities. These factors may prove important vis-à-vis refinancing, the building's underlying mortgage when that time comes or, for that matter of the client to obtain an end loan for the unit in question.

After a review of the formal technical documents, the practitioner may be well-served to have a short informal discussion with the building's managing agent, super or other tenants residing in the building. He should also suggest that this client consider retaining a qualified engineer to inspect the apartment and accessible public areas of the building and issue a written inspection report.

CONTRACT OF SALE

The seller's attorney typically prepares the contract of sale. The Blumberg "M-123" form has become almost universally accepted for this transaction. Its provisions are generally evenhanded and need few modifications. However, the practitioner may wish to fine-tune the document through a rider. The following points are suggested areas to cover without becoming overbearing.

§ Seller's attorney should be obligated to provide proof of timely payment of all applicable transfer taxes.

§ The tenant/shareholder should be held responsible under the proprietary lease for the upkeep and maintenance of appliances and systems within the apartment.

§ Representation by seller that neither seller nor seller's predecessor-in-interest has made any alterations to the unit without complying with all codes, laws, rules and regulations which may bear upon such alteration.

POST-CONTRACT MATTERS

Promptly after the execution and delivery of the contract of sale, the practitioner should order a lien and judgment search with respect to the seller, the cooperative corporation and the building, with a request for a continuation to be supplied at closing.

In addition, cautious counsel may wish to consider the availability of leasehold title insurance for cooperative apartments, and the appropriateness of recommending that the client obtain it.

The client should promptly submit a purchase application package (including all required supporting documentation) to the co-op's managing agent, as well as a loan application to a lender, within the time prescribed by the contract of sale. The prudent attorney should have the client obtain receipts for these submissions, evidencing proof of timely compliance.

Should the purchase application not be approved or purchaser fail to obtain a loan commitment within the time prescribed in the contract of sale, immediate notification, in accordance with the contract, should be given to the seller so as to ensure the return of the contract deposit.

If the purchase application is approved and the loan commitment is obtained, the practitioner should then establish a firm closing date after conferring with the client, seller's counsel, managing agent and client's lender's counsel. Prior to the closing, the practitioner should obtain copies of the city and state transfer tax returns from seller's counsel and review them to confirm that they are appropriately completed.

It is most important to keep in mind that the purchaser has secondary liability for failure to make payment of any city and state taxes which seller fails to pay. For those transactions involving a purchase price of $1 million or more, the purchaser will be required to pay the New York State "mansion" tax in an amount equal to one percent of the sales price.

Counsel should advise the client to inspect the unit within 24 hours prior to closing to assure that the unit is in the condition required by the terms of the contract. The client should also be advised to have insurance (both personal property and general liability coverage) in effect as of the date of closing.

The managing agent should be advised as to the manner in which the purchaser will take title (tenants-in-common, joint tenancy or, effective Jan. 1, 1996 tenants by the entirety).

Closings are generally held at the office of the managing agent of the cooperative. The managing agent prepares most of the closing documents, including the co-op's consent to the transfer; assignment and assumption of proprietary lease and/or new proprietary lease; stock power; and new stock certificate. All closing documents, including those prepared by purchaser's lending institution, should be reviewed to assure compliance with the "business terms" of the transaction. Appropriate apportionments should be made for maintenance and assessments, where applicable.

Of course, the client's lender will prepare the security agreement, UCC-1's assignment in blank, stock powers in blank, and recognition agreement all of which will secure the advance made to the client. If the seller is paying off a loan at closing, a representative of his lender will be present to deliver UCC-3's (terminating the lease liability of the seller's lender), the original stock certificate and proprietary leases previously issued to seller.

The attorney should ensure that at post-closing obligations of seller, if any, are performed and that all required taxes have been paid. As soon after the closing as may be practicable, a closing statement summarizing the transaction should be supplied to the client for his future reference and for that of his accountant.

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