CO-OP BOARD DENIALS: A GUIDELINE*

© Eric P. Gonchar. All rights reserved. No portion of this article may be reproduced without the expressed written permission of Eric P. Gonchar.

Unfortunately, co-op Board discretionary decisions to approve or deny a Purchaser admission in a coop still exists. Purchasers still face denials for admission to coop buildings. There was a time when many co-op Boards concluded that if a bank would give a prospective buyer a loan, then the Board would consent to the sale of an apartment. Co-op Boards have since become much more concerned and selective about their future neighbors. This article will explore why co-op Boards can deny a Purchaser admission to a co-op and what remedies the Purchaser or Seller may have.

The first concept that all Sellers and prospective owners of a co-op apartment must grasp is that cooperative ownership is inherently different than that of ”fee” ownership whereby the owner has an unrestricted interest in real property. Co-ops were created to promote stability in a building and accordingly a co-op Board can determine who may and may not become a shareholder. Co-op’s can use the scrutiny of reviewing a prospective Purchaser’s applications as a way of protecting the shareholders from those who do not fit the financial and social profile of a building. Unless specifically excepted with exact language in the proprietary lease, a transfer of shares to an apartment cannot take place without Board consent.

Buying an apartment in a co-op requires an invasion into a Purchaser’s financial and social background. A Board will dig through the Purchaser’s bank statements, tax returns, testimonials, recommendation letters, and references which can be hundreds of pages. If the Purchaser passes muster, he or she has access to its protected world. If the Board sifts through that material and decides the Purchaser is not good enough, it is hard not to take the news personally. A Board does not have to give you a reason for its decision — it can reject a candidate for any reason or no reason, so long as it does not legally discriminate. For a scorned buyer, the effect can be discouraging, embarrassing, and baffling. Even in a market that is relatively flat, some Boards and Sellers seem to be flexing their muscles, making demands that might seem unreasonable to potential buyers.

Boards generally reject buyers for financial reasons. But these decisions often do not come down to bank statements alone. Co-ops are vertical neighborhoods with unique personalities and cultures. A Board that is looking for a certain type of person can glean information from financial documents about a candidate’s political leanings, health problems, and even marital strife. There are cases in which it’s a total mystery. The Purchasers have plenty of money and the reference letters are lovely and there is just have no way of knowing if there was something in the past that annoyed a Board member. There is a fine line, however, between maintaining a building’s culture and discrimination, a claim that can be hard to prove.

The “Business Judgment Rule”

It has long been the recognized rule in New York that generally a court will not question the decisions made by a Board of a private corporation. This concept of non­ judicial review has been referred to as the ”business judgment rule.” New York courts have applied the business judgment rule to co-op corporation decisions thereby granting co-op Boards great discretion in deciding whether to approve or deny the sale of an apartment. Co-op discretion has been clarified in a landmark case decided in 1990 entitled Levandusky v. One Fifth Avenue Apartment Corp. The Levandusky case set forth the following guidelines that a co-op must follow in order to withstand the judicial review of the courts: The Board’s actions must be (i) in furtherance of the purpose of the co-op; (ii) within the scope of its authority; and (iii) in good faith.

This three prong test essentially shifts the burden of proof from the defending co­-op Board to the challenging party. The rule set forth in Levandusky does not automatically bar judicial review of the Board action provided the plaintiff can demonstrate that the Board acted for a purpose other than for which the co-op was formed, beyond the scope of its authority or in bad faith. If the plaintiff is successful in meeting this threshold, the court will hear the case and the burden of proof will then shift back to the Board. Seven years later, the courts still look at the Levandusky case as a guideline to shareholder actions against co-op Boards.

In determining if a Board has exceeded its authority, a court will review the co-op’s governing documents for explicit authorization of the Board actions. These documents include the certificate of incorporation, by-laws, and the proprietary lease. Most leases provide that the transfer of shares and lease to a new tenant/shareholder must be made with the consent of the Board. Some leases provide for no approval and, in the event of a denial, the lease should be reviewed to determine if the Board acted beyond the scope of its authority.

If a Board exercises discriminatory practices in its approval process, a court may review improper Board action. If a denial is based on race, creed, color, sex, age, religion or disability, the prospective Purchaser or owner cannot merely allege discrimination but must meet the burden of proof. In the case entitled Simpson v. Berkley Owner’s Corp., the Appellate Division of New York determined that, absent illegal discrimination, the co-op Board has the right to deny a prospective shareholder’s application for a purchase of an apartment for “any reason or no reason.” In this case, the co-op’s denial of a purchase application was upheld. The court stated that unless the plaintiff could submit evidence that the Board did not act in the best interests of its shareholders, the court need not review the case. The Simpson case puts a tremendous task on the prospective Purchaser if he or she feels that such denial was discriminatory: obtaining sufficient evidence that the Board’s actions were predicated on a discriminatory practice. The burden of establishing discrimination by a claimant can be time consuming and very costly.

A Board can determine, in its own discretion, whether the application of a prospective Purchaser did not reflect that he or she can meet the financial obligations of owning a co-op apartment. In addition, a Board can decide if the Purchaser intended to occupy the apartment or if  the Purchaser intended to merely invest in the apartment and sublet it. While a Purchaser may believe there are discriminatory overtones, the reality is that co-op Boards do not have to disclose why a prospective Purchaser has been denied admission.

The “good faith” element of the three prong Levandusky case focuses on the fiduciary relationship between the co-op Board and its shareholders. Similar to discrimination cases, when bad faith is alleged and backed by solid evidence, the courts will review the Board’s actions but such review will not guarantee the outcome of the case.

In summary, the Levandusky case continues to act as a shield protecting co-op Boards against judicial scrutiny of valid Board actions by referring to the business judgment rule. A co-op Board, absent any contrary clause in the lease, can deny the approval of a new tenant/shareholder without reason provided it is not discriminatory or that the Board acted beyond the scope of its authority. Many prospective Purchasers swallow their pride after a co-op Board denial and move on. Most feel that it is not appealing to sue the people that you may be sharing a home with and most do not pursue the purchase of a co-op once denied. For the owner, the harm may be even greater: after making plans to move, taking the apartment off the market for weeks and many times, months, possibly even entering into a contract to purchase another home, the Seller must start the process all over again with no remuneration.

Conditional Approvals

Many co-op Boards have imposed additional financial conditions as a prerequisite to approving the sale of an apartment. Typically, a co-op Board will impose a financial condition on a prospective Purchaser when there is concern about the buyer’s ability to pay for the maintenance and the carrying charges of a loan. As previously pointed out, New York law allows a Board to restrict a sale provided that any additional conditions are not made in ”bad faith” or are not discriminatory. The three most frequent conditions imposed on prospective shareholders are: (i) a deposit or “escrow” of monies to be used in the event that maintenance in not paid; (ii) a guaranty from a relative or third party to insure maintenance is timely paid;  and (iii) insisting that the Purchaser reduce the amount of money being borrowed so as to reduce monthly carrying costs.

The standard form of contract of sale for a co-op apartment used by most attorneys is one which is published by Blumberg and developed by the Committee of Condominiums and Cooperatives of the Real Property Section of the New York Bar Association. This contract provides, in part, that the sale of the apartment is contingent upon the unconditional approval by the co-op corporation. As stated above, some co-op Boards will place additional conditions upon their approval of a Purchaser. In such circumstances, this additional “conditional” approval gives the Purchaser the right to cancel the contract if the Purchaser does not want to meet the demands of the Co-op.

1. Placing Funds in Escrow– The Co-op may require a prospective Purchaser to place funds in escrow with the co-op. The amount varies but usually totals between one and three years of maintenance. These funds are used in the event the Purchaser fails to make the maintenance payments or if legal action is commenced against the Purchaser. The funds are usually held in a non-interest bearing account without a time expiration other than the sale of the apartment when the funds are returned. Some co-op’s allow the Purchaser to apply for the return of the funds after one or two years of consistent maintenance payments.
2. Personal Guaranty –  The Board may condition its approval to purchase an apartment on the receipt of a written guaranty of maintenance. This guaranty usually is provided by a family member. But Purchasers should be careful with this option as most likely the guaranty may have to supply a complete financial summary with tax returns and bank statements.
3. Reduction of Loan Amount – If financing is involved in the purchase, the Board may insist that the Purchaser reduce the amount of the loan the Purchaser intends to secure in connection with the Purchaser of the apartment. This would reduce the amount of the monthly loan payments made by the Purchaser.

The Board can impose any combination of these three conditions or all of them. If a Purchaser has been denied for no apparent reason and still wants to try to purchase the apartment, the Seller can appeal to the Board to reconsider the Purchaser’s application by offering one or more of the conditions. If, however, the Purchaser agrees to meet these conditions for approval, the Seller should obtain an agreement in writing from the Purchaser to confirm the Purchaser’s agreement to the additional co-op requirement(s). Unless the Purchaser can or does not want to meet these additional requirements, the Purchaser will have the right to cancel the contract and can obtain a refund of his or her down payment.

If a Seller is concerned about the financial condition of the Purchaser upon acceptance of an offer, the Seller can insist that the contract contain a provision that the Purchaser will agree to place money in escrow with the co-op, provide a guarantor or reduce the loan amount.

It is prohibited for a co-op to impose unique restrictions on different Purchasers. If a properly adopted co-op by-law or resolution imposes financial conditions, such as limiting the amount a Purchaser can finance to purchase an apartment or requiring a prospective Purchaser to prepay maintenance, such a policy is acceptable provided these conditions apply to all shareholders and/or prospective Purchasers. However, New York courts have prohibited two types of financial limitations imposed by co-ops, even if they apply equally to all shareholders: A co-op cannot require that sales be approved only if the shares are sold for a minimum price nor can a co-op require that a shareholder settle all claims or litigation with the co-op before the Board approves the sale of an apartment.

In 1995, a New York court determined that a co-op Board cannot set a minimum sales price policy stating that such a rule was outside the scope of a Board’s authority and that it was an unreasonable restraint on the transfer of apartments. While the co-op set this rule to protect the value of the property and contended the decision to set minimum sales prices was protected by the Levandusky case, the court held that the co-op overreached its authority.

As seen above, the co-op corporation can be a third-party influence to a contract of sale. Even though the co-op is not a party to the contract, it can adversely influence the outcome of the transaction. Accordingly, since the standard contract prohibits any changes to the contract unless they are in writing, if the co-op imposes additional conditions which the parties do not agree to in writing, the Purchaser will have the right to cancel the contract.

Delays in Approvals

In some cases, the problem with co-ops is not a denial of a Purchaser’s application to purchase an apartment, but delays in meeting and approving the Purchaser. The standard contract of sale provides that if a co-op Board has not made a decision to approve or deny a Purchaser by the closing date set forth in the contract of sale, the closing is automatically postponed for thirty business days for the purpose of obtaining Board approval. If the approval is not obtained by the postponed date, either the Seller or the Purchaser has the right to cancel the contract.

Frequently, the Purchaser does not desire to cancel the contract when there is a delayed interview. Since the Purchaser has no contact with the co-op (the Purchaser is not a shareholder), it is essentially up to the Seller to inform the co-op of the possibility of losing the sale due to any further delays by the co-op Board. 

A Purchaser’s attorney may want to write a letter to the Seller’s attorney that provides that in the event a co-op meeting is not scheduled within a certain time frame, the Purchaser will exercise the right to cancel the contract. The Seller’s attorney can then provide this letter to the co-op requesting that an interview be set up before the Board causes the transaction to fold.

Pre-emptive Tactics

Some co-op Boards allow for pre-approval of a shareholder before the contract is signed. There are several white glove buildings that may offer a preliminary interview and financial review before the contract is negotiated and executed. This practice allows the Purchaser to obtain a better understanding if the co-op will allow the transaction to proceed and saves the Purchaser from the expense of legal fees associated with a fully negotiated contract and application fees. But more importantly, it saves the Purchaser from an unwanted and embarrassing Board turndown. A Board denial may act as a ‘scarlet letter’ for future purchases by the buyer. Many contracts contain a representation that the Purchaser has never been denied by a co-op which could be a red flag for a Seller when disclosed in a contract.

Good Faith

The contract provides that a Purchaser must act in good faith when purchasing a co-op apartment. If the Purchaser falsely represents his or her financial status one way prior to contract signing and submits a Board application another way and is denied, the Seller may have grounds to claim a default and retain the down payment. Furthermore, a Purchaser cannot knowingly try to obtain a Board turn down at an interview. If a Purchaser is denied due to his or her actions in actions at an interview and is denied, the Seller may have grounds to claim a default and retain the down payment and is denied, the Seller may have grounds to claim a default and retain the down payment. Of course, in such circumstances, the Seller will need to prove these claims. But until then, the Purchaser’s down payment will most likely stay tied up in escrow until the matter is resolved or settled.

Conclusion

Co-op corporations continue to decide for themselves with whom they wish to share their homes, common areas, meetings, rules and responsibilities provided that such ownership is not discriminatory. New York courts have always given Boards great discretion in deciding to approve or deny the sale of apartments. The courts will impose parameters limiting Board discretion if there are discriminatory practices and more and more cases are being heard scrutinizing this discretion.

*DISCLAIMER. Nothing herein is offered as legal advice. All information in this article is for informational purposes only. Please consult with an attorney before taking any legal actions.