Many cooperatives and condominiums have overlooked, for decades, potent statutory rights enabling them to recapture building amenities currently under long-term, unfavorable leases with their developers. Because those rights were first promulgated during the 1980s’ cooperative and condominium conversion boom, they are often discounted as stale or forgotten altogether. But recent litigation may offer new hope for deploying those robust rights.
It All Started With Simple Supply-and-Demand. In the late 1970s, housing demand surged as the real estate market was flooded with “baby boomers,” divorcees, and the elderly. Rather than meet demand with new housing, developers converted existing rental properties to cooperative and condominium status. (U.S. Cong. House Comm. On Gov. Operations, Hearings on Condominium and Cooperative Conversion: The Federal Response (Part I), 97th Cong. First Sess. (March 30, 31, and April 1, 1981)). And in the process, many developers exploited their initial control over these newly-formed entities, carving out for themselves and their affiliates long-term leases of profitable on-site amenities (e.g., parking garages, laundry facilities)—often on self-serving, “sweetheart” terms.
In 1980, the U.S. Congress enacted the Condominium and Cooperative Protection and Abuse Act (15 USC 3601 et seq.) (Abuse Act) to “prevent specific abusive practices…in the cooperative and condominium process…particularly…‘sweetheart’ lease arrangements and self-dealing contracts.” Darnet Realty Assocs. V. 136 East 56th Street Owners, 214 F.3d 79, 81 (2d Cir. 2000). It armed cooperative shareholders and condominium unit owners with a “potent weapon”—i.e., “the federal right to terminate self-dealing leases without having to resort to judicial action.” 181 E. 73rd St. Co. v. 181 E. 73rd Tenants, 954 F.2d 45, 47-48 (2d Cir. 1992) (emphasis added). Through the Abuse Act, Congress sought to level the playing field by crafting a mechanism through which cooperatives and condominiums could terminate qualifying “sweetheart” leases and recapture valuable amenities in their own buildings.
Not All Leases Were Created Equal. To be sure, not all leases are terminable under the Abuse Act. To qualify, a lease must: (1) have been executed after Oct. 8, 1980; (2) cover property that “provides for operation, maintenance, or management of” a cooperative/condominium or serve its constituents; (3) be between a cooperative/condominium and its sponsor-developer; (4) have been entered into while the cooperative/condominium was under “special developer control or because the developer held a majority of votes;” and (5) exceed a term of three years. 15 U.S.C. 3607(a). Only if all these pre-conditions are met does the law endow cooperative shareholders and condominium unit owners with Abuse Act termination rights.
Sounds Great. What’s the Catch? There is no catch. But qualifying leases may be terminated only during a narrow and ill-defined two-year window beginning from the earlier of when the developer (a) loses “special developer control” in the project, or (b) ceases owning more than 25 percent of the units in the project. 15 U.S.C. 3607(b). Yet, while the plain language of the statute strikes a discouraging note for buildings of older vintage, even leases dating back to the 1980s may still be eligible for termination.
‘Special Developer Control’ Does Not Equal Board Control. The developer’s loss of “special developer control” is one trigger for the opening of the Abuse Act’s two-year termination window. But what is “special developer control” and when is it lost?
While one could well imagine any number of specific indicia of developer control that might qualify—including simple board majority—the statutory definition of “special developer control” is expansive, embracing “any right arising under state law, cooperative or condominium instruments, the association’s bylaws, charter or articles of association or incorporation, or power of attorney or similar agreement through which the developer may control or direct the unit owners’ association or its executive board.” 15 U.S.C. 3603(22) (emphasis added); 305 E. 40th Garage v. 305 E. 40th Owners, 833 F. Supp. 991, 999 (S.D.N.Y. 1993). That’s quite broad.
Indeed, long after losing their formal grip over a project, developers often retain the right, under the project’s governing documents, to veto amendments to cooperative and condominium bylaws. And that power alone may constitute “special developer control.” See, e.g., Darnet Realty Assocs., 214 F.3d 79. The key inquiry is whether the developer “retain[s] significant clout” over building affairs. Darnet Realty Assocs. v. 136 East 56th St. Owners, 153 F.3d 21, 27 (2d Cir 1998); if it does, “special developer control” has not been lost.
When Does a Developer Hit the 25 Percent Ownership Threshold? If not triggered by the loss of “special developer control,” the Abuse Act’s two-year termination window opens when the “developer” ceases to own more than 25 percent of the project’s “units.” 15 U.S.C. 3607(b)(2). Here, too, the statute embraces more than meets the eye.
Easily enough, the Abuse Act itself defines “developer” to include not only the developer but also any “successor” to the developer who “offers to sell or sells his interest in units in a cooperative or condominium project and who has the authority to exercise special developer control.” 15 U.S.C. 3603(14)(B). So purchasers of developer-owned units who retain developer perks (i.e., “holders of unsold shares”)—including any form of “special developer control”—might qualify as “successors,” and, by extension, constitute “developers” for purposes of calculating the percentage of developer-owned units. 305 E. 40th Garage, 833 F. Supp. at 995). And while broad indeed, such a “liberal interpretation of the term ‘successor’…comports with the act’s goal of protecting the individual tenant/owner.” 305 E. 40th Garage, 833 F. Supp. at 995).
But that “liberal interpretation” does not mean that mere “holder of unsold shares” status alone is sufficient to qualify as a developer “successor.” There must also be some bona fide nexus between the developer and the “holder of unsold shares” such that the latter shares some interest in the developer’s self-dealing lease. 136 E. 56th St. Owners v. Darnet Realty Assocs., 1999 U.S. Dist. Lexis 970, *18-20 (S.D.N.Y. 1999); Darnet Realty Assocs., 214 F.3d at 85. Perhaps this proviso—coupled with the fading prospects of establishing continued “special developer control”—has discouraged cooperatives and condominiums from pursuing Abuse Act termination, as the dearth of recent litigation on the issue suggests.
Notice—And the (Unsettled) Consequences of a Developer’s Failure to Provide It. Despite the apparent dormancy of the Abuse Act, however, one recent litigation may offer cooperatives and condominiums new hope for revisiting their termination rights.
Aware of the potential for cooperatives and condominiums to miss the narrow two-year termination window—either because it is so ill-defined or because information necessary to calculate it is often unavailable—the New York State Attorney General has long required developers to disclose to shareholders or unit owners their Abuse Act termination rights and the two-year window limitation. (New York State Attorney General, Condominium and Cooperative Abuse Relief Act of 1980 (Jan. 15, 1985)). Indeed, to comply with those directives, many developers include in their projects’ governing documents an undertaking to provide such notice to affected shareholders or unit owners. And, more recently, New York General Business Law 353-e was amended, effective Aug. 30, 2010, to obligate developers to incorporate robust notice provisions into cooperative and condominium governing documents New York State Attorney General, NY GBL Amendment on Self-Dealing Contracts (Oct. 1, 2010).
These notice requirements are a welcome protection for cooperatives and condominiums, but what are the consequences of a developer’s failure to provide such notice? Does it simply give rise to a claim against the developer for money damages, or, under equitable doctrines, does it toll the two-year termination window? New York courts have yet to address this question squarely, but a recent case, Sutton Associates v. Sutton Gardens Owners (Supreme Court, New York County, Index No. 654531/2017), could provide useful guidance.
Sutton Associates was a textbook Abuse Act termination case—except for timing. While the subject lease (for the building’s profitable indoor garage) met all statutory pre-conditions, termination would have become effective around 10 days after the two-year window otherwise closed. The cooperative nonetheless proceeded to serve notice that it was terminating the garage lease under the Abuse Act, and litigation ensued: the developer sought a judicial declaration that the termination was untimely, and the cooperative counterclaimed for a judicial declaration that termination was timely.
While the cooperative’s termination may have been otherwise untimely, more than 30 years earlier, in 1985, the developer had amended its offering plan and agreed that, “to permit tenant-shareholders to know when any [termination] right [under the Abuse Act] matures…the sponsor will send a notice to all tenant-shareholders within 15 days after…‘special control’ is terminated, or when the sponsor…ceases to own more than 25 percent of the apartment units, whichever occurs first.” But the developer never sent such notice.
Following discovery and the court’s denial of dueling summary judgment motions, the parties ultimately reached a settlement on the eve of trial. The court did not have occasion to rule on the consequences of the developer’s failure to give the agreed-upon notice, but the settlement terms (highly favorable to the cooperative) bespeak the very real prospect that the lack of notice would have tolled the termination window and exposed the developer to the risk of immediate termination of its “sweetheart” lease.
The Sutton Associates case thus offers optimism to cooperatives and condominiums that may have overlooked Abuse Act rights, particularly if their governing documents contain developer notice obligations.
Even as it nears its Ruby anniversary, the Abuse Act remains underutilized and often misapprehended. But given the uncertain consequences of a developer’s failure to give required notice, cooperatives and condominiums would do well to revisit the Abuse Act and their own governing documents. Those that do might be surprised to learn that they are not out of time and not out of luck.
Ethan A. Kobre is a commercial litigation partner, and Milad Boddoohi a real estate litigation associate, with Schwartz Sladkus Reich Greenberg Atlas, counsel to the defendant in the referenced ‘Sutton Associates v. Sutton Gardens Owners’ litigation.