Condominiums—Plaintiff Alleged That Sponsor Failed to Sell Unsold Units and the Special Risks Section of the Offering Plan Did Not Disclose the Risk That the Sponsor Would Retain the Units as Rental Units—Breach of Contract and Breach of the Implied Covenant of Good Faith and Fair Dealing Claims—Rental Tenants Allegedly Increased Electric Charges and Wear and Tear in the Building—’511 W. 232nd Owners Corp. v. Jennifer Realty’ Applicable to Sale of New Construction Condominiums—Case Law Does Not Define What Constitutes a Viable Condominium or Cooperative

The plaintiff had purchased a condominium in a newly constructed building in 2002. The sponsor had filed an offering plan (plan) with the NYS Department of Law (AG) pursuant to which it offered for sale 65 residential units. One unit was reserved for the resident manager. The plaintiff alleged that the plan included “an implied promise” that the sponsor would “sell all unsold units within a reasonable time.” The complaint also alleged that the “special risks” section of the plan “did not disclose that there was a risk that [the sponsor] would retain the unconditional right to rent rather than sell units.” The plaintiff further alleged that the sponsor had “not filed any amendments to the [plan] since April 4, 2004, [had] allowed the [plan] to lapse, and [had] not sold any of the units that were unsold on that date but [had] instead leased many, if not all, of the unsold units.”

The plaintiff argued that the sponsor’s failure to sell the unsold units “defeated the primary purpose of the contract which was to allow for the timely sale of a sufficient number of units so as to create a fully viable condominium and to turn control of the condominium board over to the plaintiff and the other units owners.” Such conduct allegedly undermined the plaintiff’s “ability to sell her units, discouraged lenders from offering reasonable financing or refinancing terms and caused plaintiff’s and other unit owner’s common charges to increase.”

The plaintiff also asserted claims “derivatively on behalf of the other unit owners….” The plaintiff demanded $1 million, a judgment directing the sponsor to fully perform its contractual obligations and a declaratory judgment that the sponsor was “in default of its obligations under the [plan]; and an injunction directing [the sponsor] to immediately file amendments to the [plan], directing [the sponsor] to offer all unsold units for sale immediately, directing [the sponsor] to sell all unsold units within a time provided by the court, and directing [the sponsor] and its members to relinquish any seats held on the condominium board.” The sponsor moved for summary judgment dismissing the complaint. “To the extent that any of plaintiff’s claims survive dismissal, [the sponsor] also [moved] for an order consolidating this action” with other related litigation.

Additionally, the sponsor sought a protective order against disclosure of “confidential” business information. The plaintiff cross-moved for summary judgment and to amend her complaint “to allege that a pre-litigation demand made upon the condominium’s board of directors, if required, would have been futile.”

The sponsor asserted that of the 64 residential units originally offered for sale, 35 had been sold and the remaining 29 units were now rental units. The sponsor alleged that between 2002 and 2005, units were sold at between $1 million and $5.7 million dollars and units had recently been sold or refinanced. The sponsor acknowledged that the plan is not current and it is not currently offering “any residential units for sale, although it may resume selling activity in the future by making the appropriate filings.”

The plaintiff alleged that the plan did not disclose that the sponsor had “the unfettered right to stop the sale of units” and to instead rent the units. The plaintiff claimed that she would not have purchased if such disclosure had been made. She also alleged that “[the sponsor], not the owners, retains control over the condominium through its retention of large block of units” and the presence of rental tenants resulted in a $100 increase in the monthly electric charges and additional “wear and tear in the building.” The plaintiff further alleged that “the sponsor and various board members were late in paying common charges but were not charged late fees whereas plaintiff has routinely been charged a $1,000 per month late fee.”

A prior Appellate Division decision held that an offering plan between a cooperative sponsor and purchasers is a “contract, the purpose of which is to sell apartment units within a building so as to form a stable cooperative….” The Appellate Division had held that “the sponsor made an implied promise within the [plan] to sell unsold units within a reasonable time and that the sponsor’s failure to do so gave rise to a viable breach of contract claim by the co-op board and tenant-owners against the sponsor.” The Court of Appeals affirmed such Appellate Division decision, but noted that “it was addressing only the sufficiency of the breach of contract cause of action, not its merits” (511 W. 232nd Owners Corp. v. Jennifer Realty) (Jennifer Realty). The Court of Appeals further explained that the implied covenant of good faith and fair dealing was “especially critical in cooperative conversions ‘because purchasing tenants and sponsors do not deal as equals in terms of access to information or business acumen and thus, tenants often lack equal bargaining power’….”

In December 2006, the A.G. issued regulations in response to the foregoing litigation. The regulations require that “offering plans for newly constructed, vacant or non-residential condominiums disclose whether the ‘sponsor is reserving the right to rent rather than sell units and whether sponsor is limiting its right to rent rather than sell based on objective criteria, such as a significant decline in market prices of a specific percentage and the conditions upon which the sponsor will resume sales.’ If the sponsor is reserving an unconditional right to rent rather than sell, the cover of the [plan] must state in bold print ‘Because Sponsor is retaining the unconditional right to rent rather than sell units, this plan may not result in the creation of a condominium in which a majority of the units are owned by owner-occupants or investors unrelated to the sponsor.’ The regulations also require the [plan] to disclose, in the special risks section,” that the sponsor may rent units and there “is no commitment to sell more than the 15 percent necessary to declare the plan effective….”

The sponsor argued that Jennifer Realty was inapplicable “to new construction condominiums because the concerns” cited by the Court of Appeals “regarding rent stabilized tenants surrendering their stabilized rights in exchange for shares in a converted cooperative” are inapplicable “to someone purchasing million dollar condominiums like those in the [subject] building.” The sponsor further asserted that the alleged “implied promise to sell all units within a reasonable time is contradicted by the express terms of the [plan],” wherein the sponsor reserved its right to rent units. The special risk section of the plan stated that the “[s]ponsor has reserved the right to rent or lease any Residential Unit prior to closing the sale thereof to the Purchaser thereof or any other party and residents of the Condominium may by [sic] comprised of both Unit Owners and tenants leasing from Sponsor.”

The plan also provided that “there will be a greater number of visitors to the Residential Unit while the sponsor is offering unsold units for sale or lease than would normally be the case and ‘[n]o representation of warranty is made and no assurance is given as to when such selling and leasing activity will terminate.’”

The court found that Jennifer Realty was applicable to the subject plan. Jennifer Realty held that a valid cause of action for breach of contract had been stated, but did “not hold as a matter of law that there is an implied promise on the part of all cooperative sponsors to sell enough units so as to create viable cooperatives.”

The plan did not reserve to the sponsor, the “unconditional and unqualified right to rent residential units in the building. Rather, [the sponsor's] right to rent units [was] expressly limited by…the Special Risk section of the [plan] which gives [the sponsor] the right to rent the 64 units offered for sale by the [plan] only until the close of sale of the units.” The court opined that “implicit in the [plan] [was] a promise by [the sponsor] that it would, in good faith, endeavor to sell all 64 residential units…and would retain the right to lease only until such time as all units were sold.” The court stated that the plan language could not be interpreted “as a warning to unit purchasers that [the sponsor] would retain a significant number of units for lease at market rates and not offer them for sale.”

The court further explained that “[w]here, as here, there is no express provision in an offering plan reserving to a…sponsor the unconditioned right to rent residential units, an implied promise on the part of the sponsor to create a viable condominium ‘embraces the pledge’” that no party which will have “the effect of destroying or injuring the right of the other party to receive the fruits of the contract….” The court believed that such holding comports with the A.G.’s regulations which, “although not in effect when [the sponsor's] plan was drafted, is nevertheless instructive on the question before the court.” “The regulation, which is entitled to deference…sets forth the [A.G.'s] position that any condominium sponsor wishing to retain an unconditional right to rent must do so explicitly and unambiguously in the special risks section of the offering plan.”

The sponsor’s managing member had admitted that the sponsor “breached its implied duty to timely sell all the units in the building when it stopped offering units for sale and allowed the offering plan to lapse.” The issue then was whether the sponsor’s “breach by its retention of 29 units for rent so undermined the offering plan that its fundamental objective—the creation of a viable condominium—was subverted.” Case law did “not define what constitutes a viable condominium or cooperative.”

The Jennifer Realty complaint had alleged that because “most of the apartments were rented rather than owner-occupied, many transients lived in the building thereby causing it increased wear and tear and forcing the cooperative board to charge even higher monthly maintenance fees.” Thus, the court found that “in order to make a prima facie showing that the condominium is not viable plaintiff must establish that [the sponsor's] retention of a minority of residential units for lease frustrated plaintiff’s ability to resell her units, interfered with plaintiff’s ability to obtain favorable financing terms and caused wear and tear to the building for which plaintiff has had to pay increased common charges.”

Here, the sponsor had submitted an affidavit which established that “less than half of the residential units in the building are currently being leased” and “residential units have recently been sold or refinanced.” The court found that the plaintiff “[failed] to raise a triable issue of fact.” The plaintiff did not establish that she was unable “to obtain favorable financing terms because of [the sponsor's] failure to sell all of the residential units,” nor did she establish that she was unable to sell any of her three units. The complaint revealed that the plaintiff had been “able to sell two of the three units she originally purchased, albeit at an alleged loss, in 2003….”

The court found that the wear and tear and increased electrical charge allegations were “conclusory and speculative.” Moreover, since “a majority of the units are tenant-owned, the owners have the ability, should they so choose, to gain effective control and management of the condominium through the condominium board.” Additionally, the plaintiff’s attorney’s affidavit lacked “probative weight and [could not] raise a triable issue.” Thus, the plaintiff had “failed to raise a triable issue of fact in response to [the sponsor's]” submissions.

The court then dismissed the plaintiff’s breach of contract claim based on alleged damages to the building’s common elements since the plaintiff lacked standing to seek damages for injury to a building’s common elements. The “condominium board has the exclusive authority to enforce rights related to common elements….” Additionally, the proposed amended complaint failed to set forth “with the required particularity circumstances from which it could be concluded that a demand by plaintiff upon the condominium board to require [the sponsor] to sell the unsold residential units would be futile….”

In New York, “a demand would be futile if the complaint alleges with particularity that (1) a majority of the directors are interested in the transaction, or (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction, or (3) the directors failed to exercise their business judgment in approving the transaction….” The amended complaint alleged that “[the sponsor's] principal is interested in the transaction and that [two other directors were] interested because [the sponsor had] conferred unique benefits on them, including the waiver of late fees for common charges.”

The court noted that “[a] charge of interest must be made with particularity and simply making conclusory allegations of wrongdoing or control, like the ones found in plaintiff’s amended complaint, is insufficient to circumvent the requirement of demand….” The court further stated that although it may “be assumed that [the sponsor's principal] is interested in the transaction…, plaintiff’s conclusory allegations with respect to [the other two directors] do not state with the requisite particularity that they are interested in the transaction or so controlled by [the sponsor] so as to make a demand futile.”

Moreover, the amended complaint “failed to plead with the requisite particularity that the members had specific information or reason to inform themselves of [the sponsor's] failure to sell all units in the building.” The court stated that “[t]he nonspecific allegation that the board members failed to inform themselves of the transaction because the issue was never brought up or discussed at a board meeting is insufficient….”

Finally, the court stated that “[a]llegations that the board failed to exercise its business judgment” by permitting the condominium “to pay for repairs within units owned by [the sponsor] or for failing to take action against [the sponsor] for its failure to obtain a certificate of occupancy or by allowing the condominium to assess fines against plaintiff [were] irrelevant on the issue of whether the board should have required [the sponsor] to sell all residential units in the building.” Since the amended complaint was “plainly lacking in merit,” the court denied the motion to file such complaint. Accordingly, the court granted the defendant’s motion for summary judgment and dismissed the complaint.

Comment: Generally, market conditions had compelled sponsors to retain units as rental units. They never intended at the outset, to not sell all of their units. Over time, some sponsors decided that they were happy owning rental units and they refused to sell such units. This caused problems for those who had bought, because many lenders refused to provide financing, either a mortgage for a new purchaser or a refinance for an existing unit owner, in buildings where a significant number of units remained unsold.

With respect to offering plans that preceded the aforementioned attorney general’s regulations, the ability to prevail on an implied covenant of good faith and fair dealing claim based on a sponsor’s refusal to sell remaining units depended upon the language of the offering plan. If a plan expressly reserved a sponsor’s right to not sell all units, it was difficult to establish an implied promise to the contrary.

Bauer v. Beekman International Center, 110211-2011, NYLJ 1202619524844, at *1 (Sup. NY, Decided Aug. 16, 2013), Silver, J.

Landlord-Tenant—Tenant Permitted to Operate Day Care Facility in Apartment Located in HUD Building Since Tenants Occupied the Premises as Their Primary Residence—Interpretation of “Incidental Business”

A landlord of a “HUD” building, commenced a holdover proceeding, seeking to regain possession of an apartment from tenants, “on the grounds that they have violated the terms of their lease and HUD regulations by operating a daycare at the premises.” The parties had entered into a stipulation of settlement (stipulation) which provided “in pertinent part: ‘[r]espondents represent that although the premises is being used as a daycare center, it is only being used as an incidental business, which generates only incidental income.’” The tenants had provided proof that they had insurance which covered their day use of the apartment.

The tenants did not dispute that the daycare business generated their “primary source of income.” They argued, however, that “the term ‘incidental business,’ as written in the stipulation and HUD Handbook, implies that in order to legally operate a business out of a HUD apartment, the operation of the business must be incidental to the tenants’ use of the apartment as their primary residence.”

The court noted that “New York State public policy supports the operation of day cares within places of residence. See N.Y. State Soc. Services Law 390.” Courts have held that operation of a daycare center is permissible within rent stabilized apartments. The salient issue was whether operation of a daycare business in a HUD apartment is permitted by HUD regulations.

HUD regulations provide that “[w]ith the consent of the PHA, members of the household may engage in legal profit-making activities in the dwelling unit, where the PHA determines that such activities are incidental to primary use of the leased unit for residence by members of the household.” The HUD handbook provides “[t]enants who conduct incidental business in their unit and receive incidental business income are not in violation of…’the Model Lease for Subsidized Programs.’” Although the HUD handbook permits owners of HUD buildings to establish rules controlling “the amount of traffic, noise, signs, parking within the grounds, and hours of work performed,” the handbook did not restrict the incidental business that can be conducted from apartments. Additionally, a memorandum authored by the HUD Office of Counsel, stated that “[e]very provision in a written instrument entered into relating to real property which purports to forbid or restrict” use of occupancy “as a family day care home for children is void….”

The landlord did not dispute that the premises were the tenants’ primary residence. The landlord argued that since the operation of the daycare center constituted the tenants’ “primary source of income,” the tenants had breached the Stipulation which limited the operation of the daycare center to an “incidental business” which only generates “incidental income.” The daycare center was the tenants’ primary source of income.

The court found that based on NYS public policy and HUD rules and regulations, the tenants were permitted to operate the home daycare business in their apartment, as long as they utilized their apartment as their primary residence. The court further noted that the tenant wife had a 35 year tenancy in the premises and had recertified her income every year in accordance with HUD requirements. Thus, the landlord knew or should have known that the tenant “generate[d] her primary income from the day care at the time it entered into the stipulation, as [the tenant] [had] been running the day care for fifteen years.”

The court further reasoned that any ambiguities in a contract were to be resolved strictly against the party that drafted the stipulation, i.e., against the landlord. The matter had been marked off the calendar, without prejudice, while the parties had attempted to resolve the matter. Accordingly, the court refused to restore the subject proceeding to the calendar for entry of a judgment of possession and warrant of eviction against the tenant.

Riverdale Osborne Towers Housing Assoc. v. Keaton, 68620/2012, NYLJ 1202617847740, at *1 (Civ., KI, Decided Aug. 16, 2013), Scheckowitz, J.

Scott E. Mollen is a partner at Herrick, Feinstein and an adjunct professor at St. John’s University School of Law.