Why the Storefront Isn’t So Simple

That dry cleaner or restaurant on your building's ground floor might seem like a simple revenue stream, but the dynamics behind managing commercial tenants are surprisingly complex. Christopher Tumulty, partner at Smith, Gambrell & Russell, explains the different challenges commercial tenants bring depending whether they are in a co-op or condo, and what board directors should understand about their power in each circumstance. For co-ops, in particular, boards need to be an active manager of the commercial tenant while condo boards, spared that task, must remain vigilant. Habitat’s Paula Chin conducts the interview.

The business of running a building is demanding work that requires making endless decisions — some that can quickly lead your board into a quagmire of legal difficulties. Legal Talk interviews New York's leading co-op/condo attorneys to find solutions, and get some guidance, on these challenges. For more co-op and condo insights, sign up to receive Habitat's free newsletters or become a Habitat subscriber today!

Transcript

Paula Chin: Welcome to Legal Talk, a conversation about governance issues that New York's co-op and condo boards are tackling today. I'm Paula Chin with Habitat, the New York City magazine for co-op and condo board directors, and my guest today is Christopher Tumulty. 

When it comes to the relationship between boards and their commercial tenants or commercial owners, boards sometimes don't understand what rights they have, especially when it comes to renting space to tenants. And that's crucial if problems arise, so boards know what leverage they have and don't have.

Chris, let's start with the basics on commercial spaces in co-ops and condos. If you could just set the lay of the land for us. 

Christopher Tumulty: Thanks, Paula. And thanks for having me. I'm always happy to chat with you guys. a lot of your readers have buildings where there is a commercial space , in either ground floor or street level, and this can be a great revenue raiser.

It can be a convenience for the residents depending on what type of business is in there. But it can also create headaches. And and obviously, when those headaches arise, you have to understand what your remedies are and how best to deal with that as a board. 

Your options are gonna depend primarily on what type of building you're in, whether it's a condominium or a co-op, because there's gonna be a great disparity in the amount of leverage and power you have over that tenant. First of all, with a co-op, which the majority of the buildings are.

The co-op oftentimes, most of the time is gonna be the direct landlord. That co-op corporation will own that ground floor space. And in that situation the co-op board has the most power over that tenant, but also has the most risk, because you have all the risks associated with being a landlord.

You have the flexibility and power to decide who your tenant's gonna be. You can lease it to whatever business you'd like to lease it out to. And that is a determination that the board has to look at and understand various factors-- pricing and the types of use that is gonna be accompanying that business, whether it's a retail space, whether it's a doctor's office, whether it's gonna be a restaurant.

Or a convenience store. Obviously those all have different hours of operation, different uses, different maybe odors that might come out of the, that space. So you have to bring that all to consideration and balance that obviously against the rental revenue that you can see there.

Whereas on the flip side if you're in a condominium building you're not gonna have that level of choice with respect to the types of tenant that you have in the first place because that ground floor space is often gonna be owned by a unit owner that then is the landlord. So the unit owner of the commercial space, just like any other unit owner in the building, they owe common charges to the condominium association and then they can do with their property, oftentimes, anything they wish to do. And sometimes this ground floor or commercial space will be something that is held back and retained by the developer sponsor. And there may be additional rights and privileges built into the original governing documents that give the board even less oversight and control over what happens in those scenarios.

There's not as much risk there because you don't have the risk of nonpayment, you don't have to deal with the direct issues. You don't have to deal with lease concessions. You can always look to your unit owner and have the common charges that are due on a monthly basis regardless of the status of the tenant or the lease or what's happening there.

So there's a control and risk dichotomy there that you have to consider depending on where you're at. 

Paula Chin: Can you tell us some examples? Let's start with condos, the kind of problems that might arise with their commercial unit owners? 

Christopher Tumulty: Sure. With a condominium the board may have issues with how the space is being used or the way it's being built out.

An example that I have of a building on the Upper West Side, it's a condo building, where I represented the board and there was a commercial owner that leased out space to a tenant and was allowing the tenant to do build outs. And that all is normal except that the tenant was interfering with building systems and common elements and restricting access to the condominium's professionals to access those areas.

So it all starts with letters back and forth, and threats to sue, and you have to go and dig into the governing documents. What we're ultimately able to do was I was able to negotiate with the lawyer for the commercial unit owner to agree upon a short agreement that sets forth what the specific rights and remedies were with respect to first of all, the commercial owners' governance rights, seats on the board, which was another issue. And separate from that, what types of construction processes would be followed when a build-out was happening, what types of insurance would be required, what types of approvals, times of day and areas and what scope would be permitted and not permitted.

Now, this doesn't mean to say that the condo board has the same type of oversight and approval rights as it would with respect to a residential owner, but we had to set some guardrails, particularly with respect to impacts on common elements, which was the hook for the condo board.

Anything that commercial owner is doing that adversely impacts the common elements of the condominium, that's fair game for the condo board to come in and say, we have to step in and we have to protect this, and this is within our purview, and it's outside the scope of what you're doing within your unit, which they would most likely be able to argue they have full right to renovate and build out as they wish without having to come to the condo board for approval. So by finding those common element impacts, the condo board has the ability to go to that commercial owner and negotiate some way forward without having a resort to litigation.

Paula Chin: Is there something boards can do proactively, say, before a conflict with a commercial unit owner arises such as this one? Can you lay out the rules in advance? 

Christopher Tumulty: In certain cases you can have a commercial owner sign up to an alteration policy, an alteration agreement. When you have a commercial space that's been inherited from a sponsor or owned by the sponsor, they're gonna resist that and reject that. Depending on what the status of the ownership is, and also depending on the relationship with that owner, you may have a really great owner that has their seat on the board, that comes and participates in board meetings, and works with the residential owners.

And oftentimes those don't end up coming to me because there's not a problem. That certainly exists and that's great when that happens. So it's really about building a good relationship, involving that owner in a condo particularly in the building management.

And so that they're aware of these issues and why they're important to the residents as they arise. Oftentimes, there's an adverse impulse between a commercial sponsor owner and residential board members. But everyone would be better off if that commercial owner is involved and understands why this construction is disruptive or why this certain use is not gonna be met kindly by the unit owners.

And even if they might have a right to do that, it's better to have them involved and have them on their board and have their board seat honored so that they can deal with this. So just to turn the other flip side of that on a co-op, how you can protect against this in the first instance, there's a lot more you can do because the co-op is the landlord. The co-op owns that space in the first instance. So it all starts with finding the right tenant. You as a co-op board, you have to become a commercial landlord. You have to make sure you hire the right people, hire a broker.

You have to have everyone focused and on board with this because you're gonna have to decide what type of tenant you want. A lot of times you could have a tenant that's gonna pay a big rent, but you're not gonna like the type of business they're gonna run. So you have to think about all these things in advance.

You may have to be ready, particularly respect to a retail tenant or something like that, which would oftentimes be a very desirable tenant 'cause there're not a lot of disruption. There's great hours, but there might require some rental months concessions-- free rent for several months to build out.

Restaurants might also require that as well. Certainly garages, if you have a garage space. That's always a great tenant, and that also provides a benefit to the residents: you can negotiate for spaces and the like. So at the beginning of the relationship, the co-op board has a lot of authority in terms of drafting that lease, creating the rights and obligations within that document in the first instance. They should talk to their lawyer about creating that lease, about what they want and what their oversight is in that scenario. That's really the best approach to avoiding problems is have that lease exactly how you want in the first instance because you're in the driver's seat at that point, as the landlord. 

Paula Chin: Circling back to condos, I think you mentioned if the condo unit owner is on the board, does that create added complications? 

Christopher Tumulty: I don't think so. Oftentimes they're gonna have a seat on the board pursuant to the bylaws anyway. Most bylaws, when there is a commercial space, when that condominium was formed, the bylaws are often written in a way that reserve one seat for a commercial owner.

There obviously is gonna be some reservation of seats for the sponsor during that sponsor control period, but there's often gonna be left on there a split, that these seats are for residents. And then there's an opportunity to appoint one board member from the commercial owner.

And that is a board seat for the entire building. So that commercial board member has obligations and fiduciary responsibilities to the condominium. They sit on that board just like any other board member. And they're entitled to notice of meetings and they're entitled to be involved in the process, just like any other board member.

And they have responsibility to the building and to the residents, just like any other board member. So I think it's a benefit when they are on the board because they are obligations that they need to fulfill. The board seat, whether it's occupied by a residential unit owner that was elected at an annual meeting or commercial board member seat that was appointed by a commercial unit owner, that board seat is the same. They have fiduciary obligations to all unit owners and to act in the best interest of the condominium as a whole. To your question, I think it's beneficial when that commercial owner is involved in the overall management of the condominium because they first of all have a seat at the table for when these concerns arise in the first instance and can hopefully address them before they get out of hand. And secondly, they do have a legal obligation to the building and are not strictly beholden to the interest of that commercial owner. 

Paula Chin: How about an example where the commercial unit owner is renting the space out to a restaurant, and the restaurant has code violations or is a nuisance: whose responsibility is it to get those problems fixed?

And what happens, for example, if the restaurant people don't correct it? Do the violations and the fines fall upon the unit owner? 

Christopher Tumulty: So there's a few different points there. The tenant of the restaurant owner, they have obligations under a commercial lease to a commercial unit owner, right?

And then that commercial unit owner has obligations under the bylaws to the condominium association, and then the enforcement runs in reverse. So if the condominium association is approached and the board is approached with problems, maybe from residents complaining about noise or about odors or about use or whatever else. They, in the first instance, look to the commercial owner and they may or may not have the ability to issue fines to the commercial owner. But the enforcement is gonna vary depending on what the bylaws provide. But in the case of they do have authority, they could issue a fine, which would then be recorded as an additional common charge and would be owed to, to the condominium association.

And then running down the line, the commercial owner would then have hopefully the ability under the commercial lease to recoup those fines or to call the owner, in this case, a restaurant owner, in default under the terms of the lease. And then there are the remedies that would that would follow that, whether it's a holdover proceeding for possession based on a breach of the lease, or other monetary remedies that the landlord may have against their tenant. And it's a question of enforcement. It comes back to how we started. The level of control that the board has is less in that scenario because they're relying on somebody else to enforce these rights.

There are other potential tort claims. You mentioned a nuisance. A board could have those types of claims or other unit owners could have those types of claims, but that's not as solid as the contract claims that would run in connection with the bylaws. Which by the way, in a condominium, the bylaws are treated as a contract between the board and the unit owners, so they're enforceable in breach of contract action.

And then also down the line the lease is obviously a contract and there's rights and remedies that come with that as between the business owner and the commercial space owner, condominium unit owner. 

Paula Chin: Taking things a step back. Have there been issues when a unit owner sells their unit to somebody else and that owner perhaps creates new problems with their tenant?

Christopher Tumulty: Sure. So the condominium board has only a right of first refusal and may not in certain situations even with a commercial space. So there's not a lot of control that can be exercised over that transaction. But the condominium's gonna have the same remedies as they would under the bylaws against, the seller, unit owner and the buyer unit owner. So the examples that I just gave of the enforcement options? They would run with respect to the buyer as well. 

Paula Chin: Chris, is there a final takeaway you have that would apply to condos in terms of what they can expect and what they should do when problems arise? 

Christopher Tumulty: I think my takeaway applies to both, and it's just broadly, pay attention to that commercial space. Don't treat it as just revenue coming in, especially in a co-op. You have to be an active manager of that space.

You have to be actively involved in whether there's a lease renewal coming up, how you wanna negotiate that, you what kind of tenant you want. Oftentimes there are boards that will just think of it as just a line item. We have this business here, we don't really have any involvement with it.

And then they don't think about it until issues come up. They say, what can I do? And then they have to dig in and look at what their rights and remedies are. With respect to a condo, in that situation you just have to be vigilant and hopefully nip small problems in the bud before they become big problems.

Don't wait and give a commercial owner that seems like he's going to be very lax with respect to how his tenant acts. Don't give him a lot of leeway. Make sure that when these problems arise, you go right to him or her initially and address this. And make sure that the commercial owner knows that the condo board is going to be vigilant in enforcing the bylaws against that owner, and therefore they should be vigilant in enforcing the lease obligations against the tenant.

Paula Chin: As always, timeliness is of the essence. Chris, thank you so much for joining us today. 

Christopher Tumulty: Thank you so much, Paula.