The Proprietary Lease Amendment That Backfired Spectacularly

The Dakota, a historic co-op on Manhattan’s Upper West Side, won their case — spending $2.4 million in legal fees defending themselves against a shareholder’s charge of discrimination. And then the court said they couldn’t collect a dime in legal fees.

William McCracken, partner at Moritt Hock & Hamroff, walks through this head-spinning case, explaining how a seemingly minor amendment to the building's proprietary lease unraveled everything. McCracken reveals which buildings might face the same problem and what boards should be asking their attorneys right now. It's a cautionary tale about the hidden risks lurking in legal documents that seemed perfectly fine for decades. Habitat's Carol Ott 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

Carol Ott: Attorney's fees. Now that's a topic that doesn't sound very dramatic, but a recent court decision has suddenly brought into question the ability of co-op boards to charge back legal fees in shareholder disputes and more. This could be hugely consequential for co-ops. So today we're going to explain what happened and what your board's options are now.

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Carol Ott: I am Carol Ott with Habitat Magazine, and joining me today is Bill McCracken, partner at Moritt Hock & Hamroff. Welcome, Bill. 

Bill McCracken: Hi, Carol. 

Carol Ott: How are you doing? 

Bill McCracken: Good. 

Carol Ott: Let's set the stage for those of us who are aren't lawyers. First of all, explain what our attorneys fee provisions, where they're spelled out, and how do they normally work in a co-op case.

Bill McCracken: Okay, sure. And, I'm gonna try not to get too weedy, but some of this can get a little weedy. Okay so I apologize in advance to your viewers, but stick with us because we'll get there. But to answer your question, you often have in litigation, in contracts of all types, you have attorney's fees, provisions, or prevailing party provision where, and most relevant here is if the parties get into a dispute, then the parties agree ahead of time that the winning party will be entitled to their attorney's fees reimbursed by the losing party.

That is something that needs to be in contracts because the default rule in this country, unlike in some other countries is that everybody pays their own attorney's fees and you bear your own costs and it's not included as part of your victory in the litigation. So if you want to have that, which is useful for people who think that they're right to be able to ship attorney's fees to the other side, then you have to put it in your contract.

And so. A proprietary lease is a contract like any others, but it's a, it's a lease for a co-op apartment building. And like many residential leases, there are attorney's fees provisions in there. And the one that we're focused on today is one that was originally drafted by landlord, naturally, and then landlords naturally wanted to make it as an advantageous to landlords as possible.

So they put these sort of one-sided attorney's fees provisions in their proprietary leases saying that if we have to sue you because you're in default, we can recover our attorney's fees in that litigation. So if you stop paying your rent or you start, you know, doing things that you're not supposed to do under the rules and I have to go to court and sue you as the landlord, as the co-op, then I can recover my attorney's fees.

The issue became that people thought that that wasn't fair, that that tenants don't have the bargaining power to get their side, if they go into court and they win that they should get their attorney's fees reimbursed. And so at some point many years ago, the state legislature passed something called Real Property Law 2 34, which said in effect that all of these landlord friendly attorney's fees provisions, if they don't have, if they don't have the ability for the tenant to recover as the prevailing party, then we're gonna just imply it as a matter of law.

Anytime there's a landlord friendly prevailing party provision attorney's fees, provision in litigation, if the tenant wins, they get their attorney's fees back from the landlord. And so it sort of, it was an attempt by statute to even the playing field for these attorney's fees provisions. 

Carol Ott: So lemme just ask in proprietary leases now in co-ops, is that language, whichI think basically says whoever wins gets their attorney's fees paid for. Is that language in all proprietary leases? 

Bill McCracken: Well, there's in, in every proprietary lease I can think of. There is some language like that. And the traditional form from the 1970s, you know, the one that you've seen a thousand times in a proprietary lease.

It doesn't actually say anything about being a prevailing party. It says that if there's a defaulting shareholder, and if the landlord, the co-op, incurs legal fees in suing that shareholder, then they get their legal fees back, right? And so there is a premise. There was a premise in that attorney's fees provision, or this is how we've always read it, that it requires a sort of prevailing party concept because there's a defaulting shareholder.

It's not just, I sue you and I get my attorney's fees. I sue you because you have defaulted, and therefore, if I'm the prevailing party, I get my attorney's fees and under RPL 2 34, it was the tenants were protect protected, so if they prevail, they get their attorney's fees. But in the typical classic proprietary lease, it's not really spelled out too clearly.

And that actually became a problem because when people look at these leases and they're trying to make them more clear and give shareholders and everybody else more guidance as to when the co-op might be able to re recover attorney’s fees, they start expanding that classic form. Try and add things to it.

You know, if I have to send a letter because your, your apartment's leaking, or you know you're making too much noise, it doesn't go to litigation, do I get to recover my attorney's fees? Then what if, instead of I'm, when I sue you for nonpayment or rent or for making noise or whatever, what if, what if you just sue the co-op one day out of the blue and shouldn't I get my attorney's fees back in that situation as well?

That's actually what happened in this most recent case is the Dakota Building, and everybody knows the Dakota on 72nd and Central Park West, most famous apartment building in the world, most famous co-op building in the world. They had one of these classic sort of bare bones attorney's fees provisions and at some point someone realized that, you know, we should add in to that provision that if you sue the co-op, then we should get our attorney's fees provision in that as well.

The problem is, and we, I guess we can get to the case shortly, but I don't want to go too far, is in drafting that language, you have to be very careful and it turns out that, that the court thought that they weren't careful enough in how they drafted it, so. 

Carol Ott: So talk, talk about the Dakota case because that apparently has sent ripples through the legal community.

Bill McCracken: Sure. Yes. And, and in fairness, the Dakota case, it's, Kasowitz Benson versus JP Morgan Chase. It has a very odd posture. Kasowitz Benson was the firm that was representing a former board president, who tried to buy an apartment an additional apartment in the Dakota and was turned down, sued the board for racial discrimination, and the board racked up over $2 million in legal fees, but were successful in the case.

They were successful in the case, so they were the prevailing party, so they sent that shareholder a bill for the $2 million, I think it was $2.4 million in the legal fees that the co-op had had incurred and successfully defending this litigation. No problem. Right? Like that's, you're the prevailing party.

I should get that. So the thing that happened in this building is that this shareholder had other debts as well. He had a more, he had a loan, a co-op loan on his apartments in the Dakota, and he stopped paying his loan payments. And then JP Morgan Chase defaulted him under his loan documents. And as everybody knows, probably, watching this interview is typically a co-op has a first lien against a shareholder.

So meaning that if, if you owe the co-op money and you owe the bank money, the co-op gets paid first. That's by statute that's very well established, and the bank was scratching the heads trying to figure out how they were going to get any money out of the sky when he owed the co-op $2.4 million. So they came up with an interesting strategy and a successful one.

Ultimately, they rely on a case that had been decided a few years ago that your magazine talked about at the time, as being problematic. It was called the Krodel versus Amalgamated case, where that co-op had again, drafted a new sort of form of proprietary lease and had included all sorts of circumstances in which the co-op could get their legal fees reimbursed. But because it was so broad and because the way that case unfolded, basically that co-op board under their lease became entitled to their attorney's fees, even though they weren't the prevailing party. You follow me? I do. So you have a circumstance under that lease whereby even though I don't win under the lease, I'm still entitled to get my attorney's fees back.

Which seems unfair, and that's what the court said. The court said, look, it's all fine that you have this attorney's fees provision, but it's not, it is actually against public policy for you to be able to recover your attorney's fees in a situation where you didn't actually prevail. Like why? How could, how could you have a situation where the tenant's just sort of standing up for themselves and asserting their rights?

They're still obligated to pay the co-op for the trouble. It doesn't seem right. And so they threw out that entire attorney's fees provision as being unconscionable. And so when that decision came down, that was in end of 2018. Again, there were, there were articles in Habitat Magazine talking about this is a problem, but it was sort of, people looked at it because that particular lease was a little bit unusual.

They weren't necessarily the prevailing party. So it, it seemed like there was a sense of fairness there. This case is different in the Dakota case because the co-op did prevail, right? Clearly they won. They had a total victory. The pro, the properties provision was not that unusual and so it came as a big surprise that it got struck down and it got struck down.

The bank argued that it was unconscionable under that prior crude case, and the reason why is when the Dakota had amended their proprietary lease to add in a little proviso that if you sue the co-op, I get my attorney's fees then as well, what they forgot to do, according to the court, is they forgot to make it clear that if you sue the co-op and lose and the co-op wins.

Then the co-op gets to recover its attorney's fees. All it says in the amendment that they did is that if you sue the co-op, we get our attorney's fees 

Carol Ott: regardless of whether who, 

Bill McCracken: regardless to who wins. And when they did the amendment to the shareholders of the Dakota, they were explaining that this is only intended to apply when you are the prevailing party.

That's why it's okay to adopt this amendment shareholders. But if you look at the language and the court looked very closely at the language, doesn't actually say that in that particular amendment, and so the court said, I don't care that you actually won. You still have the same problem with this provision, which is that there are circumstances in which even if you were in the wrong, co-op, the shareholder sues you and, and is trying to enforce their rights and their right under your proprietary lease. You could have a claim against them for attorney's fees. That's not fair. That's against public policy. I'm throwing the whole thing out, even though in this particular case they had $2.4 million that they, they prevailed on.

Now they're in a situation where they can't recover that and the bank j ped in front of it and they have, they now have effectively the first lien, against that shareholder. 

Carol Ott: Okay. So this was in one case, practically, what, what, how will this case affect. The co-op community and, and broadly speaking, you know, many co-ops.

It's one thing to have a lawsuit against a shareholder. It's another thing where we as a board ask our attorney to write a letter to the shareholder saying, you know, you owe us money, or you're behind in rears, or you're annoying or something. 

Bill McCracken: Right? So I think there are two things to say about that, and this probably would be the big takeaways for anybody watching.

One is all of these decisions have to do with what happens in a litigation between a co-op and a shareholder. None of these cases really deal with that problem that you're talking about when I have to write a letter or there's a dispute that doesn't go to litigation. So I would say that none of these cases directly affect those circumstances.

That doesn't mean that there might not be an issue with those, but I can't set like, nobody's saying that. Like, because the Dakota building, the Kasowitz case has been decided the way it was. Now, you can't charge back a shareholder when I write them a letter. Not saying that, that's not, at least that's not what the court said.

However, the second part of this is anybody who reads the case’s decision or the Krodel decision before it. They need to ask their lawyers, look at our attorney's fees provision. Are there circumstances under which under our lease we could become entitled to recover attorney's fees? Even if even if we are in the wrong, right.

Even if we didn't, even if we are the bad guy and we are in default. Are we still entitled to charge attorney's fees back to the shareholder that we're in a dispute with? Because in that case, we may have a problem. 

Carol Ott: In your experience, are there many proprietary leases that would have language like that?

Bill McCracken: So I would say that the classic proprietary leases, the bare bones attorney's fees provisions, I have to think that they are safe under the new regime because they've always been safe. They haven't ever been declared unconscionable or against public policy. But if you, particularly if you, if you redone your attorney's fees provision, or if you've expanded o over the years, that's when you have to go back and look at it and see how carefully that you drafted those amendments.

I have seen prop leases, and we've done them that try to have like a savings provision in the attorney's fees provision that says, you know, notwithstanding anything else in here. We only recover our fees if we're the prevailing party. Right? Or if the shareholder is in default to try and cover that, that concern that the courts have expressed about fairness, because we're not, we're not actually trying to charge back a shareholder legal fees when we're wrong, right?

Like, we're not. But that's, that's what I would say. Like I would, I certainly think it's something that to be concerned about, but I don't think that it means that every prop lease in the city, or even most prop leases in the city are now not gonna be enforceable for these attorney's fees provisions.

Carol Ott: And just remind our listeners, if the board pulled up their proprietary lease and, and realize that particular, section needed to be amended. The procedure to do that is what? 

Bill McCracken: Well that's, that's what the big problem with all of this is because if it was just as simple as fixing it, then you could just fix it.

But amending a proprietary lease is usually very difficult. Usually need a super majority, at least 66 and two thirds of the shareholders to approve an amendment to the proprietary lease. And. Even when you're doing something relatively routine, like extending the term or, or what have you, it can be expensive and time consuming.

You have to educate the shareholders while you're asking for it. Some of them won't vote. Some of you know, they just won't bother and it, it can be a very difficult process to get any sort of pro properties amendment passed and certainly one where you know you are telling the shareholders that I can charge you back money under these circumstances.

It might be a tough ask. So that's the answer. It is usually a super majority of the shareholders, and that's not easy. 

Carol Ott: And so looking forward, if you had to leave board members with one takeaway and there's a balance here that you've, that you have laid out, what would that be? 

Bill McCracken: So yes, the takeaway.

The takeaway mainly is, if you're concerned about this issue, send your proprietary lease to your attorney and tell them exactly this. Are there circumstances under which the co-op would become entitled to legal fees even though they weren't either the prevailing party or the non-default party? And if, if there are circumstances that that could come up, that raises a question of fairness, then I need the attorney to advise me what to do next. 

Carol Ott: Alright, thank you very much. It sounds like great advice. I'm Carol Ott and this has been Bill McCracken. Thanks so much for listening.