How One Co-op Got a Crash Course in Its Own Rules

What would happen if your co-op's proprietary lease didn't actually give your board the powers you've always assumed it had? That's not a hypothetical — it's exactly what happened to one New York co-op. Tracy Peterson, a principal at Braverman Greenspun, takes Carol Ott through a case where digging into a co-op's proprietary lease revealed a provision so unexpected that it had escaped notice — by attorneys, managing agents, and board members alike — for more than 40 years. She breaks down what the board found, how they handled the fallout, and what every board member should take away: read your governing documents, because the surprises are in there. 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: A standard proprietary lease in a co-op gives a board a wide swath of rights to approve or reject sublets and transfers. But what if this lease is not standard?

Folson Group: I'm Tina Larsson with the Folson Group. We deliver done for you property management searches. You make the final call, we handle the rest. Add to that our seamless project management and strategic cost optimization. And you get a partner that empowers boards to make smart, confident decisions that move your building forward.

Carol Ott: I'm Carol Ott with Habitat Magazine, and my guest today is Tracy Peterson, a principal at Braverman Greenspun. Welcome, Tracy. 

Tracy Peterson: Hi, Carol, nice to be here. 

Carol Ott: So you're working with a client who discovered that their proprietary lease was not standard. Can you tell me what was going on there? 

Tracy Peterson: Sure. So like most co-ops in, in New York City this was a conversion from the 1980s, and from the outset, the proprietary lease, instead of having the standard provision that you noted in your introduction has instead a right of first refusal provision, which is a provision that is more common in condominium bylaws.

Carol Ott: And do you wanna just explain I know it's certainly not common for co-ops, but explain what it is in a condominium sense. 

Tracy Peterson: Sure. So condominiums, unlike co-ops, generally don't have the right to reject a lessor or purchaser. Rather, when a unit owner would like to lease out his or her apartment or sell his or her apartment they submit a package to the board, and the board has an opportunity to say, "You know what?

We think this is a great deal. We'd like to take the same deal, same terms, in lieu of renting to this prospective renter or selling to this prospective purchaser." but that's the only, it's the only power that a condominium board has to prevent a lease or a sale from going through. A condominium board can't otherwise say, "Nope, you can't rent to that person.

Nope, you can't sell to that person." 

Carol Ott: So you're saying in this co-op's proprietary lease- ... the board did have the right of first refusal? 

Tracy Peterson: The board had only the right of first refusal, however the board and every purchaser shareholder, sublessor, et cetera, et cetera, proceeded as if the proprietary lease had the standard provision that allowed the board to grant or withhold consent for any reason or no reason.

And it was only within the past year- through a series of events that really it was actually bizarre. It was a bizarre set of events where there was somebody who moved into an apartment as a sublessor over the objections of the shareholder. And the the woman who was occupying the apartment as a purported sublessor took the position that the board had approved her.

And when we were going back and forth and trying to figure out what exactly had happened and how, we realized that the proprietary lease only had this right of first refusal provision and not the standard provision, which surprised everybody. Because as I said, for 40-plus years, the, this co-op had been operating as if it had the standard lease provision, and at no time did a purchaser or purchaser's attorney or prospective subless- sublessee say, "Hey, wait a minute.

You can't reject me," or, "You can't demand this type of information because all you have is the right of first refusal." 

Carol Ott: So let me ask you, A, One, questions about the attorneys that have represented a variety of shareholders o- over the past 40 years and how in-depth they actually looked. But B, okay, so what?

Tracy Peterson: One of the hallmarks of a typical co-op is that there's high owner occupancy. Whereas condominiums are valued by certain purchasers by having flexibility where you can use it, you can buy it as investment property and easily rent out the property. There's no, you don't have any rules that require you to live there for any particular length of time before you can lease, et cetera, et cetera.

So with this co-op where the board doesn't have the power to withhold consent to subleases, excuse me it's gonna, it could conceivably become more like a condominium and have low owner occupancy and more transient occupancy of renters cycling through and shareholders purchasing for investment purposes rather than long-term homes.

Carol Ott: Before the board comes to that realization, now there was a discovery that they've been operating, in, not according to their proprietary lease. What was the fallout from that in their, in that particular co-op? 

Tracy Peterson: Yeah, good question. So far so far there really hasn't been much fallout.

But once this came to light, the board was very transparent with the shareholders, issued a memo. We held a town hall meeting, which I attended to help explain the situation, answer questions, provide alternate paths forward To the shareholders. And there has so far been one individual who has demanded y- money to compensate him for alleged lost rent during a period when he claims that the board improperly withheld consent to a sublease.

Carol Ott: So the board explained this to the shareholders, and going forward, what, do they have to change how they ad- admit people? What can... Are they gonna change their proprietary lease? How are they gonna proceed? 

Folson Group: So 

Tracy Peterson: they have not decided whether or not they're going to change their proprietary lease.

I believe that there was a survey done of shareholders. No ultimate decision has been made about what they wanna do in that regard, but of course, once they became aware of the limits on their powers w- with respect to approving or not approving subleases or transfers they overhauled their process for submitting s- sublease applications and transfer applications.

Carol Ott: And when you said they overhauled their process, to become what? To do what? 

Tracy Peterson: So it- it's just, it's different information that has to be provided. 

That's all. So just so that it tracks with the proprietary lease, meaning the proprietary lease requires that a copy of the proposed purchase agreement or a copy of the proposed sublease gets submitted along with whatever additional information that the board may request, and then there's a period of time after which the last bit of information is submitted that the board has to either exercise its right of first refu- refusal to say, "Hey, we'd like to purchase under the same terms," or, "We'd like to sublet under the same terms," or release its right of first refusal.

Carol Ott: So realistically I don't know many co-ops, and actually also condos, but who actually can exercise their right because they don't have the money. So realistically, this co-op has... If they don't change their practice, they've become a condominium. 

Tracy Peterson: They have become a condomin- they're still a co-op, but they are more like a condominium in terms of subleasing and transfers.

You're absolutely correct that it is highly unusual for a condominium board to exercise the right of first refus- refusal. It's difficult to do, whether because of funds on hand or because almost all sets of condo bylaws require a super majority of, or e- even if not a super majority, a majority of unit owner approval to exercise the right of first refusal, and all this has to be done in a pretty tight period of time, which makes it difficult.

However, some sets of documents also allow boards to designate others to exercise the right on the board's behalf. So if you have an individual who perhaps has cash on hand and is willing to do it, in some instances it can be exercised in that regard, in that way. But in the 17, eight, eh, it's 18, 18 years that I've been doing this type of work, I have never seen a board exercise the right of first refusal.

Carol Ott: It is interesting if they wanted to go ahead... There's like a hybrid co-op. They would have the ability, unlike a condominium, to evict somebody or it would be easier to get rid of a problematic shareholder, and yet people who buy into their building Might have more of ability to sublet their apartments or sell their apartments without a board scrutiny.

Tracy Peterson: Yeah, that's abs- that's absolutely right. 

Carol Ott: Could you imagine that this could become a model? 

Tracy Peterson: I can't. First of all- 

... 

Tracy Peterson: Almost all new construction in the city is a condominium, not co-op. This was a rarity. Frankly, this is the only co-op proprietary lease that I've ever seen that has this particular provision.

Once it popped up, I started asking my colleagues and others at other firms whether they had ever seen anything like that, asking managing agents, and I've been told, a couple people have seen one or two, but this is very unusual 

Carol Ott: In a in a typical co-op, the propri- let's say they have a standard proprietary lease, the var- variety of rules for reviewing the purchase application and sublet, sub- sublet applications, does that reside in the house rules, or is that in the proprietary lease?

Tracy Peterson: So the proprietary lease is the umbrella of the parameters pursuant to which a board can exercise its powers to accept or reject. And then sometimes boards will have published subletting or purchase rules saying, "This is what you need to submit," et cetera, et cetera. And others don't have anything written.

It's a policy that's gets trans- that the managing agent will verbally advise prospective sublessees or purchasers. 

Carol Ott: So at the moment, the building, the co-op has no plans to update or to change their proprietary lease? 

Tracy Peterson: There are discussions about whether to become more standard i- in other words, to change the provision to be more in line with other co-ops in the city, or whether to keep the right of first refusal construct and maybe just update it a little bit.

But no, like I said, no decision's been made. 

Carol Ott: If they ke- if they kept the way they are now, will, would that impact any other part of their operations or governance? 

Tracy Peterson: Nothing comes to mind. 

Carol Ott: And for other boards who are listening to this what section in their proprietary lease, if they wanted to just take a look and see, confirm what their proprietary lease says, where would they look?

Tracy Peterson: It's usually in paragraph 15 or 16 of a standard form proprietary lease. 

Carol Ott: Okay. And your takeaway for all boards who have heard this story would be what? 

Tracy Peterson: Read your governing documents. Read them. Familiarize yourself with them. And not just for these provisions. It's, it's always good to know, what are we supposed to do when a board member resigns?

What do we do with elections? How far in advance do we have to notice them? What do we do if we want to amend our governing documents? Having a basic understanding of these types of things is really helpful in the day-to-day operations. How often do we have to meet? Of course, if your board has general counsel or a managing agent, these questions could also be posed to the managing agent or general counsel.

And oftentimes, bylaws, proprietary leases are written in ways that a layperson may not be able to interpret them as well as a lawyer, and some things can be ambiguous or confusing. But at least to know what you don't know is always helpful. 

Carol Ott: And I think we will end on that note. That's great advice.

Thank you so much. I'm Carol Ott, and we've been speaking with Tracy Peterson. Thank you so much. 

Tracy Peterson: Thank you, Carol