Housing cooperatives, or “co-ops” as they’re commonly known, occupy an unusual niche among forms of joint stock enterprises. Like any corporation, the tenant-shareholders have a common interest in maximizing for everyone’s benefit the value of the co-op’s assets, i.e., the apartment building and its common elements, but being neighbors who live above, below and beside one another, the tenant-shareholders also have intrinsically competitive interests regarding rights of access, use, development, transferability, etc., that can have a direct, disparate impact on quality of life and the resale value of their individual apartment units.
In large co-ops, where no single tenant-shareholder has a significant percentage of voting power, the centralized management authority of a democratically elected board of directors, exercised pursuant to the co-op’s by-laws, can regulate and mute any divergence between common and individual stockholder interests. Such centralized management, as in any corporation with widely dispersed ownership, effectively compartmentalizes decision-making at the board and shareholder levels.
But not all co-ops are large. In Manhattan and other parts of New York City there are many small co-op properties, including converted walk-up tenements and industrial loft buildings, with as few as four, five or six units where each tenant-shareholder may have a seat on the co-op’s board of directors and material voting power, thereby melding into one the theoretically distinct realms of director and shareholder authority and likewise conflating common and individual concerns.
Which also means that relations between tenant-shareholders in small co-ops can fall victim to the same kinds of infighting and dissension that afflict any small, closely held, owner-operated business enterprise. Some years ago I wrote about a Brooklyn co-op shareholder who petitioned for judicial dissolution of a five-unit co-op on grounds of oppressive conduct by the majority shareholders, which led to a statutory buy-out and contested valuation proceeding (read here and here). A Manhattan appellate panel’s decision last month in Akasa Holdings, LLC v Sweet, 2014 NY Slip Op 01822 [1st Dept Mar. 20, 2014], illustrates another kind of co-op shareholder dispute involving a battle for board control of a four-unit co-op, pitting one tenant-shareholder owning a majority of the voting shares against the other three tenant-shareholders.
The Co-op at 55 Crosby Street
According to the complaint in Akasa (read here), the subject property is “a luxury cooperative designed by three well-known architects including Frank Gehry” located at 55 Crosby Street in the fashionable Soho district of Manhattan. The five-story building has four units: a two-floor unit with basement acquired by the plaintiff in 2011 to which 51% of the co-op’s shares are allocated, and three one-floor units, each owned separately, with an aggregate share allocation of the remaining 49%.
Article III, Section 1 of the co-op’s by-laws (read here) provide that the number of directors on the co-op’s board “shall be three, or such other number, no more than seven nor less than three, as may be from time to time provided herein,” and can only be changed by shareholder vote. The shareholders’ agreement in Section 5.1.3 (read here) provides that the shareholders “agree to cause the nomination for election and to vote their Shares for the election of each Shareholder . . . as a director of the [co-op], as long as each of them is a Shareholder of the [co-op]”.
Notice that these two provisions in the by-laws and shareholders’ agreement, while not textually inconsistent, are not exactly in sync with one another either, which ultimately is what led to the litigation.
Until 2009, each unit-holder nominated one director to the four-member board. In June 2009, a majority of the shareholders voted to elect a five-member board, two seats on which were taken by the then-owners of the unit purchased by plaintiff the following year. However, not long after plaintiff acquired its unit in 2011, the shareholders held an election for a four-member board designating one seat per unit, to which the plaintiff objected and contended that the proper size of the board should be five directors, not four.
The impasse continued into 2012 when plaintiff filed suit against the other unit holders seeking a declaration that the defendants were in breach of the by-laws and shareholders’ agreement and that the co-op must recognize a five-member board including two designees of the plaintiff. The defendants filed an answer denying the complaint’s material allegations and asserting counterclaims for indemnity of litigation expenses incurred in the action by the defendants and by the co-op as a nominal defendant (read here).
The Lower Court’s Ruling
Both sides moved for summary judgment on plaintiff’s claims to impose a five-member board. The plaintiff also moved to dismiss the defendants’ counterclaims for indemnification.
In a November 2012 decision and order (read here), Manhattan Commercial Division Justice Shirley Werner Kornreich ruled for the plaintiff on both issues. First, she found that the operative provisions of the by-laws and shareholders’ agreement,
read together, clearly set forth the following procedure for determining the size of the Board and electing directors: (1) pursuant to Article III, Section 1 of the By-Laws, the shareholders are to vote on a number, between 3 and 7, of directors to serve on the Board; (2) pursuant to § 5.1.3 of the Shareholder Agreement, the shareholders are to nominate candidates to serve as directors on the Board; and (3) pursuant to § 5.1.3 of the Shareholder Agreement, the shareholders are to vote on each of the nominees.
In a footnote, Justice Kornreich noted that, “[a]ssuming the parties wish to vote in accordance with their apparent allegiances,” at the next shareholders’ meeting plaintiff could use its 51% voting interest to establish a five-member board and to nominate and ensure the election of two directors, while the defendants will then be able to fill the three remaining board seats.
Justice Kornreich also dismissed the counterclaims for indemnification, finding that the relevant provision in the by-laws only provides for indemnification for claims brought for the co-op’s benefit or against an individual related to his or her actions as a director or officer of the co-op, neither of which applied to the plaintiff’s claims.
The Appellate Court’s Affirmance
The defendants appealed Justice Kornreich’s decision to the Appellate Division, First Department, which last month unanimously affirmed the lower court’s ruling.
As to the board’s composition, the appellate panel agreed that the by-laws “state in plainly understood terms that the [co-op] may have between three and seven directors and that the shareholders shall decide on the number of directors.” Section 5.1.3 of the shareholders’ agreement, upon which the defendants heavily relied,
gives each shareholder (or its designee) the right to be a director; however, it does not limit each shareholder to one director. It would have been easy enough for the shareholders’ agreement or the by-laws to provide, “There shall be only one director per shareholder.” However, they do not so provide, and we will not add this term.
Defendants contend that the parties who drafted the shareholders’ agreement meant for each shareholder to have an equal voice on the board. However, we are concerned “with what the parties intended . . . only to the extent that they evidenced what they intended by what they wrote.” [Citation omitted.]
The appellate panel also rejected the defendants’ reliance on the co-op’s longstanding practice of having only one director per shareholder, noting that, in addition to the clear language of the shareholders’ agreement, between 2009 and 2011 the former owners of the unit acquired by plaintiff had two board representatives.
Finally, the appellate court also upheld dismissal of defendants’ counterclaims on the ground that plaintiff did not sue the defendants as directors or officers, but only in their capacity as shareholders, and that the by-laws did not provide for indemnification for such claims.
For those unfamiliar with co-op ownership, it’s important to understand that shares in co-ops are allocated per apartment based on relative size, desirability of location within the building, views, number of bathrooms, etc., and that common maintenance charges, which include property taxes, are assessed in proportion to the share allocation. Thus, in Akasa the plaintiff presumably pays 51% of the co-op maintenance charges. That’s the primary reason why I’d be surprised to learn of any co-ops consisting of however many units in which seats on the board are allotted per unit rather than by election in which each tenant-shareholder votes their share allocation for however many seats are specified in the by-laws.