Preventing Sponsors and Holders of Unsold Shares from Gaining Control of a Cooperative’s Board of Directors1/17/2017 | By: Pamela Gallagher, Esq. | GDB 2017 Winter Newsletter
Cooperatives and resident shareholders in New York recently had an important win in the appellate court for Manhattan. The Court found that sponsors and all other “holders of unsold shares” cannot wrest control from resident shareholders of a coop board if the governing documents state that “holders of unsold shares” are prevented from having a majority of the seats on the board.A “holder of unsold shares” is typically defined in a cooperative’s governing documents to include both the sponsor plus any person who buys shares allocated to a particular apartment directly from the sponsor and who has not lived in the apartment. Each subsequent purchaser of those shares remains a holder of unsold shares until the owner of the shares lives in the apartment, or allows a family member to live in the apartment.
In many cooperative apartment buildings, the sponsor is prohibited from holding a majority of the seats on the board of directors. Usually, this is because the cooperative’s governing documents state that the sponsor will not control the board after a certain period. Sometimes, the governing documents will also prohibit holders of unsold shares from controlling a majority of seats on the board to ensure that the majority of board seats are held by resident shareholders.
What happens when the sponsor tries to work around these prohibitions? Increasingly, courts are strictly enforcing these restrictions, even if the holder of unsold shares is not the sponsor.
In some buildings, many holders of unsold shares sublet their apartments and have never resided in the building. In that case, if no previous shareholder (or family member) has resided in the apartment, the current owner remains a holder of unsold shares. If such an owner wants to be elected to the board of directors, the shareholder must determine if holders of unsold shares are prohibited under the governing documents from holding a majority of seats on the board. If so, then they may be precluded from becoming directors, because the sponsor may have already filled the maximum number of available director seats for the sponsor. Then there would be no seats available for investors who bought from the sponsor because that would give the holders of unsold shares majority control of the board.
Recently, the appellate court for Manhattan prohibited a sponsor from filling the majority of a cooperative’s board seats with a combination of sponsor designees and holders of unsold shares. In Tiemann Place Realty, LLC v. 55 Tiemann Owners Corp., the cooperative’s governing documents stated that holders of unsold shares (including the sponsor) could elect up to two of the five members of the board of directors. The sponsor argued that other holders of unsold shares should not be limited by a provision meant to limit the sponsor’s control of the board. The court disagreed, finding that the limitation on seats held by holders of unsold shares was enforceable against all holders of unsold shares, including both the sponsor and non-occupying investors who bought from the sponsor. The holders’ of unsold shares attempt to take control away from the resident shareholders would be contrary to the provisions of the governing documents.
Cooperatives with a strong interest in maintaining resident shareholder control over the board of directors should look closely at the cooperative’s governing documents to ensure that the sponsor and other holders of unsold shares are not improperly holding or seeking election to a majority of seats on the board.