CONDOMINIUM LAW “GAME CHANGER”?
By: Victor M. Metsch and Michael P. Regan
While arguably lacking the devastating impact of “The Punch”* and the near-theological sports mystique of “The Immaculate Reception”**, the recently decided case of Board of Managers of the Marbury Club Condominium v. Marbury Corners, LLC, 28 Misc.3d 1240(A), 2010 WL 3730082, 2010 N.Y. Slip Op. 51650(U), (Sup. Ct. West. Co., 9/22/10, Comm. Div., Scheinkman, J.) may resonate in the condominium community as “The Shot Heard ‘Round the World”.***
Marbury Corners upsets the (erroneously) conventional wisdom about both the immutable significance of disclosures made in, and the Attorney General’s “approval” of, an offering plan, and the near sacred belief in the post-closing sanctity of sponsor-imposed provisions of the plan.
In Marbury Corners, several years after all the units had been sold, the Court upheld a challenge to a $2.2 million note given to the sponsor by the sponsor-controlled board before the plan became effective. In a suit brought by the unit owner-elected board, the Court held that the note, even though disclosed, was not authorized by law.
RPL “Ground Rules”
Real Property Law § 339-jj provides that, to the extent authorized by the declaration and by-laws, the board of managers may incur a debt on behalf of the unit owners.
In addition, subject to the declaration and by-laws, the board of managers may incur a debt for limited purposes provided that (a) the debt is incurred no earlier than the fifth anniversary of the first conveyance and (b) a majority in common interest of the unit owner consent.
The sponsor argued that RPL § 339-jj did not apply, because the promissory note was disclosed in the offering plan in the section entitled “SPECIAL RISKS,” stating that “[u]pon the conveyance of title to the first Unit, the Condominium will execute and deliver to the Sponsor a Promissory Note in the amount of $2,200,000,” and further disclosed that “the note would be for a term of 40 years” and “secured by a pledge of the Condominium’s rights and interests to common charges, a security agreement and UCC-1 financing statements….” The Court called a “foul,” ruling that such disclosure in the offering plan was no substitute for compliance with RPL § 339-jj.
The Court also ruled “out of bounds” the sponsor’s argument that the Attorney General’s acceptance of the plan for filing constituted its approval of the plan’s terms. The Court noted that the Attorney General’s responsibility with respect to a proposed offering plan is very limited. The Attorney General does not undertake an exhaustive investigation into the truth or legality of the plan’s contents. Rather, the Attorney General’s role is limited to determining whether basic information is being conveyed to prospective purchasers.
Sponsor’s “Hail Mary” Justification for the Note
In response to the new board’s challenge to the legality of the note, and the sponsor’s secured interest in the unit owners’ common charges, the sponsor offered the following justification. According to the sponsor, because the Village of Pelham had adopted the Homestead Tax Option under Section 1903 of the New York Real Property Tax Law, the units were going to be taxed at full market value, and sales prices for each unit would function as the basis for assessing taxes.
Because it feared that such tax treatment might turn off prospective purchasers, the sponsor withdrew the offering plan for the condominium and submitted to the Attorney General’s office an offering plan for cooperative ownership. Cooperative ownership would, according to the sponsor, allow the building to be treated as a rental building for real estate tax purposes, resulting in lower taxes to the prospective purchasers.
According to the sponsor, the Village threatened to rescind its approvals if the sponsor moved forward with its plan to change to cooperative ownership. To allegedly avoid a fight with the Village and delays in construction and completion of the building, the sponsor reverted to the condominium project and implemented a plan to attract purchasers.
The sponsor allegedly “reduced” the sales prices on which the assessed tax valuations would be based, thus making the units more marketable to prospective purchasers. The “balance” of the “full” purchase price for the units – represented by the $2.2 million note – would be paid by the unit owners through their common charges over a period of 40 years, payable interest only at a rate of 4.5% for the first five years, and payable thereafter at an interest rate of 5.5% with the principal to be amortized over a 35-year period.
The unit owners should have been pleased to receive these purported “tax savings,” right? Wrong. Nowhere in the offering plan was the purpose or intent behind the note disclosed. The unit owners believed that the purchase price they paid for their units was the actual and full price.
And even if the sponsor had disclosed in the offering plan that the purpose of the note was to deprive the tax authority of tax money and pay the sponsor the “balance” of the purchase prices, such a scheme would still violate RRL § 339-jj. In the absence of authority to issue the note in the condominium declaration or by-laws, the note was illegal.****
Call “Time Out” Before Making an Important Play
The moral of this story is two-fold. First, condominium sponsors must think twice before undertaking “creative” financing and pricing strategies. Unit owners are afforded certain protections by statute and common law, even before they purchase their units. Disclosure in the offering plan, a legal document prepared by sponsor, does not give the sponsor carte blanche to implement every creative idea. And not all creative ideas are good ones in the eyes of the law.
Second, unit owners would be well advised to know their condominium documents – the declaration, the by-laws and the offering plan. Counsel can assist in that regard as well. To the untrained eye, the offering plan in this case seemed standard. But below the surface it contained illegal terms that might have otherwise cost the owners dearly.
Victor M. Metsch, a Senior Litigation Partner at Hartman & Craven LLP, and Michael P. Regan, a Litigation Associate with the Firm, represented the condominium.
* On December 9, 1977, during an NBA game between Los Angeles and Houston, the Laker’s Kermit Washington infamously slugged and nearly killed the Rockets’ Rudy Tomjanovich.
** At Three Rivers Stadium on December 23, 1972, with 22 seconds and no time outs remaining, Pittsburgh running back Franco Harris caught a deflected pass, just before it hit the ground, from Steelers quarterback Terry Bradshaw for a game winning touchdown.
*** “The Giants Win the Pennant!” The Giants Win the Pennant!” The game ending home run at the Polo Grounds on October 3, 1952 by New York outfielder Bobby Thompson off Brooklyn pitcher Ralph Branca that gave the pennant to the Giants over the Dodgers.
**** The Court also granted the condominium’s claim for damages and scheduled a conference for the purpose of considering resolution of that claim.