Apt. Owner Sues Co-Op Board and Managing Agent

This was originally posted on the SGR Blog.

Was There Liability for Almost $1m Façade Repair?

The owner of an apartment in a residential co-op has every right to sue the board and managing agent for a perceived breach of the proprietary lease or for breach of fiduciary duty. But sustaining a claim may be easier said than done. And, as a recent case illustrates, a shareholder’s claim arising out of an almost one million dollar façade repair was tested at the outset by several threshold legal defenses. 

Bernard Weinstein was a resident in a cooperative apartment building owned by 12282 Owners’ Corp. Weinstein asserted claims against the Co-Op’s Board of Directors and against the Co-Op’s managing agent, AKAM Associates, Inc., for failure to properly maintain the exterior of the building. The Co-op and AKAM moved to dismiss the complaint.

The Co-Op owned the apartment building located at 122 East 82nd Street in Manhattan. In 1988, Weinstein and his wife purchased the shares for unit 8AD.

Paragraph 2 of the proprietary lease required the Co-Op to keep the building in good repair at its own expense, except as expressly provided otherwise elsewhere in the lease. Paragraph 18 of the proprietary lease excluded from the Co-Op’s maintenance responsibilities limited areas of the building, such as the interior space of apartments in the building. 

According to the allegations of the complaint, in 2010 the Co-Op’s Board became aware of “an old vertical crack” in the building’s façade. The Board opted to address the problem through hiring a contractor who undertook to caulk the crack in the façade every five years, rejecting the position of other engineers whose view was that “extensive brick work to close up the crack was required.” In a 2011 letter to shareholders, the Board stated that it had started the necessary caulking to protect against future damage to the façade. 

In 2017 and 2018, the Co-Op’s architect found that the façade had sustained substantial internal damage due to improper installation of air conditioning “sleeves” in 1984 that had allowed moisture to enter the façade, causing it to deteriorate over time. The Board announced that to address those problems, the Co-Op would undertake a significant repair project, to be financed in part with an assessment on each shareholder. The Board later announced that the cost of the project would be approximately $980,000.

Weinstein was not pleased with the Board’s actions with respect to the façade. In a 2018 letter to the Board, he rejected the Board’s attempt to “hold the Co-Op’s shareholders responsible for the costs” and, instead, demanded among other things that the Board assert claims against AKAM for failing to ensure that the façade was properly inspected and maintained. In early 2019, Weinstein followed up with “a formal shareholder demand that the Board … bring suit against AKAM … and any other professionals responsible for the harm to the building.” Finally, in May 2019, he sent the Board a draft derivative complaint against both the Board and AKAM. 

Weinstein asserted claims against the Board for breach of fiduciary duty and breach of the proprietary lease for failing to properly oversee the inspection and maintenance of the building’s façade, and for failing to take steps to hold AKAM and contractors retained by the Board and AKAM legally responsible for their failures to detect and remedy the damage to the façade. He also asserted claims against AKAM for breach of fiduciary duty and breach of the lease for failing to retain competent professionals to inspect and maintain the façade and failing to monitor the façade’s condition. And sought to recover the resulting damages suffered by “the Co-Op and its shareholders,” in the amount of the façade’s repair costs, namely $980,000 (or more), as well as attorney fees. 

The Board and AKAM argued that Weinstein could maintain the action only if he did so jointly with his wife, who also had an ownership interest in their apartment’s shares of the Co-Op.

Joint tenants take and hold property as though they together constitute one person. Joint tenants possess an undivided interest in the property. An individual or entity is a necessary party to litigation if complete relief is to be accorded between the persons who are parties to the action or if the entity might be inequitably affected by a judgment in the action. Joinder is mandatory if the non-party is subject to the court’s jurisdiction. 

Here, the Weinsteins held their shares as joint tenants with the right of survivorship. Both joint tenants had a shared interest in their apartment. Complete relief rendered by the court could adversely affect Ms. Weinstein’s interests—and she was a necessary party for this litigation. 

Dismissal for failure to join a necessary party, however, is a last resort. A party may amend the pleading at any time by leave of court or by stipulation. Leave is freely given absent showing it would cause surprise or prejudice. Weinstein sought to replead should the court grant any part of the motion to dismiss. And he filed a proposed amended complaint, which added his wife as a plaintiff but did not otherwise modify the allegations of the existing complaint. The Co-Op and AKAM did not oppose that request and did not allege any prejudice or surprise. Ordinarily, the Court would grant leave to replead in the form of the proposed amended complaint. But given the disposition of the remainder of the motion, the Court concluded that granting leave would be futile.

The Co-Op and AKAM contended that Weinstein’s action should be dismissed because paragraph 45 of the proprietary lease required him to provide advance written notice to the Board of this suit and he did not do so. The Court did not agree that paragraph 45 of the lease unambiguously required advance written notice so as to warrant dismissal at the pleading stage.

Paragraph 45 of the lease provides that the “Lessee may not institute an action against the Lessor or defend or assert a counterclaim in any action by the Lessor related to the Lessee’s failure to pay rent” (in the form of maintenance charges), when the action, defense, or counterclaim is “based on the Lessor’s failure to comply with its obligation under this lease or any law, ordinance or governmental regulation” absent advance written notice to the Co-Op of the action.

The parties advanced two alternative readings of that provision. Weinstein argued that paragraph 45 applied only when the lessee’s action, defense, or counterclaim was “related to the Lessee’s failure to pay rent,” which was not the case here. The Co-Op and AKAM contended that paragraph 45 applied in two scenarios, not one: (i) when the lessee commenced an action against the lessor based on the lessor defaulting on a term of the lease or violating an applicable provision of law; or (ii) when the lessee raised that default or violation by the lessor as a defense or counterclaim in an action commenced by the lessor against the lessee relating to the lessee’s failure to pay rent. And that contention was not without force: the only instance in which a lessee might bring an action against the Co-Op that was both based on a lease-default by the Co-Op (or the Co-Op’s violation of an applicable statutory provision) and related to the lessee’s failure to pay rent would be a preemptive declaratory-judgment action brought by the lessee to obtain legal sanction for his refusal to pay maintenance charges. It seemed at least somewhat unlikely that this particular type of action—not other non-rent-related actions brought by lessees against the Co-Op—would alone be subject to an advance notice requirement. But even if the Court was to conclude that the Co-op and AKAM had the better interpretation of paragraph 45, that would not render Weinstein’s narrower reading unreasonable. Put simply, paragraph 45 was ambiguous. And given that ambiguity, the Court could not rely on paragraph 45 to dismiss Weinstein’s claims at the pleading stage, before a factual record was developed about the parties’ intent with respect to this provision.

The Co-Op and AKAM next contended that Weinstein’s complaint lacked particularized allegations that he demanded that the Board assert claims against AKAM. And moved to dismiss each cause of action on the ground that Weinstein had not shown that making the demand would be futile. The Court disagreed. Weinstein sufficiently alleged that he did make a demand on the Board.

A shareholder who wants to bring a derivative suit must set forth, with particularity, either a demand to the board to initiate litigation or, if no such demand was made, why that effort would have been futile. The form and language of such a demand are not prescribed, leaving a plaintiff with different avenues to satisfy this requirement. A plaintiff may fulfill that requirement by forwarding a draft copy of the complaint with a demand letter to defendant directors.

Weinstein’s counsel wrote to the Board’s counsel, in September 2018, demanding the Board assert a claim against AKAM. His counsel followed up with a letter to the Board in February 2019, formally requesting the letter serve as a demand that the Co-Op sue AKAM and any other professionals responsible for harming the building. Weinstein then forwarded a draft derivative complaint to the Board in May 2019. Those communications all demonstrated that he made the requisite demand to the Board to initiate an action.

The Co-Op and AKAM noted that the caption of Weinstein’s complaint indicated that he was asserting at least some claims directly in his individual capacity (rather than derivatively on behalf of the Co-Op). They contended that he lacked standing to raise such individual claims. The Court agreed that Weinstein’s claim against the Board for breach of the proprietary lease must be dismissed for improperly mingling direct and derivative claims.

On the one hand, the proprietary lease expressly provided that it was a contract between the Co-Op and the Weinsteins in particular. To the extent that the Board’s actions breached the lease, that would violate the legal rights of Weinstein and his wife, not the rights of the Co-Op. Thus, Weinstein sought redress on behalf of himself personally, rather than for the Co-Op.

On the other hand, the injury Weinstein identified as resulting from the breach was the $980,000 sum that he alleged the Co-Op would have to spend on repairing the damage to the building’s façade due to the Board’s alleged failure to maintain the façade in good repair. That injury was one to the Co-Op. It was felt only derivatively by individual shareholders (like Weinstein) based on the Co-Op passing through that injury to shareholders in the form of increased maintenance fees. And a claim that sought redress for injuries suffered by a corporation (and felt by individuals as equity owners of the corporation), and that would result in recovery to the corporation, was a derivative claim.

In other words, Weinstein was seeking to premise a direct, individual claim on an injury that he had not suffered in his individual capacity (i.e., the repair costs incurred by the Co-Op). Alternatively, he was seeking to premise a derivative claim for injury to the Co-Op on the breach of his contractual right as against the Co-Op (the lease provisions obligating the Co-Op to keep the building in good repair). Thus, however, the Court looked at the matter, the claim failed to state a cause of action for relief and was dismissed.

The Co-Op and AKAM contended that Weinstein’s fiduciary-duty claim against the Board, brought derivatively on behalf of the Co-Op, must be dismissed under the business judgment rule. That rule, which applied to decisions of residential-cooperative boards, required the Court to defer to board determinations so long as the board acted for the purpose of the cooperative, within the scope of its authority, and in good faith. In other words, without a showing of a breach of fiduciary duty to the corporation, judicial inquiry into the actions of corporate directors was prohibited, even though the results showed that what the directors did was unwise or inexpedient. Claims for breach of fiduciary duty must be pleaded with particularity.

The Co-Op and AKAM argued that Weinstein had not pleaded with particularity that the Board’s actions were undertaken in bad faith, or otherwise fell outside the scope of the business judgment rule. The Court agreed.

The vast majority of Weinstein’s allegations asserted that the Co-Op had incurred (or would need to incur) nearly $1 million in unnecessary costs because the Board did not competently retain or oversee contractors responsible for inspecting and repairing the building’s façade. And failed to take necessary or appropriate steps to hold contractors (including the Co-Op’s longtime managing agent AKAM) responsible for poorly or even negligently performed work. But allegations merely of mismanagement alone were not enough. To the contrary, absent a showing of discrimination, self-dealing, or misconduct by the Board or its members, judicial inquiry into the actions of corporate directors was prohibited—even if the results showed that what Board members did was unwise or inexpedient.

Weinstein also alleged, upon information and belief, that the Board did not investigate or act to repair the façade damage between 2010 and 2018 because the directors were concerned that if costs for such repairs required the Board to issue an even bigger assessment on the shareholders, the shareholders would be likely to vote those directors of the Board. Thus, upon information and belief, the Board’s failure to act between 2010 and 2018 was allegedly motivated, either wholly or in large part, by their desire to entrench their positions on the Board.

Board decisions driven by the directors’ self-interest rather than the best interests of the Co-Op would not be shielded by the business judgment rule. But Weinstein’s allegations did not provide any particulars about the directors’ assertedly self-interested motives, or how those motives affected the Board’s decision-making process. And the allegations were pleaded “upon information and belief”—but they did not disclose the source of information that formed the basis of that belief, as was required. Those allegations, standing alone, did not state a claim for relief.

Weinstein asserted derivative breach-of-lease and fiduciary-duty claims on behalf of the Co-Op against AKAM. The fiduciary duty that AKAM was alleged to owe the Co-Op stemmed, and was defined by, AKAM’s obligations under the contract between those entities. The fiduciary-duty claim against AKAM thus essentially overlapped the breach-of-lease claim. The two claims rose—or fell—together.

The Co-Op and AKAM contended that those claims should be dismissed because AKAM’s actions as the Co-Op’s managing agent were shielded by the business judgment rule in the same manner as the Board’s actions. But the Court found their contention unpersuasive. The business judgment rule in the context of cooperative and condominium apartments was derived from precedent addressing challenges to decisions made by corporate directors of commercial enterprises. And the cases in this area consistently described the rule as shielding the acts of cooperative and condominium boards and board members, in particular. Treating the business-judgment rule as also applying to actions of a cooperative corporation’s agents, as well as its board of directors (and individual directors), would significantly expand the scope of the rule. And the Co-Op provided no authority standing for that proposition.

Under the particular circumstances of this case, however, this Court’s conclusion that the business judgment rule did not apply of its own force to shield AKAM’s conduct did not end the inquiry. One aspect of the Board’s conduct that was shielded by the business judgment rule was the Board’s decision-making with respect to AKAM—including whether to sue AKAM for its failure to recommend and oversee competent contractors to inspect, maintain, and repair the building’s façade. The Court held that the Board was legally entitled to decide on behalf of the Co-Op—without judicial second-guessing—to decline to bring contractual or fiduciary-duty claims against AKAM relating to AKAM’s conduct with respect to building maintenance and repair. 

The Court concluded that even if AKAM was not itself covered by the business-judgment rule, permitting Weinstein’s derivative claims against AKAM to go forward would impermissibly circumvent that rule as it protected the decisions of the Board.

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