Rules Are [Not] Made to Be Broken

Supreme Court recently addressed a motion to dismiss claims by residential unit owners—who were holders of unsold shares — that the cooperative’s board of directors had impermissibly amended various rules relating the housing of pets, subleasing and move-in charges.

Ironically, the Court issued an extremely and extraordinarily lengthy summary and analysis of the arguments and counter-arguments with respect to the by-laws and proprietary lease, only to find and conclude that the relevant provisions ran unambiguously in favor of the board.

Murray House, a residential cooperative, owns a building at 220 Madison Avenue. The elected Board of Direct was authorized, pursuant to its by-laws, to manage the business and affairs of the cooperative.

Solstice was the managing agent. On November 29, 2011, Solstice entered into an agreement with Murray House requiring Solstice to maintain the building, manage employees, bill and collect maintenance payments from shareholders, and remain abreast of housing policies and applicable laws and regulations.

Plaintiffs were eleven (11) shareholder-lessees who were “Holders of Unsold Shares” allocated to twenty-three (23) apartments in the building. As “Holders of Unsold Shares,” the shares allocated to plaintiffs were never owned by persons or members of their immediate family who occupied such apartments. And, as such, the holders were exempt from certain rules that applied to other shareholders.

In May 2017, the board revised the house rules. Plaintiffs maintained that their consent was required (but not sought or obtained) before the board did so.

The three May 2017 House Rules which plaintiffs challenged were as follows:

(1) all shareholders who reside in the building are permitted to have one dog and/or two cats in their apartment, whereas residents who are not shareholders are prohibited from harboring pets in the apartment (Pet Policy);

 (2) a non-refundable $750 fee is charged to all persons who move into and out of the building, regardless of whether the occupant is a shareholder or subtenant (Moving Fees);

(3) all subtenants, including those of Holders of Unsold Shares, are required to submit a copy of their lease and on-line data form to the cooperative prior to move-in (Move-In Requirements)

The By-Laws provided that “[t]he board of directors shall have [the] power to make and change reasonable rules applicable to the apartment building owned or leased by the corporation whenever the board deems it advisable to do so”. And further provided that “[a]ll house rules shall be binding upon all tenants and occupants of the apartment building”.

The proprietary lease provided that “[t]he Lessor has adopted House Rules which are appended hereto; and the Directors may alter, amend or repeal such House Rules and adopt new House Rules[.]” And that “[t]he Lessee hereby covenants to comply with all such House Rules [.]” 

Plaintiffs filed a derivative action as Holders of Unsold Shares and on behalf of all shareholders similarly situated, alleging that the Business Corporation Law, as well as the cooperative’s by-laws, proprietary lease and house rules (“Governing Documents”), all prohibited the Pet Policy, Moving Fees and Move-In Requirements.

Plaintiffs alleged that the Pet Policy violated the BCL because “it resulted in the disparate treatment of shareholders of [the] Apt. Corp., based upon whether they resided in the Building.” As for the Moving Fees, plaintiffs alleged that such fees were “unlawful” because the “Board does not have the requisite authority to implement such a fee”. Plaintiffs also alleged that the Move-In Requirements constituted “impermissible requirements directed towards such Holders of Unsold Shares inasmuch as those provisions mandate[d] new burdens and additional requirements for them and their subtenants.”

Plaintiffs also alleged that Solstice was required to “enforce the Governing Documents and comply with New York Law” pursuant to the management agreement; and that Solstice breached the Management Agreement through its enforcement of the house rules.

Plaintiffs asserted causes of action for breach of fiduciary duty (against the Board and Solstice); a declaratory judgment (against the Board); breach of contract (against Solstice); and for reimbursement of attorneys’ fees  (against the Board).

Defendants moved to dismiss the complaint in its entirety and to declare that the Board did not violate the BCL, the By-Laws or the Proprietary Lease when they adopted the May 2017 House Rules.

Defendants maintained that the Governing Documents refuted plaintiffs’ claims of disparate treatment. Specifically, defendants argued that the cooperative only issued one class of shares and that the challenged rules were equally applicable to all shareholders. With respect to the Pet Policy, defendants argued that the policy permitted every shareholder to maintain a dog in his or her apartment and prohibited every subtenant of every shareholder from sheltering pets in the apartment.

As for the Moving Fees, defendants asserted that the fees were applicable to every shareholder, subtenant or occupant who moved in or out of the building. Defendants noted that the house rules explicitly stated that “[t]here is a non-refundable move-in and move-out fee of $750 for each instance”. Additionally, defendants pointed out that the house rules further provided that “[a]ll subtenants including those of Holders of Unsold Shares are required to abide by the move-in and move-out rules that are part of these House Rules including the payment of any associated fees.”

Defendants argued that the house rules provided that “[i]f the apartment is being rented by the Holder of Unsold Shares, the Board must receive a copy of his or her lease prior to move-in … Holder of Unsold Shares’ subtenants must fill-in the subtenant online data form, sign the subtenant form, submit the non-refundable move-in fee and the refundable move-in fee prior to move-in.”

According to defendants, the same rules applied to subtenants of other shareholders who were not Holders of Unsold Shares. Defendants maintained that these sublets, unlike the sublets of Holders of Unsold Shares, were subject to board approval after submission of an application. Additionally, defendants argued that its decisions were governed by the business judgment rule, which prohibited judicial inquiry into legitimate corporate actions, and that the Governing Documents refuted plaintiffs’ claim that the board exceeded the scope of its authority.

As for the cause of action for breach of fiduciary duty against the board, defendants maintained that the claim should also be dismissed because there was a written agreement between the parties which governed the matter in dispute. With respect to the breach of contract claim against Solstice, defendants maintained that dismissal was warranted because the management agreement did not require Solstice to “enforce the Governing Documents and comply with New York law” as plaintiffs alleged. With respect to the cause of action for breach of fiduciary duty against Solstice, defendants maintained that’s the claim was duplicative of the breach of contract claim and should be dismissed. Lastly, defendants argued that plaintiffs were not entitled to reimbursement of attorneys’ fees because this action was without merit and should be dismissed.

Plaintiffs argued in opposition that the house rules were incorporated into the proprietary lease and that any house rules that altered the proprietary lease constituted a de facto amendment of the proprietary lease and were impermissible. Plaintiffs also maintained that,  as Holders of Unsold Shares, they possessed an absolute right to sublet their apartments without any restriction as set forth under the Governing Documents.

Plaintiffs acknowledged that the Board was authorized to adopt house rules without shareholders’ consent. However, plaintiffs argued that the Board could not amend the proprietary lease or by-laws, as such documents could only be amended by a supermajority vote of the shareholders, and with the consent of all Holders of Unsold Shares to the extent that the proposed amendment affected any rights of the Holders of Unsold Shares. Specifically, plaintiffs argued that the house rules were invalid because they restricted the rights of Holders of Unsold Shares to freely sublease their apartments by requiring them to only sublet to persons who were non-pet owners and to pay fees and submit financial and personal information to management.

Plaintiffs relied upon paragraph 6 of the Proprietary Lease which stated that:

“the proprietary leases then in effect and thereafter to be executed may be changed by the approval of lessees owning at least 2/3 of the Lessor’s shares then issued […] in no event shall any change in the form of proprietary lease and any of the provisions thereof be made which shall adversely affect certain rights granted to (i) purchasers of Unsold Shares[.]”

As such, plaintiffs maintained the Board eliminated the right of Holders of Unsold Shares to freely sublease while not eliminating the rights of other shareholders, which constituted unequal treatment of shares of the same class of stock in violation of BCL §501(c), without any legitimate corporate purpose.

With respect to the causes of action against Solstice for breach of contract and breach of fiduciary duty, plaintiffs maintained that they sufficiently stated claims because the management contract between the Board and Solstice required Solstice to act in the cooperative’s best interests and in accordance with New York law, which Solstice violated by implementing illegal house rules. Lastly, plaintiffs asserted that the Board’s actions, which restricted their right to sublease, caused them to incur legal fees and expenses, entitling plaintiffs to reimbursement of such fees and expenses pursuant to BCL §626(e).

In reply, defendants reiterated the arguments in support of dismissal and argued that the paragraph of the Proprietary Lease upon which plaintiffs” relied did not involve amendments to the House Rules. Rather, the paragraph addressed the required procedure and approval for amending the form Proprietary Lease.

With respect to paragraph 38(c) of the Proprietary Lease, defendants noted that such provision provided that any alterations to the form Proprietary Lease will not adversely affect the rights and privileges of rights which the Holders of Unsold Shares enjoy unless they consent. As such, defendants maintained that paragraph 38(c) did not expand any right to sublet and only affirmed the subletting rights previously extended to Holders of Unsold Shares.

The relationship between the lessee and a cooperative corporation was governed by the certificate of incorporation, the corporation’s bylaws, and the proprietary lease.

Generally, when parties set down their agreement in a clear, complete document, their writing is enforced according to its terms and extrinsic evidence is generally inadmissible to add to or vary the writing.

The Court found that language of the Governing Documents was unambiguous and the Court could not vary their terms. Rather, the Court was required to enforce the parties’ explicit understanding as set forth in the Governing Documents.

The Court’s reading of the Governing Documents demonstrated that the Board was authorized to amend the House Rules. Contrary to plaintiffs’ contention, paragraphs 6 and 38(c) of the Proprietary Lease did not require that the Board to obtain consent from the Holders of Unsold Shares to amend the House Rules. Rather, those provisions addressed amendments to the Proprietary Lease and not to the House Rules. Further, neither provision expressly indicated that the Board was required to obtain consent from the Holders of Unsold Shares to amend the House Rules.

Defendants correctly argued that the challenged House Rules did not violate BCL §501(c), which provides that “each share shall be equal to every other share of the same class.” The challenged House Rules were applicable to all subtenants, whether they are subtenants of a Holder of Unsold Shares or of an ordinary shareholder. Further, the challenged House Rules did not eliminate any rights of the Holders of Unsold Shares.

The business judgment rule prohibited judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes. So long as the board acted for the purposes of the cooperative, within the scope of its authority and in good faith, the Court would not substitute its judgment for the Board. Since the Governing Documents authorized the Board to amend the House Rules, which all shareholders, including plaintiffs, consented and agreed to comply with, the challenged amendments did not violate BCL §501(c) The cause of action for breach of fiduciary duty was dismissed.

The cause of action for a declaratory judgment was dismissed since the Governing Documents refuted the plaintiffs’ claims. Rather, defendants were entitled to a declaration that defendants did not violate BCL §501(c), the By-Laws or the Proprietary Lease when they adopted the May 2017 House Rules.

Plaintiffs alleged that Solstice was required to “enforce the Governing Documents and comply with New York Law” pursuant to the Management Agreement, and that “Solstice breached the Management Agreement” through its enforcement of the House Rules. However, as defendants contended and the Court found,, the Management Agreement did not require Solstice to “enforce the Governing Documents and comply with New York law” as plaintiffs alleged. Rather, Solstice was required, under the terms of the Management Agreement, to maintain the building, manage employees, bill and collect maintenance payments from shareholders, and remain abreast of cooperative housing policies, and applicable laws and regulations.

As such, the Management Agreement conclusively refuted plaintiffs’ breach of contract claim against Solstice.  The breach of contract claim was dismissed.  The cause of action for breach of fiduciary duty against Solstice was also dismissed because it was duplicative of the claim for breach of contract.

BCL §626(e) provides, in pertinent part, that:

“If the action on behalf of the corporation was successful, in whole or in part … the court may award the plaintiff or plaintiffs, claimant or claimants, reasonable expenses, including reasonable attorney’s fees…”

Because the first through fourth causes of action were dismissed, plaintiffs were not the “successful” party entitled to reimbursement of attorneys’ fees under BCL §626(e).

Copy link
Powered by Social Snap