Which Rule Rules?

A dustup at the Village Dunes co-op in Montauk highlights the differing standards that may govern the enforceability of decisions made by co-op boards.

This dispute began when a shareholder sought the consent of the co-op board to make alterations to his apartment, including raising the ceiling of the apartment, enclosing an unfinished common area above the apartment for his exclusive use, and replacing a window with one of a different type and size.

The proprietary lease provided that the board could not unreasonably withhold its consent to a proposed alteration. When the board denied the shareholder’s request, he filed a lawsuit, seeking damages for breach of contract as well as an injunction authorizing the proposed alterations to proceed.

The co-op contended that the board’s rejection of the proposed alterations was protected by the Business Judgment Rule, which affords boards a great deal of leeway in decision making, free of judicial second-guessing, so long as decisions are made “for the purposes of the cooperative, within the scope of its authority, and in good faith.” The shareholder, on the other hand, contended that, since the proprietary lease provided that consent to an alteration could not be unreasonably withheld, the Business Judgment Rule did not apply. So the case came down to two clear questions: which rule ruled? And what is a “reasonable” decision?

The Appellate Division held that the board was not protected by the Business Judgment Rule. In the court’s view, once the lease established a standard of “reasonableness,” the board’s decision had to be reasonable to an outside observer and was subject to judicial review.

Nonetheless, the court ruled in favor of the cooperative. In an affidavit, the co-op board’s president had stated that the board did not agree to the proposed removal of second-floor walls and ceilings. Three concerns were identified: the remaining wall would be attached and supported by the building roof; the ceiling of the renovated unit would be the underside of the roof system; and the space above the current ceiling would be walled off from the common area, rendering this space accessible only to the plaintiff. Under these circumstances, the court ruled that the board’s decision was reasonable.

Boards should be aware, however, that, as this case demonstrates, as soon as a proprietary lease references a “reasonable” standard, their decisions may be subjected to a higher, more demanding level of scrutiny. This should be a consideration when boards make decisions and when they select language to be used in amending and updating proprietary leases.