BY ROBERT GRANT, DIRECTOR
MIDBORO MANAGEMENT
I am not an attorney. I work under the "law of agency" representing cooperatives. Like many of my colleagues, Midboro Management has an active closing department. Transferring stock to a shareholder purchasing a cooperative apartment is fairly routine. Stock transfers are based on long established presumptions that the apartment corporation (the "Lessor") has absolute control over the stock it issues, and has a primary, built-in lien on those shares. That lien allows the Co-op to collect maintenance and other charges ahead of any other creditors a shareholder may have, including bank loans, mechanic liens, lines of credit or other encumbrances.
But, is this presumption actually clearly established in the laws of New York State? Surprisingly, the answer is no. There have been a number of court rulings, unknown to many boards and managing agents (and even to some real estate attorneys) that shake the foundation of this core belief that Co-ops have automatic liens on their own stock. There are conflicting opinions throughout the legal community. There are also conflicting opinions in court decisions including rulings from the Appellate Division of the State Supreme Court.
The conflicts seem to center on how to classify Co-op stock, and how to deal with liens on Co-op stock. This issue has become so contentious that there are even several court decisions challenging whether a Co-op's built-in lien on its own stock (as described in the proprietary lease and by laws) is a perfected security agreement.
"Making a positive difference in the community and for our customers," says Jagde, "is the SDI difference." In point of fact, SDI has cultivated a reputation for reaching out to the community in a variety
of ways. For example, the company has been honored repeatedly by Westchester ARC, a chapter of the New York State ARC and a United Way Agency that serves individuals with developmental disabilities, for its
on going employment of developmentally disabled persons. SDI also has earned the New York State Employer Recognition Award and the Westchester County Office for the Disabled Certificate of Merit.
A number of attorneys warned me that managing agents must be very careful when they are involved in transfers of stock and terminating leases and stock because of the way liens against the stock are viewed, and because of how Co-op stock itself is viewed. Nothing, however, prepared me for reading the actual court case rulings. Judges wrote decisions that seemed to contradict what I had taken for granted for years as a managing agent. Some of these decisions go against conventional ideas prevalent throughout the cooperative community and management industry in New York. It seems that something is wrong, or unclear in the New York State statutes if the courts themselves are confused. A few actual cases will illustrate the problem.
CASE #1:
A Co-op board sent a default notice to a shareholder for nonpayment. When the shareholder refused to pay the arrears, the board voted to terminate the lease and cancel the stock, which was done by mailing notices prepared by the Co-op's legal counsel, exactly according to the standard terms of a proprietary lease (typically clause #31).
Simultaneously, the attorney sent a copy of the default notice and then a copy of the termination notice to the shareholder's lender, who had a lien on the shares. When the shareholder still refused to pay the arrears, the Co-op terminated the lease and stock. Ultimately the bank paid the Co-op more than $20,000 for all unpaid maintenance fees, legal fees and disbursements, to protect their security interest. The bank then requested that the canceled stock be reissued in the bank's name. The "former" shareholder sued to restrain the Co-op from conducting a foreclosure sale and issuing the stock in the bank's name. The Supreme Court, Kings County, ruled against the shareholder. The shareholder appealed the decision, and the Appellate Court, Second Department reversed the decision, and held that the shareholder was entitled to a preliminary restraining order.
This court decided, in part, that the Co-op did not have an enforceable security interest because the proprietary lease did not constitute a valid security agreement. The judges wrote: "Since reservation of title under a lease does not create a security interest unless the parties so intended, the mere existence of a proprietary lease, without more, does not establish an enforceable security agreement to which the Uniform Commercial Code applies. Preservation of the status quo, absent a clear showing of entitlement to proceed under Uniform Commercial Code Article 9 [the UCC section dealing with judicial sales, private sales and foreclosure sales] is essential because, otherwise, a Cooperative corporation would be able to divest shareholder-lessees of their ownership interests in their apartments without any judicial determination of equitable defenses or counterclaims." - J. McMillan v. Park Towers Owners Corp. Supreme Court, Appellate Division, Second Department 3/25/96.
It is clear that no Co-op has a right to simply take equity ownership of stock from a shareholder, regardless of the language in the by laws and the proprietary lease, without a judicial proceeding. But, beyond that, is the mere existence of a proprietary lease an "enforceable security agreement?" This court ruled that it is not.
CASE #2:
A shareholder contracted to sell his cooperative apartment for $400,000. He represented that there was no lien on the shares, and a UCC title search failed to show that there was any current lien. The shareholder issued a Lost Certificate Affidavit and Indemnity Agreement, indemnifying the Co-op and the managing agent against losses incurred from sale and issuance of new stock. There was no copy of a recognition agreement in the owner's file.
The Co-op delivered a consent at the closing, which stated that "Lessor corporation has not been notified of any pledge or disposition of, or lien upon such shares." Amazingly, the seller not only had an unrecorded mortgage, but continued making monthly mortgage payments for one full year following the sale! When the mortgage payments stopped, and the bank discovered what had transpired, they sued the Co-op, arguing that despite not filing a continuation of its original UCC lien, it had perfected its security interest by taking physical possession of the certified stock certificate and lease in the mid 1980's. The Co-op cross sued its managing agent for any loses it might suffer as a result of reissuing the stock to the new shareholder. The current managing agent contended that it was not the agent in the mid 1980s; that the files it inherited did not contain a recognition agreement; and, that accepting an affidavit of a lost stock and lease and an agreement indemnifying both the Co-op and the managing agent was standard industry practice.
The court ruled that, despite not knowing about the prior recognition agreement, and despite not finding a current lien during a UCC search, the Co-op was still liable, stating: "The Co-op participated in a transaction that destroyed the bank's collateral. The fault of the Co-op here was in canceling the shares and issuing a new Proprietary Lease when it had executed an agreement that it would not do so. It is sufficient on this motion to conclude that the acts of the Co-op's agent cannot remove the Co-op's liability for its breach of contract. In this case it is clear that the bank has established a basis for it to recover its loss from the Co-op. The seller may have orchestrated a fraud, but there can be no doubt that the Co-op harmonized with him [whether unknowingly and innocently] in that it acted without regard for the rights of the secured lender and violated its contractual obligation under the recognition agreement. Accordingly, the banks' motion for summary judgment on its claim against the Co-op is granted. The Clerk shall enter judgment against the Co-op in the sum of $140,406 with interest from November 1, 1995. The Co-op's cross motion for a default judgment against the managing agent is denied." - Collins v. Douglas Elliman-Gibbons & Ives; L.I. Svgs Bank v. 136 West 64th St. Corp. (NYLJ 5/7/97 29;4)
The agent and/or the attorney for the Co-op failed to require a "Lost Certificate Bond" from the seller. They had no way to know, from their current files and from their UCC lien search that the seller still owed money on his original loan. The Aztec form consent agreement did not require the seller to warrant and attest that there are no liens or encumbrances on the stock. It is an unfortunate reality that some management companies keep incomplete files, and fail to even make copies of recognition agreements when acting as transfer agents, or require that attorneys who act as transfer agents provide copies of the recognition agreement. Have we gone from "buyer beware" to "Co-op beware?!"
CASE #3:
A shareholder sought a preliminary injunction to prohibit a Co-op's assertion of its right to take possession of and sell shares of stock to satisfy its claim for unpaid maintenance charges. The court issued the injunction, in part based on the shareholders claim of breach of warranty due to water leaks. But, surprisingly, this court also ruled that a proprietary lease for a cooperative apartment unit is not automatically security agreement for purposes of applying UCC remedies, and that the Co-op did not have a security interest in the tenant's stock on which it could foreclose to satisfy its claim for maintenance charges.
Specifically, the court wrote: "Here the cooperative does not advance a security agreement nor does it demonstrate that it has filed the agreement. The relevant proprietary lease clauses refer to a conditional limitation and the cooperative's ability to issue substitute shares and a lease. The clauses do not refer to a security agreement. However desirable recourse to Article 9 might be, a cooperative must demonstrate entitlement to Article 9 rights, which it has not done here. A claim of arrears in maintenance, standing alone, does not give rise to the remedies of Article 9 of the UCC." - Saada v. Master Apts. Inc. Supreme Court, New York County, 5/29/91.
In a similar case two years later (DeCastro v. Karen Gardens Apartment Corp., HCR, NYLJ 7/28/93) the court wrote: "It has been held that the customary form of proprietary lease, without more, is not a security agreement to which the Uniform Commercial Code applies (Saada v. Master Apts.). This court concurs in such holding."
These cases clearly go against the presumption that a Co-op can simply take back ownership of stock from a shareholder by following the step-by-step proprietary lease approach of declaring a shareholder in default, completing a court proceeding, and then terminating the lease and canceling the shares if the default is not cured. They illustrate the vagueness in the New York State statutes when judging the rights of shareholders and Co-op's over ownership of stock, and interfere with a Co-op's right to collect maintenance.
Next month, Part II.