Publication Date: Summer 1997

CNYC's annual Cooperative Housing Conference, held each autumn on a Sunday, is New York's most comprehensive source of cooperative and condominium information and education. With product exhibits to visit from early in the morning, a video theater showing Co-op Roundtable throughout the day, and dozens of workshops and seminars, the Conference brings together hundreds of CNYC members for a day of learning and sharing.

Reviewed below are two presentations from the 16th annual Cooperative Housing Conference: Repairs in a Cooperative and Strategies to Increase Owner Occupancy.

Although shareholders in cooperatives own shares in the buildings that are their homes, complexities arise when the time comes to determine whether the cooperative or the shareholder is responsible for a particular repair. Provisions in the proprietary lease, as well as legal considerations and government regulations, add layers to the process, so it pays to know who is responsible for what.

Attorney Howard Schechter and managing agent Tony Angelico address this difficult issue each year at the Cooperative Housing Conference. According to Mr. Schechter, the most basic - and most confusing - question is, Where does the building's responsibility end and the shareholder's begin? The simple answer: Most proprietary leases state that shareholders are responsible for everything in their apartments from the plaster on the walls inward, while the co-op takes care of the building envelope and the pipes inside the walls.

Generally, this means owners are responsible for the maintenance and repair of walls, floors and ceilings, and repair and replacement of any appliances and equipment inside the apartment, such as air conditioners, dishwashers and refrigerators. Many proprietary leases state the owner is not responsible for maintaining and repairing entry doors, windows and window frames, but Mr. Schechter advises reading your own proprietary lease to make sure.

The cooperative is generally responsible for maintaining and repairing all pipes and other conduits - gas, steam, water and electrical - located inside of the walls themselves. Most co-ops also take responsibility for the repair or replacement of any radiators or other devices inside apartments that are considered to be standard building equipment. The roof, boiler and other building elements and equipment are all the co-op's responsibility.

As an example, consider the kitchen sink. If the faucet is leaking or the trap beneath the sink needs repair, these elements are inside the apartment and are the shareholder's responsibility. If the pipe in the wall bursts, it's the building's problem.

Sometimes it isn't always that simple, though. If a shareholder installs a new radiator, either for its appearance or its efficiency, the cooperative may no longer be responsible for its care, says Mr. Schechter. The alteration agreement will stipulate if the shareholder is responsible for maintaining the new equipment. Mr. Schechter adds that some buildings choose to repair such units as part of regular building maintenance; but he cautions that if this is done once, it can permanently become the co-op's responsibility. Furthermore, many cooperatives request that a shareholder who installs additional electrical lines or special plumbing inside the walls take responsibility for maintaining these additional amenities. Mr. Schechter advises boards to keep a detailed list of all such alterations, and make sure subsequent owners purchasing units with such alterations are aware of these maintenance responsibilities.

NEGLIGENT OWNERS MUST PAY

The dividing line blurs even more when it comes to matters of negligence. Mr. Schechter notes that "if the co-op is negligent in how it takes care of the building, the law imposes an obligation on the negligent party to pay for any damage done as a result of its negligence." So, if the co-op does not maintain the roof and a resulting leak damages the interior of an apartment, the co-op is responsible not only for making the repairs, but also for restoring damaged personal property in the apartment. Similarly, if a shareholder allows his bath tub to overflow, that shareholder must pay for any damage done to the apartment below.

To further complicate matters, the definition of negligence is vague, says Mr. Schechter. Negligence is generally the result of inaction: If a pipe bursts inside the wall, the co-op probably will not be considered negligent; if the co-op doesn't repair the pipe within a reasonable period of time, that could be considered negligence. However, if a toilet backs up because of something a shareholder put into it, the interpretation of negligence is not as clear-cut. "Unfortunately, it's often left up to a court to decide," he says.

Repairing other apartments after a leak or other problem can certainly be expensive. In cases of negligence, the offending party is generally responsible for restoring the damaged apartment to its previous condition. This can include replacing any expensive wallpaper, fixtures or decorative objects. Co-ops may also find themselves paying for repairs when they are not found negligent. For example, if a pipe bursts and the plumber needs to break through an apartment wall to make the repair, the co-op will generally pay for restoring the wall. However, in such cases, the co-op only needs to restore the plaster or wallboard and perhaps a coat of primer - not any custom wall coverings. "In cases where no one is found to be solely responsible for the damage, the risk is spread over all the parties," says Mr. Schechter.

INSURANCE REDUCES FINANCIAL RISK
According to Mr. Angelico, the high cost of making such repairs is a good reason for shareholders to carry homeowners insurance. "Whether or not it is a case of negligence, having insurance takes you out of the debate," he says. "You can go on with your life while the insurance companies talk it out." He recommends taking a policy that covers "improvements and betterments" - to cover the cost of built-ins, your glorious new kitchen, and, oh yes, that expensive wallpaper.

Mr. Schechter adds that co-ops have the right to require shareholders to carry homeowners insurance, yet he does not recommend buildings exercise that right. "If you do not follow through and check that every apartment owner has insurance, and an incident occurs where an apartment is damaged and the negligent owner did not carry any insurance, the co-op could be found negligent for not enforcing its rule," he says.

If a co-op fails to make repairs in an apartment - for example, after a pipe bursts - it also risks breaching a state code called the Warranty of Habitability, says Mr. Schechter. The Warranty makes property owners responsible for ensuring that the apartments meet minimum standards of decent and safe housing. The courts have determined that this responsibility extends to cooperative corporations. Therefore, if the cooperative allows a leak to render an apartment uninhabitable, and it does not make the repair to return the walls to a habitable condition, then it breaches the Warranty of Habitability.

A state regulation called the Multiple Dwelling Law (MDL) and a city law called the Housing Maintenance code, both of which are enforced by the city, add a further layer of complexity. These laws apply to residential buildings with three or more units, and say that the building owner is responsible above all others for maintaining and repairing the building and its units. In essence, if shareholders fail to maintain their units, the city will hold co-op responsible. Even though the proprietary lease makes a shareholder responsible for repairing, say, his leaky dishwasher, the building must make sure that repair is made. If it is not, the building must make the repair itself or face violations and fines. It will then need to go after the apartment owner for the repair fees.

ALWAYS REQUIRE ALTERATION AGREEMENTS
While the proprietary lease and government regulations cover a lot of ground, the best way for a building to protect itself when a shareholder makes improvements is with an alteration agreement. According to Mr. Schechter, this document says that the shareholder accepts responsibility for the repair and replacement of any additions to the unit, and any damage caused to surrounding units or common areas as a result of the work.

Before offering a shareholder an alteration agreement, the board should satisfy itself that the proposed alteration plan meets all the co-op's standards, and that the shareholder carries the proper insurance and is using licensed and bonded architects/ engineers and contractors.

Alteration agreements often contain specific requirements intended to protect the building and its residents. For example, some co-ops require that the backs of all kitchen cabinets be open to the wall, allowing easy access for plumbers or electricians.

"A lot of this is already contained in the proprietary lease," says Mr. Schechter. "But when you're talking about people making changes within the building, it always pays to be as careful as possible."

STRATEGIES TO INCREASE OWNER OCCUPANCY

Until at least 51% of the shares in a cooperative have been sold to owner-occupants, the building will have difficulty in asserting itself as a cooperative. Lenders may be leery of financing these buildings and vendors may question their creditworthiness. This problem became particularly acute during the long downturn in the real estate market, which had limited sales for years.

Yet even now, as the market improves and owners are finally able to find buyers for their units, New York cooperatives are still facing the dilemma of having too many non-owner-occupied units. Those in this situation still find it difficult - or impossible - to refinance their underlying mortgages or secure share loans for apartments. This delays much-needed capital projects and reduces sales values.

If your building has this problem, its outlook is not hopeless. In a workshop entitled Strategies to Increase Owner Occupancy, presented at the 1996 Cooperative Housing Conference, property manager and sponsor James P. Goldstick and attorneys Steven Goldman and James Samson outlined steps you can take towards eliminating some or all of your building's unsold units.

IDENTIFY THE PROBLEM
The first thing to do is identify the problem. Boards should ask themselves, "Why does a sponsor who converted a building in 1985 still own 65% of the apartments there?" There could be a number of reasons.

One reason could be that the sponsor just hasn't had any vacancies. If his rent-regulated tenants are happy with their leases, they may see no compelling reason either to buy their units or leave the building. One solution to this problem, say the workshop speakers, is to approach the sponsor and recommend he that he encourage further "insider" sales by making attractive financing available to his tenants. A broader-scale solution involves an incentive-oriented sales program, where the sponsor trims prices aggressively as the number of renter-purchased units increases. The key to any plan, they note, is for the board to get involved - because the the best sales agents are those who have already chosen to buy.

Such a strategy paid off at one Upper Manhattan building, where the sponsor owned 26 of the 40 apartments, was carrying a $5,000-per-month negative cash flow, and owed arrears to the building of more than $100,000. The board opted to take an active role in working with the sponsor and his rent-regulated tenants. First, board members met with the sponsor and proposed a discount sales plan - the more apartments that were sold, the lower the prices. The sponsor also agreed to give financing to purchasers. Then the board went door-to-door telling tenants about the plan.

In the end, the sponsor sold 8 apartments. Owner-occupancy increased to 55%; the sponsor's negative cash flow disappeared; and the arrears were eliminated. This brought the cooperative onto solid footing, which collectively made the 18 apartments the sponsor still owns more valuable than the 26 he had before - and increased the value of all the apartments owned by the other shareholders. The mortgage on the building was then refinanced on a 10-year fixed-interest basis at an interest rate of 7.75%.

UNSOLD SHARES & FORECLOSED UNITS
The answer may not be quite as apparent if the sponsor has already sold apartments to investors, particularly those claiming rights as "holders of unsold shares". Holders of unsold shares became a common phenomenon when sponsors who could no longer carry the negative cash flow on their units sold them in blocks to investors. Those designated as holders of unsold shares have the same rights as the sponsor to sell or sublet units without the board's approval and are free from various other restrictions, such as limits on sublet duration.

For boards, the trick here is to do some homework to see whether such parties really have the designated rights they claim. For example, an investor is only a holder of unsold shares if he has complied with the provisions of section 18.3W of the Attorney General's regulations, which set specific criteria for holders of unsold shares. To find out whether a transfer in your building was in compliance, check the contracts of sale, the offering plan and other documents relating to the units in question. They should contain language that says, "the seller hereby designates buyer as a holder of unsold shares." If not, the investor is not a holder of unsold shares and is subject to the same regulations and restrictions as other shareholders.

Furthermore, even if the contract contains such language, it may not be be valid under the Attorney General's provisions. Simply stating that the buyer is designated, without complying with section 18.3W, is not legitimate. This practice has been the subject of litigation say the workshop speakers, and courts have found in favor of co-ops.

Shareholders who have bought foreclosed apartments from lenders may make similar claims, and it is up to the board to weed out those who do not legally have special rights. Most cooperative proprietary leases contain a standard paragraph 17, which defines two classes of lenders: one is a private lender, such as an apartment owner who takes back a mortgage when he sells an apartment, as defined in paragraph 17A; paragraph 17B covers institutional lenders - in most cases, banks - that make most of the share loans in a cooperative. If a private lender forecloses on an apartment, he has the same rights and obligations as any other shareholder. If an institutional lender forecloses, it is given greater rights - such as free reign to sell or sublet. This was done to make it more attractive for banks to make loans to cooperative apartments.

The first step boards should take is to look carefully at who owns foreclosed apartments. If it is still an institutional lender, you have little recourse. But if it is a private lender, you can step in and limit the owner's sublet privileges as you would any other owners'. A common scenario is that the units have been sold by a foreclosing institutional lender to an investor. In this case, the new owner does not retain the rights of the foreclosing bank, says Mr. Goldman. He notes than many buyers manage to convince the boards that the rights are transferable from the foreclosing bank, but "this is not the case, and you should contest it," he says.

PRESERVE YOUR CO-OP'S RIGHTS
In some troubled buildings, investors sometimes demand the rights of a holder of unsold shares as part of the deal. According to the workshop speakers, boards should take the position that only the Attorney General can recognize those rights. You can't recognize those rights and you shouldn't, and you should actually oppose anyone who seeks rights that can have a long-term adverse effect on the financial soundness of the cooperative, they advise.

Also, never assume that banks fully understand the extent of their rights under paragraph 17B, says Mr. Goldman. "Most don't. Not only for designation of right of holder of unsold shares. Also, this speaks to a foreclosing lender's obligation to pay a flip tax. Some proprietary leases exempt them from paying a flip tax, but at 75% of the closings I've done I've insisted that they pay a flip tax."

Astute use of these strategies will help increase owner-occupancy in your cooperative, and thus improve its financial condition. At the same time, relations between the board, the sponsor, the shareholders and the remaining renters may also benefit from these collaborative efforts.