Courts Rule on Underfunded Condominium Reserve Funds
By: Adam Leitman Bailey, P.C.
Sponsors of condominium conversions really only have two material obligations: to convert the form of ownership and fund the reserve fund. The formula for determining the amount of the reserve fund is set forth in New York Administrative Code Section 26-702(b) (the “Reserve Fund Law”). Historically, sponsors have interpreted the statutory funding requirements to their benefit, usually to the detriment of the condominium unit owners. For a long time, since the last published decision in 1996, the courts were silent regarding interpretation of the Reserve Fund Law. However, recently, two courts have ruled on the interpretation of the Reserve Fund Law in two very important cases: Board of Managers of 184 Thompson St. Condominium v. 184 Thompson St. Owner LLC, and Board of Managers of Cathedral Tower Condominium v. Sendar Associates LLC et al. These cases can have a major effect on the amount of money that sponsors are required to deposit in condominium reserve funds.
Reserve Fund Requirement
The Reserve Fund Law states that sponsors must provide a reserve fund in an amount no less than three percent of the total price of all of the units offered for sale, specifically, “[t]he sum of the cost of all units in the offering at the last price which was offered to tenants in occupancy prior to the effective date of the [offering] plan regardless of number of sales made.”
However, many sponsors are not using the actual “last price” as a means for calculating the total price of all units offered for sale. Instead, they are calculating total price based on the last discount price offered to tenants in occupancy, even if those prices had expired long before the effective date of the offering plan. This, of course, results in a lower total price and therefore a smaller reserve fund for the condominium. Most condominium boards are unaware of this practice. However, in the two cases cited above (184 Thompson and Cathedral Tower), condominium boards discovered the underfunding and challenged their sponsors in court.
The board of this condominium asked the Supreme Court of New York County to rule that the condominium’s sponsor used the discount exclusive period purchase prices to calculate the Total Price even though those prices had expired before the effective date of the offering plan. In its May 2013 decision, the Court directly quoted the last published reserve fund case (the 1996 case entitled Turtle Bay Towers Corp. v. Welco Assoc.), stating “the ‘total price’…is not the price in effect during the exclusive purchase period, i.e., the so-called ‘insider’s price,’ but rather the last price…offered to tenants in occupancy prior to the effective date of the plan.” While the Court held that the Board had not yet provided sufficient documentation to show that the Sponsor had, in fact, raised the “insider’s price,” the Court’s support of the Turtle Bay holding confirmed that the “last price” actually means the last price at which a tenant in occupancy could have contracted to purchase his or her unit immediately prior to the date the offering plan was declared effective. The Courts ruling opens the door for the condominium board to establish through discovery that the unit prices were, in fact, raised before the date the offering plan was declared effective.
A year later, in May of 2014, the Supreme Court of Nassau County followed the First Department holdings of both Turtle Bay and 184 Thompson. Referencing those cases, the Court held that “[a]bsent governing Second Department authority to the contrary, these rulings are authoritative.” The Court referenced and agreed with the First Department cases of both Turtle Bay and 184 Thompson that “under the plain language of the governing statutes, the “total price”…is not the price in effect during the exclusive purchase period, i.e., the so called ‘insider’s price,’ but rather the last price offered to tenants in occupancy prior to the effective date of the plan.” The Court further agreed that “the First Department properly construed the definition of ‘total price’…as the price in effect just prior to the effective date and not, as contended by defendants, the price in effect during the purchase period, i.e, the ‘insider’s price’.”
Both the First and Second Departments have now adopted the strict and plain meaning of the calculation of Total Price. If the discounted “insider” prices expire prior to the date an offering plan is declared effective, sponsors are compelled to fund the reserve fund based on the significantly higher price to so-called “outsiders” rather than the discounted “insider” price.
Unit owners and boards of condominium conversions should scrutinize their reserve funds to ensure that the condominium’s sponsor has complied with the calculation of Total Price. Discovering and prosecuting underfunding can result in the recovery of substantial dollars for the condominium. If sponsors wish to fund reserve funds based on the discounted “insider” prices, then they should take care in how they draft their offering plans. The discounted “insider” prices must be available to tenants in occupancy through the date that the offering plan is declared effective in order for them to use those lower prices in their calculation of the reserve fund.