Rainy Day Money – Condo Style
Reserve Fund Obligations
By: Adam Lietman Bailey
July 1st, 2011
Do you live in a condominium conversion? Are your reserves underfunded? As a condo board you may be able to recover millions of dollars from your sponsor.
Sponsors of condo conversions really have only one material obligation: to provide sufficient money for a reserve fund. If they don’t leave large enough reserves, condominiums may not have sufficient capital to perform necessary remedial construction work, leaving buyers with potentially uninhabitable homes.
Discovering and prosecuting such underfunding can result in the recovery of hundreds of thousands — if not millions — of dollars to unit-owners and boards. To recover these funds, certain questions must be asked and answered: How much money must a sponsor provide? As a unit-owner, board member or managing agent, how can you discover whether your reserve fund is underfunded? Finally, what are your enforcement options?
Sponsors who file offering plans for the conversion of rental buildings to condominium ownership in New York City must comply with Local Law 70 of 1982, the so-called Reserve Fund Law. This mandates that sponsors of condo conversions provide reserve funds at least equal to statutorily calculated minimums.
Sponsors must provide a reserve fund in an amount no less than three percent of the total price of all the units offered for sale — specifically, the “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 plan regardless of number of sales made.”
In order to properly calculate the total price, a sponsor must (1) include the offering prices of all units for sale by an offering plan, and (2) use the offering prices according to the formula prescribed by the statute.
The first part is simple. The sponsor must include the offering prices of all units in its calculation. This includes residential units, commercial units, roof units, parking units, and storage units.
The second part of the calculation is more complicated, which makes it possible for a sponsor to use artificially lowered offering prices to reduce its reserve fund obligations, without the condominium board or unit-owners ever realizing that a deception is taking place. “Last price which was offered to tenants in occupancy prior to the effective date of the plan” means that the sponsor must use the price it offered to tenants in occupancy the day immediately before the sponsor declared the offering plan effective.
Rather than follow the literal and proper calculation of total price, sponsors may try to limit the amount of the reserve funds they deliver to condominiums by calculating total price based on the last discount price offered to tenants in occupancy, instead of the actual last price. Because of threshold sale requirements necessary for offering plans to be declared effective, sponsors frequently offer tenants in occupancy discount rates during the mandatory 90-day exclusive sales period, during which only tenants in occupancy may sign purchase agreements for their units.
However, it is common for sponsors to fail to meet the threshold sales requirements during the exclusive sales period, so the discount prices expire before the date the offering plans are declared effective. In these situations, the last price offered to tenants in occupancy is not the discounted exclusive insider price but the usually substantially higher price offered to outsiders.
Actually finding this discrepancy requires a bit of detective work. A typical condominium conversion goes through numerous amendments. Any one of these, not necessarily the last one, can reveal the last set of prices immediately before the plan became effective. Although it is a criminal act to do so, sponsors looking to make their reserve fund obligations as small as possible sometimes base their calculations on the lower insider price tables, figures that are actually obsolete in most cases before the plan is effective. Thus, they are relying on board attorneys’ and purchasers’ attorneys’ lack of thoroughness in checking all of the amendments to keep their low-balling calculations hidden in plain sight.