Whether Co-op Boards Can Reject a Sale Because the Purchase Price Is ‘Too Low’
“Courts have mostly rejected anti-free market tactics of the board of directors but other cases have given boards discretion to allow such rejections.” Adam Leitman Bailey and John Desiderio discuss these cases and offer that “New York needs the Appellate Division to settle this quarrel.”
Financially qualified cooperative buyer’s applications are being rejected by boards of directors solely on the basis that the purchase price is too low. Besides causing wasted time, money and distress between the individual parties, the buyer and seller and the real estate brokers, these rejections adversely affect and create an artificial market, as the seller is forced to put the unit on the market at a price that does not reflect its true value.
The inflated board-demanded prices will appear as the first entry of a Google search for building comparables or past sales, which can adversely affect prices throughout the building. Brokers fail to show, and buyers fail to view, any lower priced selling units. This artificial market may work when a market is hot and a unit has been priced poorly, but that has not been the experience in the several cases we have been involved in.
Courts have mostly rejected these anti-free market tactics of the board of directors but other cases have given boards discretion to allow such rejections. The cases and reasoning are discussed below but New York needs the Appellate Division to settle this quarrel. Board disapproval of the sale price can kill the sale and upset the shareholder’s immediate living plans and needs. A board may have a legitimate corporate purpose for evaluating the sale price, but that interest is not unlimited.
By-Laws Authorizing Boards To Set Price
It is well established that it is not unlawful for co-ops to adopt governing by-laws that require their shareholders to first offer their shares for sale to the co-op, at book value, before offering them to non-shareholders.
As the Court of Appeals explained in Allen v. Biltmore Tissue Corp., supra, 2 NY2d at 541:
The courts have almost uniformly held valid and enforceable the first option provision, in charter or by-law, whereby a shareholder desirous of selling his stock is required to afford the corporation, his fellow shareholders or both an opportunity to buy it before he is free to offer it to outsiders…[T]his first option provision is in the nature of a contract between the corporation and its stockholders and, as such, binding upon them…[A] by-law provision against transfer by any stockholder…of any shares until they [have] first been offered for sale to other stockholders at book value, was sustained as reasonable and valid. (Internal citations omitted) (Emphasis added).
In Jones v. Surrey Cooperative Apartments, 263 AD2d 33, 36, 700 NYS2d 118 (1st Dept. 1999), the plaintiff cooperative tenant failed to raise an issue of fact as to whether defendant cooperative corporation’s exercise of an option contained in the corporation’s by-laws to repurchase her shares at book value, as opposed to market value, was “unjust and unconscionable,” and thus beyond the scope of protection afforded by the business judgment rule.
The court directed dismissal of the plaintiff’s complaint and judgment for the corporation, holding that plaintiff “bore the burden of making the requisite showing that the board of directors breached its fiduciary duty,” and that “absent a showing of discrimination, self-dealing or misconduct by board members, corporate directors are presumed to be acting ‘in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.”
In Buttitta v. Greenwich House Co-op Apartments, Inc., 11 AD3d 250, 251 783 NYS2d 26, 27 (1st Dept. 2004), the court upheld a board’s right to enforce a bylaw that prevented plaintiffs from selling their shares in the co-op on the open market and requiring them to offer the stock first to the co-op at a below-market price.
The court noted that documentary evidence, consisting of minutes of shareholder and board meetings, “conclusively establish[ed] that plaintiffs, who are husband and wife and joint tenants of the unit in question, [had] ratified the bylaw in issue by their votes at meetings where the cooperative’s right of redemption was either exercised or waived with the specific proviso that the waiver was without prejudice, and [they were] therefore precluded from challenging it.”
In such cases, “specific performance of an agreement to convey will not be refused merely because the price is inadequate or excessive. The difference must be so great as to lead to a reasonable conclusion of fraud, mistake, or concealment in the nature of fraud and to render it plain inequitable and against conscience that the contract should be enforced.” Palmer v. Chamberlin, 191 F2d 532, 540-541 (5th Cir. 1951) (cited with approval in Allen v. Biltmore Tissue Corp., supra, 2 NY2d at 541).
Where Sales Are Not Restricted
When corporate charters or by-laws do not require shareholders to sell their shares to the co-op or other shareholders at either book value or some other set price, board review of the sale prices of proposed transfers is generally subject to the business judgment rule. Nevertheless, where a co-op’s proprietary lease directs that consent to a sale or transfer of shares “shall not be unreasonably withheld,” a “’heightened standard of reasonableness’ is to be applied in lieu of the usual business judgment rule.” Matter of Kotler v. 979 Corporation, 191 AD3d 473, 474, 142 NYS3d 495 (1st Dept. 2021).
Most decisions of New York trial courts, which have adjudicated cases involving claims of board rejection of “too low” sale prices, have, ruled that the plaintiffs have sufficiently alleged causes of action against the co-op board defendants for unreasonable restraint on alienation in violation of the business judgment rule. Nevertheless, at least one case, citing the business judgment rule, has held that, in the absence of any non-speculative discriminatory, self-dealing, or bad faith motive, the sale rejection is within the purview of the board’s authority to deny its consent “for any reason or no reason.”
In Hershkowitz v. White House Owners Corp., 2010 WL 1416206 (N.Y. Sur.) (Surrogate’s Court, Nassau County, 2010), a decedent purchased a co-op unit for $425,000 with a mortgage. Upon death, following a foreclosure proceeding, the administrator executed a contract of sale for a purchase price of $141,000, which received lender approval for a “short sale.”
The corporation moved for summary judgment contending, in part, that it had a right to reject the sale on the grounds that an inadequate price would diminish the value of other apartments. The estate contended that the corporation’s authority was not unlimited, that the corporation had not acted in good faith, and that the corporation’s rejection of the sale constituted an unreasonable restraint on alienation.
The Surrogate’s Court held that, “[w]here a lease gives the board of directors of a cooperative apartment unlimited discretion to withhold consent to a sale, the business judgment rule prohibits judicial inquiry into a decision made by the board taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes,” but, nevertheless, “whether or not the corporation acted in good faith, and [was] therefore entitled to protection of the business judgment rule, [could not] be determined on a motion for summary judgment.
Cases Condemning ‘Too Low’ Decisions
In Chappell v. Trump Plaza Owners, Inc., 2011 WL 5024488 (N.Y. Sup.), 2011 N.Y. Slip Op. 32661 (U) (Trial Order), a shareholder sued her co-op for damages when the corporation refused to consent to a transfer of her shares to her contract vendee. The shareholder alleged that the board refused to interview the prospective purchasers because the purchase price was “too low,” even after the original contract price of $599,000 had been increased to $675,000.
The court recognized that the corporation had a legitimate interest in securing the highest possible price for the sale of its units, and that the proprietary lease gave the board broad discretion to withhold consent “for any reason or for no reason.” However, the court denied the co-op’s motion to dismiss the complaint, holding that the shareholder had sufficiently alleged a cause of action for unreasonable restraint on alienation because the shareholder’s counsel, in opposing the motion, had attested on personal knowledge, that the board had acted in bad faith by “preventing sales at market price, and [thus] requires shareholders to set an artificially high price as the contract price (which increases the flip tax paid at closing).” (Italics in original).
In Cohen v. Seward Park Housing Corporation, 7 Misc.3d 1015(A), 801 NYS2d 231 (N.Y. Sup., New York Co., 2005), the husband-and-wife shareholders, who already owned three units of the co-op, contracted to purchase the shares and proprietary lease of an additional unit that was contiguous to other apartments they owned. When the shareholders applied to the co-op board for consent to the transfer, the board responded by asserting the corporation’s “right of first refusal” on the ground that “the purchase price was too low or not within the market range for such apartments.”
Although the shareholders claimed that the $160,000 price was within the fair market price range, when the apartment remained unsold for several months, the shareholders increased their purchase offer to $198,000. Nevertheless, the board continued to withhold its consent to transferring the unit to the plaintiff shareholders. More than a year after the shareholders first applied for board consent, the shareholders overheard construction work being done and learned that the apartment had been sold for $230,000.
The shareholders sued alleging that the board had acted in bad faith, without a legitimate purpose, and in a discriminatory manner. They noted that they had never been in default, had excellent financial qualifications, that the board had approved applications by other shareholders and residents (including that of a board member) to purchase similar apartments at prices equal to or below market price, that those other shareholders had personal relationships with board members, that the board had not asserted the corporation’s right of first refusal against any of those similar transfers, and that certain board members had “personal animosities” against them. On these alleged facts, the court denied the corporation’s motion to dismiss the plaintiff’s cause of action for breach of fiduciary duty.
The court held that plaintiffs “[had] not simply asserted that the board holds personal animosity toward them, but have set forth circumstances which, if true, show a board seemingly unwilling to allow them to buy the apartment they wanted at any price for a reason which could be understood as exhibiting animosity,” and that “[a] showing of unequal treatment is sufficient to allege bad faith.” (Emphasis added).
In Oakley v. Longview Owners, 165 Misc2d 192,195, 628 NYS2d 468 (Sup. Ct, Westchester Co., 1995), the co-op board refused to approve the sale-assignment of the shareholder’s apartment. The board’s refusal was based, in part, on the sale price being less than a cooperative wide floor price adopted by the board after an appraisal of one-and two-bedroom apartments in a 160-unit complex. Only two of the 160 apartments were appraised.
The shareholder’s contract sale price was $37,000, and the cooperative-wide floor price was $49,000. Although the price restraint was dependent upon real estate market forces beyond the control of either party, the court held that, the restraint constituted an “open-ended and potentially long-lasting prohibition,” and “as adopted” was an unreasonable restraint on alienation.
The court also noted (a) there was no indication that the board had acted in accordance with authority given it in the co-op by-laws, and (b) there was no evidence that the shareholders were ever given prior notice of the board’s price resolution and an opportunity to vote on the restriction.
In Marine Midland Bank v. White Oak Cooperative Housing Corp., 1997 WL 34823122 (N.Y. Sup.) (Trial Order), the occupancy agreement of the corporation provided that if a stockholder-member notified the corporation of its intention to leave the project, the corporation had 60 days, but not the obligation, to purchase the member’s stock and occupancy agreement. If the corporation did not exercise its option within the sixty-day period after its receipt of written notice from the member, the stock could be sold “to any person.” Citing Oakley, supra, the court held that the requirement that the member “must sell its shares at a price set by [the corporation] to be approved is an unreasonable restraint on alienation.
The court also noted that the restriction was inconsistent with the terms of the occupancy agreement. In the absence of the corporation’s exercise of its option to purchase the stock, the stockholder was permitted to sell “to any person,” and “in that instance, [the corporation] [had] no right under the occupancy agreement to restrict the price.”
As noted above, it is not unlawful for co-ops to adopt governing by-laws that require their shareholders to first offer their shares for sale to the co-op, at book value, before offering them to non-shareholders. However, when the governing documents do not contain such option provisions, trial court level cases have mostly decided in favor of striking co-op boards reject unit sales because the sale price, which may otherwise reflect fair market value, is “too low.” However, as of now, there have been no definitive appellate court rulings on this question.
Until there is a clear holding by an appellate court that outlines the parameters within which a co-op board may or may not reject a sale for a “too low” sale price, it is still an open question whether or not board rejection of “too low” share transfers can be said to violate the business judgment rule.