July 16, 2020
The case 1513 Lexington Ave. v. Barlas provides a textbook lesson on what happens when co-op and condo boards fail to do their due diligence. They might wind up getting made whole, but it won’t be cheap or easy.
Our lesson begins when Phaedra Barlas, who was on the five-member HDFC co-op board 1513 Lexington Ave., sold her unit. A buyer was approved by the board, the shares were transferred, and the new shareholder moved in. Only then did the managing agent of Harlem Property Management discover that the $40,000 flip tax, due under the governing documents, was not paid. Neither the board nor management knew why the flip tax was not collected earlier in the sale process. The board called in the co-op’s attorney, Massimo F. D’Angelo, a partner at Adam Leitman Bailey.
“What happened was that Barlas had a document, signed by the board president, with a resolution that for this sale only the flip tax would be waived,” D’Angelo says. “There was no reason given in the document why she would not have to pay the $40,000. Barlas might have doctored the whole document.”
Was the document a forgery or an illegal transaction between the board president and Barlas? It’s unlikely the answer will ever be known – because the board president has since died. “Barlas had given the document to her lawyer, who was also her transfer agent,” D’Angelo says. “I think light bulbs should have gone off when her lawyer was presented with such an unusual resolution. But he decided to say nothing.”
D’Angelo filed suit and tried to serve a summons on Barlas. “She could not be found,” he says. “Barlas moved from apartment to apartment and ducked the service every time. It was incredible. She finally ended up moving back to Massachusetts.”
D’Angelo was running out of time because the law says a summons must be served within 120 days. The court granted an alternate manner of service – via email – which is rarely approved, and D’Angelo finally succeeded in serving Barlas with the summons.
Barlas then turned to the HDFC’s directors and officers insurance because she was a director when the sale went through. This insurance includes two kinds of protection for board members: first, it provides legal defense for the board member; and second, it provides indemnity, meaning that if a judgment goes against a director, the insurance carrier has to pay the amount of that judgment.
“However, no policy will cover a director who engages in a fraud, like we have here,” D’Angelo says. “The insurance’s duty to defend is a lot broader than the duty to indemnify. As soon as a director is sued under the policy, the insurance carrier will almost always provide the defense.”
The parties quickly agreed to settle the case out of court. “The insurance carrier decided to pay the HDFC the $40,000 flip tax immediately instead of running the risk of paying a fortune down the road in litigation, which might drag on for years,” D’Angelo says. “The co-op settled because we didn’t want to engage in protracted litigation.”
So Barlas got away without paying the flip tax, and the co-op was made whole – but at a price. In today’s so-called hard insurance market, the payment of a sizable claim will almost certainly result in the carrier charging higher premiums on future insurance policies. All the more reason this textbook lesson is worth heeding: always do your due diligence before you get to the closing table.
“I highly recommend that boards be guided by their legal counsel and management professionals in these kinds of financial transactions, when the co-op is owed money,” D’Angelo says, “especially when it comes to the collection of flip taxes, which should be paid before shares, stocks or leases are transferred to a new shareholder.”