You’re In Charge Now: Transitioning from Sponsor to Board Control
By: J.M. Wilson
November, 2012
Launching a successful business requires talent, the commitment of many people, dedication and of course, a clear cut plan and strategy. Just like launching a business, a co-op or condo needs this kind of support when it makes the transition from sponsor-run to board run.
Of course, like any new business there are going to be pitfalls and unforeseen difficulties…the transition is rarely smooth. At times it may seem daunting if not impossible to take the foundation of a co-op or condo and build a solid, stalwart, fully-functioning community—especially if the sponsor and the board in question have differing ideas of how to accomplish it.
One thing is clear though, if the sponsor and the new board remain focused, communicate clearly, stick to a strategy and bear in mind the greater good of the community, it can be accomplished and all the hard work will be rewarde
Taking Over
The United States has the Constitution and the City of New York has its Charter—these documents are the framework that detail how government works, a set of operating instructions if you will. In the same sense, your co-op or condo will have a set of governing documents, which will spell out in detail how your community will be run. These are the bylaws and they determine how your board or association will function, and how the transition of power will take place: from the sponsor who created the development to the residential board members, who will now take over the day-to-day operations and responsibilities.
Attorney Leonard H. Ritz, of the Manhattan law offices of Adam Leitman Bailey P.C., explains that, “The transition is laid out in the bylaws.” He explains that, in most situations, the board will be comprised initially of friends, employees, or other designates of the sponsor. As more units are sold within the building that number will slowly shift.”
Once the date for the transition has been decided, Ritz explains that, “on day one, all board members are designated by the sponsor.” At the first owner meeting, elections are held. Over time, the board will be filled with more actual residents and fewer members chosen by the sponsor until the residential members have a clear majority. Eventually, if all goes as planned, the sponsor will have little or no representation on the board.
Conversion scenarios are somewhat different. In this scenario, the sponsor has to relinquish control of the board once 50 percent of the units have been sold, or after five years. In this scenario, there is a firm deadline of transition regardless of percentage, which the sponsor may still control, says Anthony Morelli, a real estate attorney in Manhattan specializing in co-op and condos. He explains that with new construction, the sponsor has the right decide what at what percentage they must turn control over, but just as in the conversion scenario, they must hand control over in five years.
Learning the Ropes
A new organization is a lot like a child, and just like a child, a newly-formed board has to learn how to crawl before it can walk. There will be missteps and mistakes at the beginning as the new board members learn their roles, duties and responsibilities. According to Ritz, one of the biggest challenges for a new board is basic: they have to learn how to run a building. This may seem obvious, but in reality, learning how to become leaders and decision-makers can be a significant challenge for some people. Once the sponsor has faded into the background and has handed over the responsibility to the board, the board now has to bear the responsibility on their own.
“They’re learning how to balance the needs of the building. They might need to make assessments that they’ll have to pay and so will the people around them. It can be difficult,” says Ritz. He explains that this can be a bitter pill for some to swallow but they have to remember that “they’re neighbors, and now they’re also managers.”
Manhattan attorney Adam Leitman Bailey adds that this transition can be especially difficult for people who are not used to making these types of managerial decisions in their everyday life. In Manhattan, for example, with its high concentration of A-type personalities and high-level business people, “many board members have been on boards before,” so they know how board meetings work and how decisions are made by committee, notes Bailey. In other instances, a building’s board members may have no experience at all and will need to be taught the basics, right down to how Robert’s Rules of Order work. Again, it’s a learning curve.
The Secrets of Success
According to Bailey, he believes that one key to success is not being afraid to ask questions. “The best boards come to us before there is a problem,” says Bailey. “Problems happen when they go ahead and do something and don’t tell us.” Bailey notes that past client boards have done everything from putting a new structure on the roof without getting permits to selling off or renting common areas—both big no-no’s and both things that could have been avoided with a quick call to their manager or attorney.
One of the major problems that sometimes occurs is when the new board adopts a casual atmosphere when running board meetings. Often times the new board may become lax in following protocol and procedure. “In smaller buildings, one of the problems is thinking that the board can run things informally,” says Ritz. Not adhering to a regular meeting schedule, not maintaining proper structure can all be a source of trouble.”
Manhattan attorney Robert Gibbs recommends that all boards, both new and long-standing run meetings based on Robert’s Rules of Order. “The use of some kind of parliamentary procedure,” Gibbs explains, “is to protect the rights of members in an organization: of the majority, of the minority, of individual members, of absentees, and of all of them together.”
“However,” Gibbs adds, “I usually recommend that boards only loosely follow Robert’s Rules. The reason is to prevent overuse. New boards can get tied up in the minutia of parliamentary procedure. A new board will have to find the right balance of order, protocol and procedure…but that is far better than no structure at all.”
Another problem that tends to happens to new boards is that they can panic easily under the weight of their new power and responsibilities. New boards should also remember that “all boards have problems,” Bailey says. “Document these problems. Talk about them. A good board will create a n association-wide newsletter and, in today’s social media world, a Facebook page that will communicate news with its residents.” These very simple ideas will help a board to figure out if there are problems within the building. Sometime these problems might be something that the board will want to inform the sponsor—if the sponsor is still involved in the management of the building.
Also, says Morelli, when the board first takes full control, “I always warn new boards to not make any quick and drastic changes, like getting rid of the property managers. It’s best to ease into their new responsibilities and learn the ropes. You can’t take over and immediately fire everyone. These new buildings are as complicated as a battleship,” he says. “Frequently, a new board will take over and say, ‘let’s get rid of everybody, which is fine if it’s the lawyers or accountants, but it’s not okay if it’s the managers.” They are the folks who know how everything works, an important skill when it comes to keeping residents happy.
Morelli advises that new boards err on the side of caution. “These new board members now have a fiduciary responsibility,” he says. “When they first take over they can make many assumptions that may not be correct, because they don’t know the full story. As they ease into their positions they will learn and then be able to make informed decisions, which are more likely to be the proper decisions.”
Development Issues
Just like the neophyte board, a building’s sponsor or developer likely will face difficult issues with the creation of a new condo or co-op. Perhaps the biggest issue, in addition to ongoing difficulties over construction or renovation, can be selling units.
Not selling apartments can lead to potentially serious issues between the sponsor and the residents. Such was the case with a 66-unit co-op at 511 West 232nd Street that became embroiled in a decade-long court case known as 511 West 232 Street Owners Corp. vs. Jennifer Realty Corp. When the building originally went co-op in the late 1980s, slightly more than 20 percent of the building’s formerly rent-controlled units were sold, says attorney Mark Axinn of Brill & Meisel in Manhattan, who represented the sponsors.
In the early 1990s, the real estate market in New York began a long, dramatic slide, making it difficult to sell property. By the time things had stalled out, the sponsors had sold roughly 38 percent of the units. The sponsors then began to rent units, leading to unit owner unrest and soon, a lawsuit contending that the sponsors had breached the spirit of the governing documents by not selling a sufficient number of units to create a fully viable co-op.
The reason for the troubles, says Manhattan-based attorney Beatrice Lesser of Gallet Dreyer & Berkey LLP—who represented the residents—was the high percentage of rentals. “There was a lot of changing of tenants, leaving and moving in the middle of the night,” she says. “The building had an influx of people who likely would not have lived there if shareholders were in control.” There were also issues, says Lesser, with regard to upkeep of the building as well as the financial well-being of the co-op. “Shareholders couldn’t sell their units unless the buyer bought it in cash because the banks wouldn’t finance,” she says. “And there was a big limitation on refinancing for the building because of sponsor presence.”
The case went on for 10 years, during which time the demand for housing in New York improved dramatically and “the sponsor started selling again, completely driven by the market,” Axinn says.
Settlement on the case was reached this year with the co-op and plaintiffs agreeing that the sponsor did not have an obligation to sell any unsold apartments, according to the settlement agreement. The co-op also partially reimbursed the sponsors for defense legal fees.
The case created ripples that have been felt throughout the co-op community, and many attorneys have taken it as evidence that there is an implied responsibility on the part of the sponsor to sell shares in a timely fashion.
Without good faith from the sponsor, though, co-op residents can suffer enormously at the hands of potentially unscrupulous sponsors, says Lesser, especially those residents who do not know that the situation could be better for them.
“Not everyone who buys a co-op is from Park Avenue,” Lesser says. “A lot of people are working class, immigrants, in the other four boroughs, people who are possibly not equipped to deal with these types of sponsors.” And sometimes, because residents might not know that alternatives exist, “you can’t muster up enough people to take on the board and make things better,” Lesser says.
Ultimately, the relationship between a sponsor and the board can be a rocky one in the beginning. Conflicts can ensue and yes, things can get ugly. That’s why good faith from both sides, a willingness to discuss issues and also, a willingness to talk to experts and understand each other’s rights and responsibilities, are all vital to a harmonious transition.