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The State of the Business Judgment Rule Appellate Court Rulings By Adam Leitman Bailey

By Adam Leitman Bailey


The greatest changes in cooperative and condominium law this past year did not come from the legislature or from the courts but from the New York Attorney General’s office (NYAG).  This article will review some of those changes and the most significant appellate cases affecting cooperatives and condominiums.

Buyouts and Conversions

With respect to cooperative and condominium conversions, the New York Attorney General’s Real Estate Finance Bureau (REFB) has focused its mission on 1) maintaining and protecting the rent regulated system and free market tenants in buildings converting to cooperative and condominium ownership and 2) increasing and maintaining the number of low and moderate income housing units.  As a result, the REFB is shifting its focus away from protecting owners suffering from buying in  poorly-built newly construction buildings.

Thus, in early 2015 the REFB’s heavily relied on a July 9th, 1986 internal Memorandum setting forth its rules with regard to buyout offers.  That memorandum stated that “buy-out offers cannot be accepted by the tenants until the Black Book is out.  There will be no exceptions to this policy—our experience of the past nine months has persuaded us that the only fair, even-handed way of enforcing this policy is not to allow any exceptions.” (emphasis supplied).  This internal memorandum was first disclosed to the public on REFB’s website almost a year ago, but it had never been published before nor had it been codified into a formal regulation.

By way of background, two types of conversions may be proposed: eviction and non-eviction.  Under an eviction plan, “a non-purchasing tenant may be evicted from an apartment by the purchaser or the sponsor after a certain period of time.” Under a non-eviction plan, a tenant may remain in the building as a renter after the conversion. Senior citizens (62 and older) and the disabled are protected from eviction although they may later buy their apartments at the price offered other tenants (at the time they make their decision). 3) The tenants usually organize themselves and hire architects, lawyers, etc., to examine the condition of the building and the offering plan itself. 4)  After the Attorney General approves the “red herring” plan, a final offering plan is made by the sponsor.  It has a black title replacing the red one of the “red herring,” and is called a “black book.”

On July 9, 2015, the REFB abolished and replaced the 1986 Memorandum.  While incorporating some of the policies of the 1986 Memorandum, writing, “The policy concerns raised by pre-red herring buyouts are the same now as they were in 1986. As such, the guidance on these buyouts set out in the 1986 Guidance Document remains in place.” However, the Memorandum does not provide “guidance” at all.  It provides inflexible rules and, as such, runs afoul of the State Administrative Procedure Act (SAPA). Under the 2015 Memorandum (M2015), “Sponsor must disclose the buyout offer and the DOL’s position on buyout agreements in the offering literature.”

If either the courts uphold M2015 or if the REFB reissues its principles as a validly promulgated regulation under SAPA, the dynamic in conversions of rent-regulated units to owner occupied units will be transformed.  Under prior law, developers routinely bought out rent-regulated tenants in order to achieve the percentages of converting units necessary to declare a plan effective.  Under the new policy, however, those percentages will no longer be available by these means.  This new policy has therefore removed from rent regulated tenants a right worth purchasing and long term tenants who were counting on such buyouts to finance their move to warmer climes now can’t. This REFB policy makes it difficult for an elderly couple in a multi-bedroom apartment to sell their rights to that apartment so that they can downsize to a unit in Florida.  (see Peter D. Salins and Gerard C. S. Mildner, Scarcity By Design (Harvard University Press, Cambridge, Massachusetts: 1992) p. 29.)

Subsequently, the regulated tenants lose the buyout monies and the housing market loses desperately needed units to be sold during this housing shortage. And the overall housing market forces home prices to remain high and unaffordable because of the large inventory of apartment kept off the market.

While the 2015 Memorandum is unclear as to precisely when the period begins in which buyouts will come under REFB scrutiny, it appears that, at the very least, any buyout agreement entered during the five months prior to the filing of the red herring is guaranteed to receive REFB disapprobation.

Legalizing an Illegal Rule

Although Attorney General’s office first protested that the 1986 and then the 2015 Memorandum were legal under SAPA, their violation of SAPA is clear.

SAPA provides for two different kinds of documents.  Under SAPA §202-e, there are “Guidance Documents” and while §202-e regulates their publication, it does nothing to define what constitutes “Guidance.”  Neither does the case law—there is none construing §202-e. However, case law from prior to §202-e’s 2004 enactment makes clear that a guideline established by an agency is considered to be a rule or regulation requiring filing with the New York Secretary of State in accordance with N.Y. Constitution, article IV, § 8 and SAPA § 202 if it is “a fixed, general principle to be applied by [the] agency without regard to other facts and circumstances relevant to the regulatory scheme of the statute it administers.” (see Matter of Sunrise Manor Nursing Home v. Axelrod, 135 A.D.2d 293, 296, 525 N.Y.S.2d 367, 369 (3d Dep’t 1988), quoting Matter of Roman Catholic Diocese of Albany v. New York State Dept. of Health, 66 N.Y.2d 948, 951, 489 N.E.2d 749, 750, 66 N.Y.S.2d 948, 951 (1985).)

Since the 1986 and 2015 Memoranda both establish inflexible requirements applied by the REFB as a rule of law, neither is valid under this body of law and the REFB must instead comply with SAPA to enact a rule or regulation under SAPA §202.

That process requires submitting to the NY Secretary of State a notice of proposed rule making, for the Department of State to publish in the State Register; affording the public normatively a period of 45 days for an opportunity to submit comments on the proposed rule.

It may take litigation to require the Attorney General’s office to follow the law, but until then converting condominiums and the sponsors, tenants and potential buyers will be unjustly harmed as a result of the illegal rule.

Adam Leitman Bailey is a founder and partner at Adam Leitman Bailey, P.C., a real estate law firm based in Manhattan. Dov Treiman, the firm’s landlord-tenant managing partner, contributed to this article.


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