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NYC Administrative Code Defines “Capital Replacement” In Terms Of Condominiums And Their Reserve Fund

December 18, 2018

By Scott E. Mollen

Condominium Conversions—Adequacy of Reserve Fund—NYC Administrative Code Definition of “Capital Replacement”

This decision involved the adequacy of a reserve fund which had been established by the defendant sponsor of a condominium conversion (sponsor). The sponsor had moved for a partial summary judgment determining that it had “properly calculated the reserve fund for the condominium” and for an order dismissing the plaintiff’s claim that the reserve fund was underfunded. The plaintiff board of managers (board) had moved for summary judgment declaring that the sponsor had failed to adequately fund the reserve fund and declaring that “certain credits taken by the defendant be disallowed.”

New York City Admin. Code (Code) Section 26-703 provides that “when a rental building is converted to a condominium the Sponsor is to adequately create a minimum reserve for the condominium.” The reserve fund is to be three percent of the total price “offered to tenants up to the effective date of the condominium offering plan (plan).”

The plan had been accepted for filing by the Attorney General on Aug. 10, 2016. The sponsor funded the reserve fund with $2,495,166. Sponsors are permitted to “decrease the total amount in the reserve fund by taking a set number of credits for capital replacements begun after the plan was submitted for filing.” The plaintiff alleged that the sponsor had, inter alia, taken “credits for work which does not qualify as a capital replacement,” and had failed to “perform work yet taking money from the reserve nonetheless.”

Code §26-703 requires that “[w]ithin thirty days after the closing of a conversion pursuant to an offering plan the offeror shall establish and transfer to the cooperative corporation or condominium board of managers, a reserve fund to be used exclusively for making capital repairs, replacements, and improvements necessary for the health and safety of the residents of such buildings.” An offeror may “fund the reserve using one of two methods; either ‘three per cent of the total price or, three per cent of the actual sales price of all cooperative shares or condominium units sold by the offeror at the time the plan is declared effective, provided, however, that if such an amount is less than one per cent of the total price, then the fund shall be established as minimum of one per cent of the total price.”

The sponsor had funded the reserve “by depositing three percent of the total price into the reserve fund.” “Under the plain language of the governing statutes, the ‘total price’ referred to §26-703(b)(i) is not the price in effect during the exclusive discount period, i.e., the so-called ‘insider price’ but rather the ‘last price offered to tenants in occupancy prior to the effective date of the plan.’”

The plaintiff argued that the inadequacy of the reserve fund was demonstrated by an affidavit from tenant “A” and an “offering sheet” provided to tenant “B.” However, “B’s” offering sheet was undated and it could not be determined whether that offer had been made prior to the effective date of the plan. Moreover, “A’s” affidavit stated that in August 2006 she received a plan but then had waited for months while some “tenants attempted to negotiate a lower price.” Those “negotiations ended approximately six months later and only then did [“A”] decide to purchase the apartment.”

The court noted that the sponsor was required to provide a reserve fund of three percent of the “last price… offered to tenants in occupancy prior to the effective date of the plan regardless of number of sales made.” The plan had been declared effective on Feb. 21, 2007. At least two tenants did not purchase their units until after they no longer qualified for the insider price. The court found that there remained “questions as to whether the tenants were offered to purchase their units at the higher price prior to the effective date of the (plan).” Accordingly, the court denied summary judgment on the issue of “the last price offered to tenants in occupancy before the effective date of the [plan].”

The court then addressed whether certain work qualified as a “capital replacement” under Code Section 26-702(c). That statute defined capital replacements as: “A building-wide replacement of a major component of any of the following systems: (1) elevator; (2) heating, ventilation and air conditioning; (3) plumbing; (4) wiring; (5) window; or, a major structural replacement to the building; provided however, that replacements made to cure code violations of record shall not be included.”

Since there did not appear to be judicial precedent which interpreted how capital replacements are defined, the court relied on the “text of the statute” in determining whether the alleged capital replacements were eligible for a credit.

The plaintiff claimed that modifications to the elevator system were not capital replacements since they were made to cure existing violations. The sponsor countered that the elevator renovations were a “complete modernization of the system” and did not constitute a replacement that was “merely to cure a code violation of record.” The court found that this issue presented a triable issue of fact. Since the elevator modernization contract failed to “itemize what services were performed,” the court could not determine if the work went beyond efforts to cure the existing violations. Thus, the court denied summary judgment with respect to the elevator work.

The plaintiff also argued that the HVAC (heating, ventilation and air conditioning) work should be reduced since the total cost of that work exceeded the estimate contemplated in the plan. The sponsor argued that the work was contemplated by the plan and “regardless of the actual price,” it was entitled to a credit. The court found that based on the language of the Code, the sponsor was entitled to recover the actual cost for the replacement of the HVAC system.

The plaintiff further argued that since the sponsor could not show that the HVAC work was actually paid for, the sponsor is not entitled to a credit. However, the statute permits “recovery for the actual cost of replacements,” and the actual costs of the replacements were conceded by the plaintiff and invoices showed the costs of the work by third party contractors. Accordingly, court granted summary judgment for the sponsor on the HVAC expense issue.

The plaintiff also asserted that the sponsor’s “addition of a single layer of roofing membrane” did not qualify for a capital replacement credit since the roof was already water-tight and it was “merely tested” not “replaced.” The plan disclosed that the building had been re-roofed on or about 1999, the roof was in “fair condition” and could be expected to last another two to four years and there were no active roof leaks.

The sponsor argued that it spent significant capital to test the roof and place a new layer of roofing membrane over it. Since there was no need to replace the existing roof, the roof was not replaced and there were merely repairs to “test cuts” made when conducting inspections, the court held that the addition of the roofing membrane did not qualify for a capital replacement credit.

Additionally, the plaintiff argued that the sponsor had improperly included terrace work as a “major structural replacement to the building.” The terrace work involved “removal of spalled cement, securing any loose materials, and patching and recoating the terraces.” Since the sponsor failed to address this issue in its brief, the court held that the terrace work failed to qualify as a capital replacement.

The plaintiff further asserted that sponsor is not entitled to credits for the replacement of 156 doors and 30 windows. The plaintiff argued that “windows, not doors, are eligible for reimbursement given that windows are expressly enumerated in the statute.” Doors are not enumerated in the statute.

The sponsor countered that sliding glass doors “should be treated as windows given that the statute describes the broader concept of a window ‘system’ and that sliding glass doors provide the same access to light and air as a window and, for many in the apartment complex, are the only access point to light and air.” The sponsor had replaced more than five times as many doors as they had replaced windows. The court looked to dictionary definitions of “windows” and “doors” and stated that “with two different purposes, and two different definitions, a door does not qualify as a window.”

However, the statute permits credits for “major structural replacements to the building.” The court cited canons of statutory interpretation which required that the court look to “the full enumerated list of replacements under the statute to determine whether the Legislature intended the replacement of 156 sliding glass doors to be considered as constituting a major structural replacement such that the defendant would be entitled to take a credit under the statute.”

Pursuant to such canons, the court held that the 156 terrace doors constitutes a major structural replacement under the statute. The court noted the sponsor’s argument that “windows and terrace doors serve the similar purpose of providing access to light and fresh air which, while expressly not mentioned in the statute, are enjoyed by the tenants” and that here, there are more “doorways in the building than windows.”

The court opined that the Legislature, “in drafting this statute, determined that there could be other major replacement costs associated with the transformation of rental units to a co-op or condominium and thus provided for credits to be granted to the sponsor for ‘major structural replacements.’” Thus, the court held that replacement of 156 “sliding glass doors falls within the type of replacement contemplated by the statute” and granted summary judgment to the sponsor with respect to the issue of windows and doorways.

Comment: Adam Leitman Bailey, counsel for the board, explained that this was an important decision which addressed several new legal issues.

I believe that the past significant increase in residential rents, (notwithstanding some recent softening in the market), coupled with proposed changes in rent stabilization and rent control laws and regulations with respect to eliminating vacancy decontrol increases, making preferential rent the base rent for future increases, limiting Major Capital Improvement and Individual Apartment Improvement increases, providing greater eviction protections, lowering rent increases on rent-controlled apartments, strengthening anti-harassment protections (some of which may be overly broad and adversely impact responsible owners), may lead some owners to consider converting their buildings from rentals to condominiums or selling their buildings to condominium converters. If that occurs, we may see increase in conversion related litigation, including disputes over the adequacy of a reserve fund.

Board of Managers of 184 Thompson Street Condominium v. 184 Thompson Street Owner, Sup. Court, New York Co., Index No. 103991/2011, decided Sept. 5, 2018, Bransten, J.

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