Scott E. Mollen

Condominiums—Reserve Fund—Board of Managers Alleged That Sponsor Miscalculated Reserve Fund, Claimed Reserved Fund Credits to Which It Was Not Entitled and Performed Shoddy Repair Work—Property Was Conveyed "As-Is," Subject to Certain Exceptions

A sponsor of a condominium conversion had priced the condominium units, established a reserve fund and undertook to make certain improvements on the building. A plaintiff board of managers (board) alleged that the sponsor had "miscalculated the amount of the reserve fund, claimed reserve fund credits to which it was not entitled, and…performed shoddy repair work in the building for which the board is entitled to damages."

The court had to determine the correct amount of the reserve fund. The options were (a) 3% of the total tenant-offeree price; (b) 3% of the total non-tenant-offeree price; or (c) 3% of (A) plus $71,100, the additional amount paid by a tenant purchaser, "A," for his apartment. The court also had to determine what reserve fund credit, if any, the sponsor could claim based on an elevator modernization. The options were (a) the full amount of the modernization costs; (b) the amount of the modernization costs minus $15,000, which is the stipulated cost of only curing code violations; or (c) zero. The court also had to determine whether the board could recover costs for repairing the sponsor's allegedly defective work in the building.

The court found that the sponsor had "correctly calculated the…amount of the reserve fund to be 3% of the total tenant-offeree price…." The court further held that the sponsor is entitled to a reserve fund credit for the elevator modernization cost, except for the $15,000 that was attributed to curing code violations. The court also held that the board was not entitled to damages for the repair costs it had incurred to allegedly correct the sponsor's work in the building.

The sponsor had submitted a non-eviction condominium offering plan (plan) to the Office of the Attorney General in September 2005. The plan provided for a 90-day period during which tenants could buy their apartments at a reduced price (Exclusive Period). The reduced price is sometimes called the "Insider Price".

Section 26-703 of the NYC Administrative Code (AC), the Reserve Fund Law (RFL) requires that sponsors establish a reserve fund "to be used exclusively for making capital repairs, replacements and improvements necessary for the health and safety of the residents of the building.".

The RFL mandated that the sponsor deposit 3% of the "total price." "Total price" means "the sum of the cost of all units in the offering at the last price, which was offered to tenants in occupancy prior to the effective date of the plan, regardless of the number of sales made." The RFL also permits sponsors to calculate the amount of the reserve fund based on sales occurring over a five-year period.

However, the sponsor did not choose that method for this conversion. The "aggregate price" to tenant-offerees, for all apartments in the building, was $83,172,200. The aggregate price to non-tenant-offerees was $92,348,000. The effective date of the plan was February 21, 2007. Following several amendments to the plan to "correct pricing errors," the total price to tenant-offerees was reduced to $83,077,700, and the total price to non-tenant-offerees became $93,229,000.

The RFL permits sponsors to receive credits against the "mandatory initial contribution to the reserve fund for the actual cost of capital replacements," which are defined to mean "a building-wide replacement of a major component" of certain systems. The RFL did not permit the sponsor to take a credit for the cost of curing code violations and the total permitted credits may not "exceed the actual cost of the capital replacements, or 1% of the 'total price,' whichever is less."

The sponsor had stated its intent to claim a credit of $831,722 for making capital improvements to several building systems. The sponsor established and funded a reserve fund in an amount equal to 3% of the total price to tenant offerees, less a credit of $831,722, for a total contribution of $1,663,444.

During the Exclusive Period, tenant ("A") did not purchase his apartment. Eventually, "A" purchased his apartment at the non-tenant-offeree price. The board contended that the sponsor should have used the aggregate outsider price, not the aggregate Insider Price to calculate the amount of the reserve fund. The sponsor argued that its discussions with "A" did not alter the "last price…offered to tenants" under the RFL.

The costs of curing six outstanding elevator violations was $15,000. However, the sponsor spent $200,000 doing a "total modernization" of the elevators. The sponsor argued that the elevator credit should not be reduced because "the old violations were cured, at no or negligible additional cost, as part of the elevator modernization work." The board argued that the sponsor was not entitled to credit for the elevator work, since "one of the significant purposes for which the elevator work was undertaken was to remove violations …, and the contract did not differentiate between…the work to cure violations and the portion done for other purposes."

The board also argued that work done by the sponsor was "riddled with defects, including problems with the HVAC system, the windows and doors, and the roof." In 2009, a board consultant issued a report (HLZA Report) which described the building's physical conditions, recommended proposed corrective action and estimated the cost of the remedial work. The board claimed that the sponsor should not be entitled to a $21,500 HVAC credit and a $333,800 for an alleged window and door credit due to alleged defects. The board also sought to recover $219,700, plus interest for repair costs.

The sponsor countered that the board was not entitled to the defect damages, since the plan provided for the "as-is" sale of the building. The "Special Risk Factors" part of the plan stated, inter alia, that the sponsor would not be obligated to "correct, repair or replace any or all defects relating to construction of the Units, the Common Elements, or the installation or operation of any appliances, fixtures or equipment therein, except as expressly provided in the plan." The plan further stated that sponsor would not "warrant the materials or workmanship of any Unit or of the Common Elements, [and] that the Housing Merchant Implied Warranty Law was inapplicable to the offering."

The plan disclosed that certain conditions or deficiencies existed and certain parts of the building were in "fair or poor condition" and certain work was recommended. The plan also stated that "Units were sold 'as-is' on the date of the purchase agreement, subject to reasonable wear and tear, and to sponsor's obligations under the plan and law to maintain the unit." The plan further provided that the roof was neither bonded nor guaranteed, but was in "fair condition and can be expected to last a minimum of another 2-4 years with routine maintenance."

The subject action had been commenced on April 1, 2011. The board asserted claims for a declaratory judgment, injunction, breach of contract, fraud/or negligent misrepresentation, and sought to impose personal liability on the sponsor's principals. The court previously dismissed several claims against the sponsor's principals and left the sponsor as the only remaining defendant. The court previously held that sponsor properly calculated the "total price" under the RFL. However, the court had not granted summary judgment in the sponsor's favor.

The Appellate Division had affirmed the court's prior decision and held that "under the plain language of the governing statutes, the 'total price' referred to in (the RFL) is not the price in effect during the exclusive purchase, i.e., the so-called 'insider's price', but rather the last price…offered to tenants in occupancy prior to the effective date of the plan." The Appellate Division held that the record contained "no conclusive evidence that the tenant-offeree prices set forth in (plan) were increased prior to the plan's effective date."

Following subsequent pleading amendments and motions for summary judgment, the court held there were issues of fact as to the adequacy of the Reserve Fund and whether a credit was properly taken for the elevator modernization. The court found that the tenant-offeree prices had not been increased. Although, one tenant ("A") purchased his apartment after the exclusive period, at the higher "non-tenant" price, the court held that such "one-off transaction did not change retroactively the lower price that was offered by the sponsor 'to tenants.'"

Neither the plan nor "subsequent amendments offered the Outsider Price to tenants in occupancy." The board had not cited any case in which a sponsor's reserve-fund obligations changed without an amendment to the plan "showing a uniform change in the prices offered to tenants in occupancy." The court noted that there was "no precedent…for the position that the one-off sale…should reformulate the sponsor's funding obligations." The "last priced…offered" is not "always synonymous with the Insider Price in effect during the Exclusive Period."

The court explained that reading the RFL "to require the reserve fund to wax and wane with the price of a single apartment, such as ("A's"), is unworkable and could lead to absurd results." The "total price is an aggregation of 'all units in the offering' and there is no uniform way to extrapolate this 'total price' from the price of one unit. That is why a change to the 'total price' must depend on a uniform change to the prices offered to all tenants."

The court further noted that the sponsor and ("A") had "wrangled over whether the Insider Price applied to his specific apartment, not to the 'tenants' at-large." The court stated that if the sponsor had accepted a compromise price with ("A") before the effective date, it would be "unclear how that price could then scale up to determine the 'total price' for purposes of the sponsor's reserve fund obligation."

The court also observed that the board's interpretation arguably could "lead to a manipulation by sponsors." If a sponsor sought to lower its reserve acquirement by offering a below-insider price to a single tenant just before the effective date, under the board's interpretation, the sponsor could then claim that the last price to tenants had dropped, thus, "triggering a reduction in the reserve fund." The court viewed such result as inconsistent with the statutory scheme. Thus, the court granted the sponsor summary judgment with respect to the reserve fund computation. The reserve fund was properly calculated as 3% of the total tenant-offeree price of $83,077,000 listed in an amendment to the plan.

The court also held that the sponsor was entitled to a reserve fund credit equal to the elevator modernization cost, less the "stipulated cost of only curing the code violations." The statutory scheme encouraged "large-scale improvements," and discouraged sponsors from "reaping a windfall for repairs they need to perform anyway." The board argued that the sponsor should have separately contracted to remove the violations. The court found that such suggestion made "no sense on the facts of this case. It would be the equivalent of requiring a sponsor to paint a wall prior to knocking it down and building a better one."

The court did not believe that the sponsor's failure to separately contract for the violations should result in a "complete loss of the credit, or instead a reduction proportionate to the costs of addressing the code violations." Rather, it was better to reduce the credit for the modernization by the stipulated cost of addressing the code violations, since that "harmonizes the statutory text while still policing against the kind of chicanery that the board purportedly fears." It was "undisputed that the sponsor's elevator modernization went far beyond the repairs required by the code violations." Accordingly, the court granted the sponsor's summary judgment as to the elevator repair credit and held that the sponsor was entitled to a credit of $224,762, less the $15,000 that the party stipulated would have been the cost of curing the violations.

The court further held that any damage caused by the sponsor's work "should result in an award of monetary damages, not a disallowance of reserve fund credit." The reserve fund credits are based on "statutory authority" and there is no statutory authority that contemplated a "disallowance of credit for defects in the sponsor's work." The RFL bars a sponsor for claiming credits for "replacements made to cure violations," but "include[d] no analogous provision governing defective work."

Additionally, the reserve fund credit measures "the actual cost of capital replacements," while the board's "alleged damages purport to measure the actual cost of repairing that work." The court reasoned that the appropriate remedy, if the sponsor had in fact "botched the work promised to perform in the building, is contract damages reflecting the costs the board incurred to fix the sponsor's work." Thus, the court dismissed the board's claim to disallow reserve fund credits based on allegedly defective work by the sponsor.

With respect to contract damages, the board relied on the HLZA Report. The sponsor countered that the "as-is" clause in the plan invalidates the board's claim. However, the "as-is" clause, was subject to the sponsor's obligations "under the plan and law to maintain the Unit." The court explained that the "as-is" clause "defeats 'contract claims…which are based on the architect's description of the building's condition included in the…plan and incorporated in the purchase agreements." The court held that the board's contract claim raised "fact questions about whether the challenged work comes within the contractual exceptions of the 'as-is' clause."

Since the "as-is" clause did "not necessarily cover the work that is being disputed, the board's claim cannot be dismissed as a matter of law." The board and the sponsor had stipulated as to relevant facts they believe would be necessary to resolve the outstanding issues in this case, either on a summary judgment motion or as a trial on stipulated facts.

The court found that the board failed to prove a prima facia case because the evidence did not establish that the sponsor "breached the…plan, or that the alleged breach resulted in the claimed damages." The board's only evidence with respect to the defective work claim was the HLZA Report, "which described conditions in the building more than two years after the first condominium unit was sold."

The court held that the HLZA Report did not prove the board's prima facia case. The board had replaced two terrace doors in 2012, over five years after the condominium conversion. The HLZA Report did not discuss defects in the terrace doors for those apartments. The plan stated that the roof could be expected to last a minimum of two to four years with routine maintenance and a roofing contract had been awarded to address rehabilitation of the roofing. The HLZA Report found that the "re-roofing job…was not done…in a manner that would be considered appropriate and in-line with industry standards." However, the HLZA Report did not "conclusively show that the roofing defects were caused by the sponsor's alleged work, rather than normal wear and tear or some other factor."

Accordingly, the court found that the board had not met its burden of proof on its claim for contract damages and granted summary judgment to the sponsor with respect to the reserved fund computation issue, the elevator credit issue to the extent of awarding the elevator modernization cost less the $15,000 for the cost of curing the violations and with respect to disallowance of the Reserve Fund credits for allegedly defective work and denied the board's entitlement to damages for the sponsor's allegedly defective work.

Board of Managers of 184 Thompson Street Condominium v. 184 Thompson Street Owner LLC, Supreme Court, New York Co., Index No. 103991/2011, decided Feb. 27, 2020, Cohen, J.

Motion for Receiver Denied—Plaintiffs Failed To Allege Waste or Loss of Property—Claims Involved Failure To Pay Profits and Distribution and Reduce Loan

A defendant moved to reargue a prior decision of the court. The plaintiffs cross-moved for appointment of a receiver.

The plaintiffs alleged that it had been awarded a five percent ownership in the defendant LLC. The plaintiffs had moved to enforce their ownership interest. The defendant moved to dismiss on the grounds that a prior agreement had stated that "A" had become a member of the company and no transfers could be made without "A's" consent. "A" had not consented to the transfer.

The court had previously denied a motion to dismiss the complaint, finding that discovery was needed with respect to "A's" interest. The K-1's of the company did not list "A" as an owner. The defendant contended that "A" had been appointed the manager of the company and not an owner, and therefore the absence of the K-1's did not mean that there were questions of fact as to whether "A's" consent was required and the lawsuit should be dismissed. The plaintiffs also sought appointment of a receiver to secure the plaintiffs' interest in the property.

The court found that since there were questions of fact as to whether "A" is a "true owner, since the tax documents do not indicate as such,…there are…questions whether "A" was the sole managing member as well." A prior document referred to "A" as both a "member" and as "sole manager."

The defendant further argued that notwithstanding the K-1 tax documents, it is entirely possible that an LLC may have non-shareholder and/or non-equity holding members. The court stated that such possibility is precisely why there are questions of fact, and the motion to reargue and the underlying motion to dismiss must be denied, and the parties must engage in discovery. Thus, the court denied the motion to reargue and the motion to dismiss a claim for a constructive trust.

The court then explained that a "temporary receiver should only be appointed where there is a clear evidentiary showing of the necessity for the conservation of the property at issue and the need to protect a party's interest in that property…." The court further stated that a temporary receiver "is appropriate where the party has presented 'clear and convincing evidence of irreparable loss or waste to the subject property and that a temporary receiver is needed to protect their interests….'"

The court opined that the subject allegations did not allege "waste or loss of the subject property." The plaintiffs sought to "recover money in the form of profits and distributions they claim they are owed." The plaintiffs also argued that a "loan has not been reduced and based upon the rental income it should have been done."

The court held that although these issues required "exploration, they do not support the appointment of a receiver since they are only money claims." The court emphasized that a "temporary receiver is not appropriate where the property itself does not require any specific protection but rather protection is sought to preserve money claims…." Thus, the court denied the motion for a receiver. The court granted a motion to amend a complaint to add a claim for an accounting.

Jensen v. 1050 Pacific LLC, Supreme Court, Kings Co., Case No. 516881/2019, decided April 22, 2020, Ruchelsman, J.

Scott E. Mollen is a partner at Herrick, Feinstein.