What Your Board Should Know
The Right of First Refusal
Co-op boards are notorious for scrutinizing potential shareholders. Condos, on the other hand, are often thought of as more lenient—and thus more desirable—by buyers because condo boards lack the power to probe too deeply into a buyer’s personal business. While this might be attractive to purchasers, it means the board has less control—and often little say—in who resides in their building.
But your board doesn’t have its hands entirely tied when faced with a sale it doesn’t approve of. Nearly every condo has the right of first refusal or (ROFR) written into its bylaws, but exercising it should not be done hastily. Here’s what you need to know.
The first right of refusal is available to nearly all condo boards, and is written into the condo bylaws. It can be exercised for a number of reasons.
“The right of first refusal exists to enable a condominium to exercise some degree of control over the transfer or leasing of apartments,” says attorney Aaron Shmulewitz, Esq., of Belkin Burden Wenig & Goldman, LLP in Manhattan. “In other words, to enable a condominium to control to a limited extent who owns and occupies apartments in the building. Most condominiums have a right of first refusal, but a small number do not.”
Most commonly, there are three reasons a board would want to exercise its right of first refusal. According to Stanley M. Kaufman, at Kaufman Friedman Plotnicki & Grun LLP in Manhattan, a board would invoke its right of first refusal: “First, to allow the condo board to prevent sales to persons considered undesirable. Second, to allow the board to acquire space that may be needed for condominium purposes—such as a superintendent’s apartment. And third, to possibly enable the board to make money on a resale if the unit is being sold below value.”
In the case of a below-market sale, the board might invoke its ROFR to prevent the sale from going through and becoming a sale of record, thus affecting the appraisal value of comparable units in the building.
“It can be used to help preserve price levels in the condo, which happens when a below-market sale is going on,” says Bruce Cholst, a partner at the law firm of Rosen & Livingston in Manhattan. “The board would not want a distress sale to affect the value in the building. I had a condo board that saw a very low purchase price and was worried about the sale going through and becoming a sale of record, being picked up by bank appraisers and affecting comps. Bank appraisers would see a distress sale and mark it down as reflective of the market in that building. A low sale equals low appraisals across the board.”
“I have represented condominiums that have deemed the purchase price for an apartment too low, exercised the ROFR, and flipped the apartment to a ‘real’ purchaser at a higher price, thereby keeping the profit and adding it to the condominium’s reserve fund,” adds Shmulewitz.
Boards also might choose to invoke the right of first refusal in the case of an undesirable potential resident.
“It’s the one way condos can screen potential candidates and find out if there is someone whose background is not desirable,” says Cholst. “The board at least in theory has the opportunity to do a background check and otherwise review who is coming into the building. They have the opportunity to preempt the purchase by exercising their right.”
In addition, exercising the right and purchasing the condo could allow the board to use that unit to benefit the rest of the community. For example, it could be turned into a common area or super’s apartment, or even rented to generate income.
“I’ve seen condos seize the opportunity to purchase small apartments and make them community rooms or give the super an apartment he or she might not have had,” says Cholst.
Exercising ROFR: What’s Involved
Despite the fact that nearly every condo has a right of first refusal written into its bylaws, it is rarely exercised. That’s because it’s somewhat difficult to do.
“My experience has been that boards exercise the right of first refusal in only a very small number of cases—anecdotally, I would say less than five percent of the time,” says Shmulewitz. “Boards don’t do it more often because most condo purchase packages do not present factual evidence of sufficient undesirability to warrant it, and the procedural requirements of doing so are daunting.”
The right of first refusal applies to sales as well as rentals. And with any sale or rental, the board has the opportunity to exercise its right of first refusal or to waive that right.
“Condo bylaws state that in order to have the deal go forward, the deal has to be recognized by the condo association,” says Cholst. “It’s a very good way for a board to get a grip on who is coming into the building. They can articulate the contents of the board package and make it similar to a co-op package, and can justify the board package based on the idea that they have the right to make an informed decision on who is buying. When they get the package, they have to review it in a timely manner. At that stage, the condo is either going to say, ‘Yes, we’re waiving our right of first refusal,’ or ‘No, we’re exercising it.’ They must produce documentation that they have the requisite owner approval to exercise the right. The deal is contingent on the condo exercising its right of first refusal. The bylaws state that if the board does not exercise its rights within a certain period, it is deemed waived.”
If the board does choose to exercise its right of first refusal, there are several steps it must take to proceed properly.
“The exercise of the ROFR usually—but not always—requires approval by a two-thirds unit owner vote, which is extremely difficult to obtain,” says Kaufman. “In addition, the condo board typically will not have enough cash on hand, and the time frame set forth in the by-laws usually makes it more difficult if not impossible for the board to raise the needed cash.”
“Usually, depending upon the bylaws, there will have to be a unit owners’ meeting and vote. If approved, the board will have to notify the buyer that the deal is dead, the board will have to substitute its down payment for that of the buyer, and there will then be a real estate transaction and ultimately a closing,” says Kaufman.
The board will have to make the purchase based on the same terms and conditions as those of the outside buyer.
“Significantly, most bylaws also provide that a board cannot exercise a ROFR without the consent of a majority of the unit owners,” says Shmulewitz.“That means that the board must convene a special meeting, or obtain written consents, within the compressed time period.”
Downsides of the ROFR
Most legal advisors agree that boards should exercise their right of first refusal only after careful consideration and contemplation—it is not a move to be made without forethought and preparation. In addition, although bylaws grant the board the right of first refusal, it cannot be used on a whim or for illegal or discriminatory reasons.
“A condominium can exercise its right of first refusal for any reason, or for no reason, though exercising it for discriminatory reasons—such as to keep an African-American or a Jewish person out of a building—would clearly be legally inappropriate,” says Shmulewitz.
While the right of first refusal has its benefits, exercising it could cause a rift between the board and the seller, and could even result in legal action.
“A successfully invoked right of first refusal could serve to keep an undesirable purchaser or tenant out of the building, and/or values [high],” says Shmulewitz. “On the other hand, a board’s exercise of the ROFR could create disharmony among the parties to that deal. It could engender litigation, and/or create a risk for the condominium should the condominium not be able to close on the purchase itself, or find a purchaser willing to do so. The condominium would forfeit an amount equal to the original purchaser’s down payment.”
Time constraints or stipulations also make it difficult for boards to successfully follow through with the right of first refusal. The process can also become costly.
“In most large condo buildings, the bylaws are designed to discourage the exercise of the right of first refusal, to promote the free alienability of units. The timeframes are difficult to manage and the board has a financial risk. For example, the board may have to rent a large space for the unit owners’ meeting, and pay counsel to attend and explain the issues. If the unit owners then do not ratify the exercise of the right of first refusal, the board will be out-of-pocket these expenses,” says Kaufman.
Then there’s the issue of a sale being done under the table, so to speak, and going through without the board even being made aware it was happening—therefore rendering the board unable to invoke its right of first refusal. In a case such as this, the board could go to court to prevent the sale from going through.
“In the typical bylaw provision, the board has the option to go to court to void the deal,” says Cholst.
It is essential that every board understand the appropriate uses, benefits and limitations to effectively exercise the right of first refusal. Applied judiciously, it can be incredibly beneficial to a board and a building, provided the board knows how to properly execute and follow through with the set procedures. With a thorough understanding of the steps it needs to take, a board will be prepared to act on this right when necessary.
Stephanie Mannino is a freelance writer and a frequent contributor to The Cooperator.