Boards, Sponsors, and the Art of Getting Along
Some relationships seem destined for rocky paths. Brothers and sisters. Mothers-in-law and daughters-in-law. Sponsors and boards. Although certainly not all board and sponsor relationships travel the bumpy road, many do. Understanding the whys and hows behind that discord can go a long way toward preventing trouble - or mending fences and setting a smoother future course for relationships that already have gotten off to a poor start.
Where It All Begins
The basis of most disagreement between boards and sponsors usually stems from just how involved the sponsor decides to stay once a building has gone co-op or condo - and that amount of involvement is decided by the sponsor from the beginning, as soon as he or she prepares an offering plan. The plan is the first step toward converting a building to co-op or condo status. "The sponsor's responsibilities are whatever the offering plan says they are and those vary in each case," says Stuart Saft, an attorney with Manhattan-based Wolf Haldenstein Adler Freeman & Herz LLP. "It's up to a sponsor to decide how active he [or she] will remain."
The offering plan details every aspect of the building in question, down to the last square inch in the basement's darkest corner. Before conversion can begin, the plan must be approved by the Attorney General's office - a process that can take up to a year to complete.
In a non-eviction plan, for a conversion to take place, the sponsor must sell at least 15 percent of the building's units. The plan can then be declaired effective. The building is then considered a co-op or condo, whether or not the sponsor sells the rest of the units. When the sponsor surpasses the initial 15 percent mark, the co-op owners are issued their shares and the condo owners get their deeds. At this point, a board is elected.
If the sponsor retains more than 50 percent ownership, he is de facto in control of the board, with control over enough seats to hold a majority in any vote. "If there are five seats on the board, he can designate three for himself," says Jules Reich, president of Somerset Investors in Great Neck, N.Y. "Generally speaking, although the sponsor may have the final vote on things, it would be unproductive for him to operate this way. The best idea is for the sponsor and the board to work together in the best interest of the building and its residents."
While the sponsor decides just how many units he or she will sell, that percentage is often dictated by other mitigating factors, including the fact that many buildings have a certain number of rent-regulated units. A sponsor is not legally allowed to remove those tenants from the building and cannot take possession of their units. "Rent-regulated tenants have the right to hold on to their property in perpetuity," Reich says. "A couple of our buildings still have people in them from the 1980s," Reich says.
The sponsor is responsible for paying the maintenance fees on these units. These fees are often burdensome, sometimes totaling up to more money than the sponsor is receiving in rent. To offset these costs, the sponsor may hold onto other non-regulated apartments, leasing them out at current market prices and thereby offsetting the loss taken on the rent-regulated apartments. In other cases, the sponsor may hold rental apartments as an investment. The number of units held in possession by the sponsor, then, is often a financial decision. Many times, this is why a sponsor continues to play a part in a converted co-op or condo building, long after either he or the board members really care to have him involved.
Ultimately, though, the sponsor must relinquish board control after five years, no matter how many units are still in his possession. They are still allowed to hold a seat on the board and vote on board matters, but they cannot create an artificial majority for themselves. The board, at this point, "makes all the decisions on every aspect of the building's operation," Saft says. "In a building that's successfully converted, the sponsor has little control."
A Few Frayed Tempers
It's just the nature of the beast that when control is in question, people will squabble. "There is just a basic dislike between buyers and sponsors," Saft says. "Buyers always feel that they overpaid for their units and sponsors always feel they did people a favor just letting them move into the building in the first place. There's just nothing you can do about it."
One of the biggest reasons for disagreement stems from the number of units remaining in the sponsor's possession. "The biggest thing is that people have their own agendas," Reich says. "On the one hand, the sponsor may not sell all the units. He's holding on to some free-market units. The board will say they want him to sell because the co-op will be better off with more owners. Owners, they argue, give the building more tender loving care." The sponsor, however, may be holding on to the units by necessity to offset costs or he or she may be desirous of keeping the units to further their profits. "Everyone sees things from their own point of view."
There is and seemingly always has been a natural tension between boards and sponsors, says Bellmarc Companies principal Neil Binder. "There is a unique interaction on a rather recurring basis, because the board's objective is to try to create a home environment which augments the quality of the service to the respective homeowners. The sponsor's objective is to try to maximize his profitability through the sale of the units."
And these divergent interests are what most often leads to misunderstandings between the board and the sponsor, says Binder.
Saft agrees. "That natural tension between sponsor and board leads into who spends money to upgrade and maintain the building," Saft says. "Sponsors don't want to put money into the building because their rent is fixed and they can't make any more money off their rentals." But owners want improvements made to the building to improve not only their living conditions, but also the value of their investment.
Building conditions and maintenance can lead to other squabbles, such as who pays for repairs if something does go awry. The sponsor can also control how personnel in the building are allocated to complete repairs and the frequency of those repairs, claims Binder.
"Shareholders might blame the sponsor who converted the building for leaving it in poor condition," Reich says. "Now they believe that the burden of repairs falls on the sponsor. Shareholders might believe that the sponsor knew "in his heart' that there might be problems and didn't address them."
And, adds Saft, "the suspicion that a sponsor is covering things up that they didn't disclose at the time of the conversion can be a significant problem." Shareholders might believe that the repairs might be done haphazardly or with a "degree of frugality" that doesn't serve the best interests of the board and its shareholders, says Binder.
With a sponsor in control of the board, other conflicts stemming from procedural bypasses can come into play. Unlike shareholders or owners, sponsors do not have to have their rental parties approved by the board before admitting them into the building. "Because the sponsor doesn't need board approval, he might put some people in his apartments who might not otherwise be approved by the board," Reich says. "The shareholders might not be pleased with the sponsor's choice of tenant."
The conflicts inherent in the whole renters-versus-owners question rears its head again in instances where board members might feel that building employees are doing work for the sponsor's units when they should only be doing work in service of the co-op or condo itself. If the board or residents feel that they are paying staff to tend to their interests when in fact those staff members are attending to the interests of renters, the question of funding and who is bearing the brunt of maintaining the building can become a contentious one.
The question of management itself often becomes a hot issue. "I always recommend against a sponsor's management company running a building because there's too much built-in suspicion," Saft says. There's a general mistrust, many times, and the board or residents may think that any manager hired by the sponsor will only have the sponsor's interests at heart.
"Owners will believe that if the sponsor says they should do "x;' then they should instead do "y' because he's probably trying to cheat us," Saft says. "But this is an unfortunate way of thinking, because the owner knows the building and has dealt with it longer." In short, the sponsor's concerns should be addressed - not simply dismissed on grounds of suspicion and potential ill-feeling.
Still, when control of the building reverts to the shareholders, they will often let go of the sponsor's manager and get their own. "Too often when shareholders get control, they think the management has been taking advantage of them because they've been under the control of the sponsor," Reich says. "That's rarely the case. The managing agents most often want the value of the apartments to go up. It's to his or her benefit to take care of the apartments as best they can."
When the going gets rough in the relationship between sponsor and board, the best solution is simply to play mature. Talk things over. Try to find a common ground or at least a starting point for discussion. When two parties in disagreement can't find a solution on their own, many times they will turn to a third party for help. "Usually, they'll sit down with the co-op attorney, who is generally a fair-minded individual, and talk things out," Reich says. Other times, they'll turn to a professional mediator. "But both sides have to agree to accept the mediator's decision." If mediation fails, the two sides often will turn to the courts. Reich argues that everything possible should be done to avoid lawsuits, which he calls "very expensive and very, very time consuming."
Unit owners also have the option of filing a complaint with the attorney general's office, contending that the sponsor didn't uphold his end of the offering plan or didn't fully disclose all of the pertinent facts contingent on managing the building. But, says Binder, the attorney general has in practice limited his involvement to only that area of full disclosure and will leave any dispute to the purview of the courts, which can be a frustrating situation.
The best-case scenario, however, is to never let a situation get so out of control that mediation that lawyers are needed. Part of it is accepting that disagreements will happen in any business venture. "In a weak market, people are always unhappy," Reich says. "In a strong market, no one ever complains. It's as normal as breathing."
Working together will pay off for everyone involved, from the sponsor to the board to the residents. "If you have a situation where the board and sponsor work together, you can accomplish more for less money and get better results," Reich says. "Try to work together to do what's best for everyone." And that seems like sound advice in any situation.
Liz Lent is a freelance writer specializing in real estate.