Mixed-Use Buildings Facing the Potential for Conflict

Many co-op and condo board members know the difficulty of working to resolve arguments between residents. In mixed-use buildings, the problems may be greater. With both commercial and residential unit owners or shareholders in a building, the board may find the disputes unmanageable. Compromise may seem unworkable, because the two sides have such fundamentally different interests.

There are several common varieties of mixed-use buildings. Many condos have both commercial unit owners and residential unit owners. Co-op buildings often have professional apartments, and less frequently, retail or other commercial space. Buildings referred to as "cond-ops" are actually condominium buildings with only a handful of units. One condo unit is owned by a cooperative apartment corporation and divided into residential co-op apartments. The rest of the building can be one or a small number of commercial condo units.

Recently, litigation between commercial and residential shareholder/ owners seems to be increasing. Of course, this may be because the number of mixed-use buildings is also increasing. It also may be because problems develop over time. Generally, conflicts do not mature until after the project has been sold by the sponsor, and direction of the board turned over to the residents. This could be because until the project is largely sold, the sponsor has a significant incentive to prevent disputes. Also, until they are in control, the opportunity for residents to raise concerns is limited.

Regardless of the form of organization, many - if not most - disagreements between the different kinds of owners are almost unavoidable. It can be argued that they are often caused by the sponsor's initial development strategy. Frequently, sponsors are more eager to sell residential space than commercial space. This may be because the profits in renting commercial space can be greater, and may be significant depending upon the location. In any event, potential purchasers of commercial space are likely to be more sophisticated than residential purchasers.

With this in mind, the sponsor may develop the project to favor the commercial space. One common way is to understate the percentage of common interests or shares given to the commercial space. This will make monthly charges relatively less for the commercial owner. Years ago, this could also result in commercial condo units receiving low tax assessments in proportion to the percentage of common interests allocated to those units. However, New York City became wise to this practice, and now largely ignores the percentage of common interest when it establishes tax assessments for commercial units.

A device condo developers have used to reduce commercial common charges is provided in the New York Real Property Law, § 339-m. This particular statute permits condo boards to allocate expenses to commercial units in a manner other than according to their common interests, if authorized by the declaration and bylaws. In fact, it also permits a special allocation of expenses for any unit based on "special or exclusive use or availability or exclusive control of particular units or common areas by particular unit owners, if so authorized by the declaration and bylaws in a manner different" from the usual allocation on the basis of percentage of common interests.

Agree to Disagree

As a result, sponsors don't even have to skew the common interests to favor commercial unit owners. They can allocate common charges directly according to their opinion of what is appropriate. Sometimes, the language is not clearly written. More than one case has been brought because the commercial and residential interests could not agree on how their governing documents should be interpreted.

Sometimes, the board fights back. A condo board in one case tried to allocate residential common charges to the commercial unit owner. The court held this was not permissible, because the board was limited to allocating to the commercial unit expenses based upon the commercial unit owners' use of the common elements. Interestingly, to make its decision, the court was forced to resort to the narrative language in the offering plan, because the declaration and bylaws weren't clear enough. Of course, the offering plan language does not really bind the parties, but the court considered the language "valuable" in interpreting the documents.

In another case, the court looked at how the commercial space was charged in a cond-op and decided that it was a "factual issue" as to whether the board acted beyond the scope of its authority in making its assessments. The court couldn't decide how to interpret the language of the documents in view of what the board was actually doing. It determined to leave the matter for a full trial of the facts.

If the courts can't make easy determinations as to what the board is required to do, how can boards be sure they are right? Where the language isn't clear, but the residential and commercial owners agree on a fair distribution of expenses, the obvious thing to do is to amend the governing documents. If the parties can't agree, they may be faced with lengthy, expensive litigation. It's easy to blame the person who wrote the language, but drafting offering plans and governing documents while anticipating most future problems is extremely difficult.

Another area of dispute relates to the use of the commercial space. Sponsors like to write in offering plans that the commercial space may be used for "any lawful purpose" to make sure it is as marketable as possible. Sophisticated residents should be concerned by this, however. Most likely, the space would be used for a restaurant, deli or other use related to food, but the right to use the unit for "any lawful purpose" includes the possibility that the space would be used for "adult entertainment" or another purpose some may find unsuitable. Many New Yorkers feel that food in their building will result in noise, crowds, odors and rodents. To minimize this concern, some sponsors have been known to leave the commercial space vacant until they have sold the bulk of their residential units.

Of course, failing to insulate residents from disruptions caused by commercial activity (which may be normal for a given business but unacceptable for residential living) can also be a source of dispute. If the residential owners don't like the way the commercial space is affecting them, they may do anything they can to frustrate the commercial owner. There have been cases lasting years involving noise and vibration complaints against commercial spaces. Attempts have even been made to cut off the commercial owner's access and parking.

Special Privileges

Sponsors may also try to give special benefits to the owners of commercial units to make sure certain space outside of the commercial unit is reserved exclusively for commercial use. Again, if the language had been clearly drafted, the possibility of argument would be reduced. Unfortunately, that is not always the case.

In one case, a board was highly motivated to prevent a restaurant from opening in a small unit in a condominium. The developer had tried to reserve the right for the commercial unit owner to incorporate a portion of the condo's common space into a restaurant - without the extra space, the restaurant might have been impractical to operate. After years of expensive litigation, the operator was successful over a dissent that pointed out that incorporating the space might be illegal. The failure to clearly delineate the rights that went with the commercial unit in the declaration and bylaws led to great expense for all concerned. In fact, after winning the case, the restaurant owner still faced hurdles with the Department of Buildings that caused significant additional delay.

Another lawsuit was apparently caused by the fact that the documentation was not consistent on whether portions of the cellar were intended for commercial or for residential use. In yet another case, the commercial and residential unit owners argued about some language governing the right to use the building vaults. It's easy to say now, but if the documents were drafted more clearly, substantial expense could have been avoided.

Sometimes the sponsor does not predict a problem and the documents don't specify responsibility at all. One case arose involving whether the condominium or the commercial owner was responsible for liability insurance involving the public sidewalk next to the building. With no real help from the documents, the court found the condominium to be responsible.

It isn't surprising that after control of the board passes to residents, the board will sometimes try to reverse what it perceives to be the bias in the documents favoring the commercial units. In attempting to do so, board members often miss a key point. Just because they are residents themselves, and are elected by the majority, who happen to be residential owners, they still owe a fiduciary duty to the commercial owners. Always taking the residents' side in establishing policies may make the board a defendant in litigation with the commercial owners.

When in litigation, boards will want to use the Business Judgment Rule as a shield for their actions, but the rule may have little place in these disputes, because most are resolved after the court has necessarily wrestled with the language in the governing documents. Since no board can behave in a manner inconsistent with these documents, the documents control. Also, even if the board's action seems otherwise proper under the documents, the specific impact on one class of owners cannot be ignored, which might result in an exception to the Business Judgment Rule.

In one situation involving a co-op, the board determined to raise money by having the proprietary lease amended to institute a sublet fee. The institution that owned the shares allocated to the commercial space had a specific right to sublet set forth in its proprietary lease, and in fact had to sublet to make use of the space. Meanwhile, the board had been discouraging residential subletting, and had even banned it for a substantial period of time. Even though there was nothing wrong with enacting a sublet fee in general, the appellate court found that instituting one which would target only the commercial units as a source of revenue might be considered discriminatory.

In practice, the areas of conflict may only be limited by the imagination of sponsors and boards. Sometimes, developers try to perpetuate the ability of the minority commercial owners to keep their special status. They might limit the ability of the majority residential owners to make changes, and preserve maximum voting rights for the commercial owners. Other times, boards look at the commercial owners as deep pockets and try to figure out how to obtain money from them.

Although conflict may be inevitable - particularly in new construction, where resident purchasers will not have this advantage - the best possibility of establishing an even-handed approach to the situation might be at the time of a conversion, when both the sponsor and tenants - represented by counsel - have a chance to negotiate their documents.

Doug Heller is a partner at Friedman, Krauss & Zlotolow LLP, a Manhattan-based law firm specializing in co-op and condo-related issues.

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5 Comments

  • Hi, I was wondering if someone could advise me of my rights. We own a commercial unit within a coop building and the building is making it difficult for us to rent the space. We also own a residential unit in the same space. There are only 3 other units so in effect we cover 2/5ths of the buildings operating charges. When we purchased the unit, the building covered basic street maintenance and leased the space to wholesalers. They even gave them long term or 5 year leases. Originally the space was a design school. Since we have owned the space – about 12 years – they have severely limited the type of tenant. The building no longer seem to permit any wholesale, makes it difficult to give leases longer than one year, and for the first time every use the occupancy on the C of O which is 10-20 for 2,000 to 4000 square feet. They also do not allow any type of business that involves food. When there are time sensitive matters they take days, even weeks, to respond. Most commercial businesses want long term leases. The building no longer funds street maintenance but says we are responsible even though the space has been largely empty for years at a time. They also charge us a fee for leasing the space though such surcharges are not in the bylaws. In addition, people sit in on board meetings who are not even leaseholders/owners. While initially they were treated as guests attending as a courtesy, some participants I believe are often hostile to our interests and frequently making contributions in a manner that I constantly find offensive. Since the coop board basically appears not to enjoy any activity downstairs so it seems to have made leasing of the space close to impossible. Since our commercial lease indicated we could use the space residentially we tried to rent is as such but discovered based on our C of O as a commercial Unit, that was not legal. The building assumed no responsibility for the misleading lease. Basically we carry a huge % of the buildings overall costs yet seem not to have any rights - Is there anything we can do to protect our interests? Sincerely, A concerned property owner in NYC
  • I have a mixed use co-op apartment. When I buy was a doctor's office and now I use it as doctor office but Now I want sell as mixed use. My co-op board want me sell as residence with no kitchen. How can I sell my apartment ?
  • I live in a mixed use building with a factory on the first floor. The original owners of the building operated machinery from 8am to 4 pm weekdays and rarely on weekends. Since the building changed hands, the new owner gradually began to run machinery as early as 5 am and will work arbitrarily on weekends. My unit is on the second floor directly above the shop and it is noisy. I looked for some information regarding hours of operation in a mixed use building but without finding anything specific. If you could give me some information that explains this or point me in the right direction, I would appreciate it. Thank you
  • The restaurant in our building (on ground floor) has a very poor presentation. As the result the building looks terrible, like a dump in Hong Kong. What can we do?
  • Hello, I live in a mixed-use condo. It has 250 apartments, 3 commercial spaces, and 1 garage. Recently, the sponsor has sold off the commercial spaces and garage. The board, however, still consists of a representative from the garage and the commercial space. Is this right? Thanks