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Don’t Rush Through the Minutes – Understanding Due Diligence

At just about every annual meeting, you often hear complaints from the shareholders/unit owners that the board is acting in a secretive manner, and that there is no communication or transparency between the board and the people they represent. Often, in an effort to assuage these demands, the board members will promise to post detailed board minutes every month in the lobby informing all those concerned as to any matters before the board. Too often, cooperative and condominium boards make these promises without understanding the potential red flags that might be raised by doing so. While communication and transparency is always a good thing, it is imperative that boards and the management companies retain, review, and understand the materials that are circulated to the owners and, just as importantly, to the representatives of potential buyers.

As a part of their fiduciary duties, boards and management companies need to act in the best interest of the co-op and condominium buildings they represent. One of their responsibilities is to ensure that apartments in the building remain an attractive investment to potential purchasers.   Simply put, retaining market value should always be on the minds of those that represent the building’s interest. The best way to accomplish this is to problem-solve in advance in the hopes of producing an answer or solution to any red flag posed by a potential purchaser or his/her representative.

An experienced residential real estate attorney should be analyzing the building’s financial statements, reviewing the offering plan and any amendments, and reviewing the minutes of board meetings as part of his/her due diligence when representing the purchaser of a cooperative or condominium unit:. It should be assumed that any buyer will be briefed on these documents and that he/she will be advised as to any potential risks before signing a Contract of Sale. Many attorneys will even provide this analysis in the form of a detailed memo to the purchaser.

Financial Statements: Breeding Ground for Red Flags

The first piece of due diligence that a buyer’s attorney often reviews is the financial statements of the cooperative or condominium for at least the past two or three years. The financials are a breeding ground for red flags and it is imperative that any board or management company understand what they are before releasing to prospective buyers.

Generally speaking, a buyer or his attorney will want to see the following: the building has been operating at a surplus for the last few years, or at the very least without any substantial deficit; there is a sufficient reserve account; the bills are being paid on a current basis and that there are no significant collection issues with maintenance or common charge payments; and there is a budget for capital improvements.

It is also important to note when a cooperative’s underlying building mortgage matures and whether there are any active, threatened, or pending instances of litigation.

If the building in question has an issue referenced above or otherwise, it is imperative that the management company be prepared to temper the concerns raised by a diligent buyer’s attorney. For example, if the financials reference upcoming capital improvements, then be ready to establish how such improvements will be paid for it. If the financials reference litigation, then have the building’s attorney on standby to prepare a basic letter explaining the case and the risks associated therewith, especially if the litigation is not being covered by the building’s insurer.

Offering Plans: Becoming Less Important Over Time

Every validly formed condominium and cooperative building has an original offering plan housed at the offices of the management company. In many cases, especially in older buildings, these offering plans have been amended several times. As a result, the original plan becomes less relevant over time. However, it is important for a board and its representatives to understand what special risks the building might be subject to. One of the most common special risks that alert purchasers is reference to lot line windows.   In this day and age, few buyers want to worry about potentially losing the view on which they just spent a good fortune. Other areas of concern are often the building’s bylaws and house rules/regulations. Ensuring that these remain relevant and updated is key, especially since most of these documents being used were written in the 1980s and are now extremely outdated.

Board Minutes: Often Overlooked by Boards

Generally speaking, board minutes kept by cooperative and condominium boards are as vanilla and non-descriptive as possible. But, every so often, simple references are made that will alarm a purchaser’s attorney. When there is a problem or potential issue in the building (i.e. bed bugs, noise violations, disturbances, water infiltration/leaks, owner disputes, litigation etc.), it is imperative that they be described in general terms. For example, using the term infestation when referencing an insect or rodent situation will alarm any potential buyer. Use of the words litigation or threatened litigation when referencing a dispute will do the same. Boards are obligated to keep adequate minutes; however, board secretaries need to be careful about how issues are couched. More importantly, management companies need to review the minutes before making available to prospective purchasers.

So while open communication and transparency are generally good goals for any board to achieve, it must be balanced with a board’s duty to protect the unit owners and preserve market values. It is crucial that boards and management companies understand the potential concerns of a purchaser and act accordingly when drafting minutes and financial statements.

Richard Klein, Esq.
Romer Debbas, LLP
275 Madison Avenue, Suite 801
212-888-3100
rklein@romerdebbas.com

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