Cooperatives Without Proprietary Leases

Photo by Patrick Tomasso on Unsplash

Since June 2019, we have been dealing with the impact of the Housing Security and Tenant Protection Act of 2019 on the ability of cooperatives and, to a lesser degree, condominiums to function in the new order. This legislation, intended to protect tenants in rent-stabilized and -controlled apartments, is being applied to cooperative boards and shareholders and unit owners wanting to lease their apartments. All have to deal with a myriad of rules and regulations. We are caught in this quagmire because co-ops are based on a document called a proprietary lease, because that was how it was done 140 years ago.

On its face, a lease does not make sense since in a cooperative because there really is no landlord or tenant, just owners and a board that the owners elect. Who ever heard of a lease in which the tenant can change the terms of the lease and extend it or take control of the landlord? There is no requirement in either New York law or federal law (i.e., the Internal Revenue Code) requiring a lease. Moreover, purchasers paying millions of dollars for an apartment do not want to be treated as or called a “tenant” and do not want to be hauled into landlord-tenant court for disputes with a board.

With that in mind, I drafted a Shareholders Agreement, which would be executed at the closing by the purchaser (as shareholder) and the board (as the corporation). The Shareholders Agreement would be the basis for the operation of the building and the shareholders’ rights to utilize a portion of the building. This change would also bring cooperatives more in line with condominiums and would therefore reduce the 15% to 20% price differential between cooperatives and condominiums. However, unlike converting a co-op to a condominium, there are no negative tax ramifications or filing of tax maps with New York City; the shareholders would merely vote to amend and restate their proprietary lease into a Shareholders Agreement.

Like a condominium, control of the building will rest with the owners and the board will only act as agent for the owners. The controlling document will be the Shareholders Agreement, which will be between each owner and the corporation. The Shareholders Agreement mirrors the relationship of the condominium’s declaration and bylaws. Unlike the traditional board of directors, the shareholders can, but need not, be restricted in selling, financing or leasing their apartments. In every regard, the Shareholders Agreement provides the owners with the control of the property, and the owner is never considered or treated as a tenant.

There are two other very large advantages to this new paradigm. The first is that the co-ops would be subject to fewer unfunded mandates that are intended to assist rent-controlled, rent-stabilized and uncontrolled tenants from the “avarice” of their landlords. For years, cooperatives have been caught in a web of rules, regulations and mandates merely because they use a document called a proprietary lease to deal with issues between the corporations and their shareholders.

This would also keep cooperative housing corporations out of landlord-tenant court, where every landlord is considered guilty, even if they are attempting to act against an unruly tenant to protect all the other residents of the building. Instead of landlord-tenant court, disputes would be handled in Supreme Court.

To make it more palatable for the lenders, the lenders will also be treated as if the apartment is a condominium unit but with one very large difference: because the mortgage on the unit is not recorded, there will be no need to go through New York’s lengthy, time-consuming and costly foreclose process. The lenders will still get to file a UCC-1, but the ability of the lender to defend their rights and obtain their collateral is increased because the lenders’ priority is improved from where they stand in a traditional proprietary lease.

This is a new concept that finally deals with the disparity in pricing between cooperatives and condominiums because it deals with the reasons for that disparity.

Stuart M. Saft
Holland & Knight LLP
31 West 52nd Street
New York, New York 10019