Coops and Condos – The Applicability of the Business Judgment Rule to Board Decisions

Cooperative and condominium directors owe a fiduciary duty to the membership to exercise their authority in the best interests of the corporation or association and all of its shareholders and owners. The concept of cooperative living is both utilitarian and libertarian. It embodies community and freedom.

The standard by which decisions of a board of directors of a cooperative or condominium are to be reviewed by the courts is known as the “business judgment rule.” In its simplest terms, the business judgment rule provides that a board action is protected from challenge if there is a good business justification for the decision and it isn’t fraudulent or an abuse of discretion. When the business judgment rule is applied, the burden of proof to establish the impropriety of the decision is on those challenging it.

In lawsuits claiming directors violated their duty in finding a tenant conduct “objectionable”, the courts have routinely applied deference to the cooperative directors determination. However, is the reasonableness of the directors determination better standard? Below is a discussion of the evolution of the business judgment doctrine as it applies to cooperative and condominium directors.

As is discussed below, it is clear that New York courts generally defer to cooperative and condominium board decisions. Nevertheless, if board action is taken for a purpose other that that of the entity, is beyond the scope of the board’s authority or is in bad faith, the courts are authorized to strictly scrutinize such action.

In the 1990 seminal decision of Levandusky v. One Fifth Avenue Apartment Corp., the Court of Appeals held that the business judgment rule was the standard for judicial review of actions taken by cooperatives and condominiums boards. The business judgment rule set forth in Levandusky bars judicial review of a board’s actions if the court finds that the actions were taken in: (i) futhe4rance of the purposes of the entity; (ii) within the scope of the board’s authority; and (iii) in good faith. However, Levandusky does not automatically preclude judicial review. If an owner can prove that a board’s actions were taken for: (i) purposes other than those of the entity; (ii) beyond the scope of the board’s authority; or (iii) in bad faith, the courts will review the challenged action.

If a unit owner can demonstrate that the actions appear to b discriminatory, Levandusky established that a court may review the actions of a board. Decided nearly eighteen years ago, Levandusky continues to be a weapon for co-op and condo boards as it mitigates suits brought by apartment owners against boards. In the recent cases, the issues covered include discriminatory actions, claims of bad faith, board managerial decisions and the enforcement of house rules and proprietary lease provisions. The bulk of the cases indicate continued adherence to the Levandusky judicial deference principle.

In 1997, the Appellate Division, First Department in Goodman v., 225 East 74th Apartments Corp., judicial review was held to be warranted when the plaintiffs, two shareholders, alleged that too many shares had been allocated to their studio apartment, and, as a result, they overpaid maintenance charges for more than ten years,. The shareholders owned 460 shared allocated to an apartment in the co-op building. They had bought the apartmne3t from the sponsor’s assignee and when they purchased the apartment, rent-regulated tenants occupied it. After the tenants vacated the apartment, the shareholders learned that they had bought a studio apartment, not a two-bedroom apartment as described in the offering plan, As a consequence of the mis-description in the offe3ring plan, the shareholders had been paying maintenance charges based on a share allocation that exceeded their share allocation by 210 shares.

The shareholders demanded that the co-op correct the improper number of shares allocated to their apartment, but the board refused to do so. Subsequently the shareholders commenced an action against the co-op. The court, citing Levandusky, stated that the standard for judicial review of the actions of co-op is analogous to the business judgment rule applied by courts to determine challenges to decisions made by corporate directors. However, in light of the individual interests of the board members in the maintenance charges, it could be argued that the directors were not disinterested parties when responding to the shareholder’s claim.

Similarly, in Cooper v. Greenbriar owners Corp., judicial review was denied. In Cooper, the court held that the business judgment rule protected a board’s decision to reject a prospective purchaser of a co-op apartment. The shareholders commenced an action against the co-op to recover monetary damages contending in their complaint that the board acted in an arbitrary, capricious and illegal manner when they rejected a prospective purchaser. Their complaint alleged that the rejection was based on the possibility that the prospective purchaser might have a baby-sitting business in the apartment.

A lower court dismissed the shareholders’ complaint finding that there was a reasonable bias and support for the rejection of the applicant, that the proceedings used by the board were fair and did not differ from the established procedures used by the board in such matters and that there was insufficient evidence to show that the board’s actions were unfairly motivated or made in bad faith. The boards’ counter claim was also dismissed. On appeal, the court affirmed the decision of the lower court and cited Levandusky stating that when the co-op board “acts for the purposes of the cooperative, within the scope of its authority and in good faith, courts will not substitute their judgment for the board’s.

In 1998, the Appellate Division First Department in Elkman v. Southgate Owners Corp., declined to substitute its judgment for that of the co-op’s board. Shareholders commenced an action against the co-op to recover damages for breach of implied warranty of habitability, breach of fiduciary duty, partial constructive eviction and breach of express lease covenants. Shareholders claimed there was a noxious odor emanation from a retail fish store in an adjacent building that was not owned or controlled by the co-op.

The alleged that the odor permeated their apartment, making certain portions of their apartment uninhabitable and that the co-op and its board had failed to do anything to remedy the situation despite numerous requests to do sol, The lower court dismissed the shareholders’ complaint except for the cause of action for breach of the implied warranty of habitability. On appeal, the court affirmed the decision of the lower court. In upholding the dismissal of the claim for breach of fiduciary duty, the court, citing Levandusky, stated that it would not substitute its judgment for that of the board of directors when there were no allegations of fraud, misconduct or self-dealing.

In 2003, the Court of Appeals in 40 West 67th Street Corp. v. Pullman extended the reach of the business judgment rule. In that case, Mr. Pullman accused his upstairs neighbors of noise violations, running a bookbinding business and housing toxic substances. Upon investigation, the board of directors ascertained that the upstairs neighbor had no such equipment and didn’t even have a television. Thereafter, Mr. Pullman initiated four lawsuits against the co-op. After a period of time, the co-op decided to evict Mr. Pullman for “objectionable conduct”.

A special meeting of shareholders was called for this purpose and the requisite super majority was reached to terminate his lease. The case went to court and the co-op encountered Real Property Actions and Proceedings Law Section 711, which essentially required the co-op to prove a person’s actions to be objectionable. The court found that the determination of the shareholders itself constitutes satisfactory proof that Mr. Pullman acted objectionably, and the cooperative did not have to bring in witnesses to testify as to what he did. Pullman further demonstrates that the trend continues to be deference to the business judgment of the cooperative housing corporation.