Co-op ruling causes concern.

A Brooklyn Housing Court decision by a former tenant advocate that allows an after-conversion tenant in a sponsor's unit the right to a renewal lease has created turmoil in the cooperative and rental communities.

If followed, the September 30th decision would effectively create a new class of tenancy that is not subject to rent stabilization laws, yet is entitled to renewal leases into perpetuity at "reasonable" rates.

Such a tenancy would create after-conversion renters entitled to remain in occupancy throughout their lives and their children's if not longer - and create numerous legal challenges over what constitutes a judge's definition of a "reasonable" rent increase.

Industry attorneys charge the Brooklyn decision was spun on word gimmickry and the reading of one legal clause in isolation.

"Every single one of us has always assumed that anyone that rents from a sponsor does not acquire any rights under the Martin Act," said Stuart M. Saft, a respected real estate and cooperative housing attorney and partner with Wolf Haldenstein Adler Freeman & Herz.

Even so, the judge harshly criticized the sponsor for not recognizing these suddenly created rights of his tenant. In dismissing the action to evict the tenant, who had rejected the terms of a proffered renewal lease and claimed protection as a "non-purchasing tenant," Judge Mark Finkelstein wrote "The mischaracterizations and misstatements of the rent regulatory status herein are basic and substantial and go to the very core of the proceeding."

The judge also suggested that litigation over what constitutes a "reasonable" renewal lease under the General Business Law (GBL) should be taken up in another matter that "alleges the proper rent regulatory status of the subject premises."

As of deadline, the owner of the unit, formerly the sponsor of the conversion, has decided to appeal.

Sources indicate the judge presiding over the Co-op Part in Manhattan Housing Court is considering applying this reasoning, and both rental and cooperative groups are eager to file amicus briefs opposing such a decision. If either that judge or other Housing Court Co-op Part judges apply the decision, the experts believe it could create years of turmoil in both the cooperative and rental communities, while an appeal is argued through the levels of state court, possibly creating financial hardship for both sponsors and the respective cooperatives.

Yes, a rule providing protection under the so-called Martin Act portion of the GBL governing co-ops and condominium conversions could encourage the sale of the shares to owner-occupiers, they say, but it could also devalue both units and buildings through thousands of suddenly needed "fire sales."

It could even create thousands of legal challenges by current market renters who don't want to move and who take up the judge's invitation to challenge what is a reasonable rent, perhaps financially devastating the other shareholders or the sponsor.

"I'm not sure whose ox is gored more," declared Salt. "The co-ops are hurt because you have thousands of apartments where the sponsors have rented them instead of selling them, and if the tenants have rights, it reduces the likelihood that the sponsor will ever be able to sell. The sponsor in this case first converted their buildings to get out of the rent laws. and they are stuck now if this ruling is upheld."

The tenants signed a lease with the sponsor of the building, PRS Development Associates, in February, 1992, five years after the conversion was effective, and began a series of disputes, particularly over rent increases requested in each new lease.

The tenants, Emil and Elizabeth Harris, claimed, and the judge agreed, that they are not free market tenants subject only to the term and conditions of a sponsor's unique free market lease and their payments and obligations under that lease, but are "non-purchasing tenants" entitled to be given renewal leases at reasonable rates under the protection of the Martin Act clauses.

Cooperators Encouraged

The Brooklyn cooperative was organized under a non-eviction plan, and such plans were devised by the legislature to protect non-purchasing tenants from eviction and displacement, while allowing other tenants to effectively buy a piece of the rock.

Cooperative conversion retains the middle class in the city, as well as in small towns around the state. Such purchasing tenants become shareholders and enjoy the tax benefits provided by the ownership of shares in the non-profit corporation that owns the building, and hopefully embodies them with the pride of ownership.

The Martin Act, the group of General Business Law statutes governing conversion, also provides for shareholders to take over the management of the property through eventual control of the board of directors.

A non-eviction plan only requires the purchase of 15 percent of the units, however, and is a threshold that many now recognize is too low to create the financial stability needed for the property, or to ensure a cooperative community will thrive.

But cooperative housing public policies and documented legislative intent encourage the conversion of the remaining rental units to owner-occupied stares upon the vacancy of each rent regulated non-purchasing tenant that was in residence prior to the effective date of the conversion plan.

Under the Martin Act, the sponsors or their successors become the "holders of unsold shares" for such occupied units, and are responsible for compliance with all rental regulations until such vacancy.

The cooperative community has operated on the definition of a "non-purchasing tenant" to include only those in residency at the time of conversion who would be otherwise entitled to purchase the unit. These tenants have been allowed to continue their full rent stabilized or rent controlled status while enjoying building improvements paid for by others.

In many instances, their low statutorily governed rents were a direct cause of sponsor bankruptcies in the early 1990's, when rents did not cover the sponsor's obligations for maintenance or mortgage payments.

Non-occupying buyers of bulk or single apartments became successor "holders of unsold shares," often bailing out sponsors and becoming White Knights to the other shareholders by quietly enduring a negative cash-flow during the worst of the recession years. "Holders of unsold shares" are also entitled to certain benefits afforded sponsors, such as the right to sell the unit to anyone without board approval.

When these investors have a vacant unit, the law has always been interpreted by the cooperative community to mean they could either sell the unit or rent it at a market rate, and the unit would not be governed by tenant rent regulation statutes.

Thus, the sponsor or holder of unsold shares could cover their expenses, provide a monthly maintenance cash-flow to the cooperative, and obtain a return on their own investment.

When the cooperative sales market was for the most part non-existent in the early 1990's, the ability to charge free market rents ensured financial stability. But since the sales market became viable in Manhattan, and most recently in parts of the other boroughs, sponsors have recently been accused of not selling units fast enough, and of using the earlier conversion as a scheme merely to get rid of rental regulations on the units.

Judge Has Tenant Bias?

Into this milieu comes Brooklyn Housing Court Justice Marc Finkelstein, whose term expires in May, 1999. He heads the new Cooperative Housing Part, where all such disputes are heard, but as a former Brooklyn Law School senior housing clinic advocate, his tenant bias is well-documented. Sources say he is also bored in his position and aspires to a higher court, and is thus seeking to demonstrate creative legal thinking and produce unique legal decisions to prove his worthiness to sit on a higher court.

Indeed, as he discusses each point and counterpoint of the arguments, he declares "Both sides are represented by able counsel, and in regard to their Martin Act contentions, the Court does not feel that either is so much being disingenuous or guilty of circular reasoning (as each claims), but rather that both are sailing colorable arguments in legally uncharted waters."

His decision in Paikoff vs. Harris relies on the definition of a "non-purchasing tenant," and a 1993 affirmation by Mary DiStephani, the then-Director of Regulatory Compliance in the Real Estate Financing Bureau under former Attorney General Robert Abrams, which was submitted in an earlier proceeding on behalf of this tenant, to make his ruling that the tenant of a sponsor after conversion is entitled to protections afforded non-purchasing tenants.

DiStephani, who is still employed by the Attorney General, portrays a public policy argument against the lifting of rent protections as one reason that renters after the conversion are entitled to rental protection status.

"The General Business Law treats such tenants as 'non-purchasing tenants,' precisely to afford these tenants a measure of protection against not-for-cause evictions and unconscionable rent increases, even though they are no longer subject to ordinary rent regulation," she wrote.

No other documentation from the Attorney General's office was ever entered into the record, sources said.

Under the statute, GBL Section 362-eeee(1)(e), the legal definition of a "non-purchasing tenant," does not include "A person who sublets a dwelling unit from a purchaser under the plan," but does include, Judge Finkelstein wrote, "a person to whom a dwelling unit is rented subsequent to the effective date" of the cooperative plan.

In the 1992 affirmation, the Compliance Director states: "The position of the Office of the Attorney General is that a sponsor or holder of unsold shares is not a purchaser under the plan.'"

Said real estate attorney Sail of the Compliance Director's writings, "They use these things out of context. This is not a ruling, or a law, or a policy, or an official Attorney General Opinion. It's merely an affirmation."

But Justice Finkelstein, while agreeing the affirmation is "not dispositive," considers the writings to be on point and "an important element to be considered."

The judge, Sail complains, "ruled in less than a vacuum" by completely ignoring GBL Section 352 eeee(1)(d) that defines the phrase "purchaser under the plan," as "a person who owns the shares allocated to the dwelling unit or the dwelling unit in a condo."

"It's not that subparagraph (d) is 40 pages away," Saft observed. "I contend that a 'sponsor' or 'a holder of unsold shares' is a 'purchaser under the plan.' If you look at only section (e) that he ruled on, his position is legitimate, but if you look at Section (d) right above that, it is not."

Judge Finkelstein even argues that if the legislature intended a holder of unsold shares be considered a "purchaser under the plan," or if a "non-purchasing tenant" status was to be limited to a person to whom an apartment is rented subsequent to the effective date of the plan but prior to closing, "the legislation should have contained a provision to that effect."

Legal sources say the law was written that way so if a prospective cooperative share purchaser moved into the cooperative, but the building was never converted at a formal closing, they would not lose rent protections.

Yet even the Rent Stabilization Code at Section 2522.5 (h)(5) states that "a housing accommodation that was subject to this code or rented to a new tenant after any such plan has been declared effective, and a closing thereunder has occurred, such housing accommodation Shall not be subject to this code."

"So the Rent Stabilization code itself, that was enacted by the legislature, does not provide rights for these tenants," Saft contended.

Dan Margulies, executive director of the Community Housing Preservation Corp. (CHIP), a middle market rental owners' group, said "Clearly, the shares were purchased by the sponsor at the effective date of the plan, and I don't think there is any question of legislative intent because no one said boo about it all these years. As a public policy matter, the legislators that have championed the cooperators should be livid with this decision because they have been criticizing sponsors for not selling, and this decision tells them they can't."

Attorney Gerald Shapiro, a partner with Mitofsky & Shapiro, also disagrees with Judge Finkelstein's decision, which he thinks creates a new class of tenant.

"The court imposed an obligation on the owner so that you have to renew his lease," Shapiro explained.

And for how long can this tenant remain? "Into perpetuity," Shapiro said. "It's going to make it difficult for these units to sell because in essence, they are selling an occupied apartment, the value of which is less than an unoccupied unit."

In fact, New York City officials are currently discussing various methods of valuing cooperative buildings to bring payments more in line with the property taxes paid by similarly valued single-family homes.

Should officials in discussion with the cooperative community decide on a method based on the gross sales value of the building, rather than the current comparison to the income of a similar rental building, the inclusion of even more regulated tenancies, and thus a lower gross sell-out value, will cause millions of dollars to vanish from the co-op and condo tax base, which comprises around $30 billion of the city's total market valuation.

Even a slightly lower total assessed valuation for all city property curtails its borrowing ability, another ominous problem the Administration now faces with the start of each fiscal year.

"The judge reached," Sail insisted. "I believe the decision is not correct, and it's driving everyone nuts."

The problems the experts predict have already been experienced in Westchester, where some cooperative and condominium units owned by sponsors and individual owners rented prior to July 7, 1993 are still subject to full stabilization protection and renewals under the Emergency Tenant Protection Act (ETPA). Several thousand units had been kept vacant and out of the housing market because under an earlier law, once a tenant came in, they became a tenant for life. Unit owners that moved out because of life changes and then could not sell, but naively rented in order to cover their own expenses, found themselves to be victims when the tenants would not leave or obtained rent rollbacks for non-compliance with rent regulations. New Rochelle was among the first communities to opt out of the ETPA requirements in 1993, and thereby created an instant pool of previously vacant or regulatorily strangled housing.

According to Jeff Hanley, executive director of the Cooperative and Condominium Advisory Council of the Building and Realty Institute of Westchester, the law adopted on July 7, 1993 removed all Westchester cooperative units rented after that date from ETPA, i.e. all stabilization rules. But it still allows renters of co-op units that were in place prior to that time to be afforded automatic renewals and rent protections.

"No one is suggesting that Judge Finkelstein's decision will subject the tenants to stabilization," explained Margulies, "but it would entitle them to renewal leases at a reasonable rent, and the major problem is that no one could get a tenant out to sell the unit."