Economics determine obligation to restore a damaged building.

In 1994, a fire devastated the building at 610 West 142nd Street in Manhattan. Over 20 percent of the apartments were completely destroyed, while others sustained various types of damage.

At the time, the building was a cooperative with 18 apartments owned by resident shareholders and the balance owned by the sponsor, the Scharf family. Some non-purchasing occupants of the apartments were rent stabilized and others were tenants at unregulated, market rents.

The damage was so expensive that the cooperative corporation which owned the building refused to make repairs and restore the building to its original condition. This resulted in a lawsuit commenced by various tenants in the building and a number of shareholders of the cooperative against the cooperative corporation and its officers, Leon Scharf and Maurice Scharf. Among others named as defendants were the Department of Housing, Preservation and Development and the bank holding the mortgage on the property.

The dislocated tenants and shareholders claimed that the cooperative corporation, as landlord, was required to restore the building and make it habitable for them, the former occupants. The cooperative claimed that the cost of restoration would be economically infeasible, since the price would be about $4.5 million while the value of the building if restored to its condition prior to the fire would not exceed $2 million. These claims were corroborated by affidavits of experts and were not substantially disputed.

Another factor in this case was that the cooperative, which was under the control of the Scharf family, unilaterally reduced the insurance coverage of the building from $3 million, as was required under the cooperative's offering plan, to $2 million, with an 80 percent co-insurance clause.

After the fire, neither the cooperative nor the Scharfs took any action at all. They did not comply with a vacate order issued by the Department of Buildings, nor did they correct the building code violations caused by the fire. The cooperative and the Scharfs claimed that if they were required to restore the building, it would amount to an unconstitutional "taking," because they would be deprived of economic benefit from their property.

This case was tried by the New York City Civil Court Judge Peter Wendt, who concluded that even though the cost of repair may exceed a building's value, a landlord is required to restore a damaged building since the rights of tenants in a rental building and the rights of shareholders in a cooperative, as well as New York's strong public policy, require that landlords maintain their buildings in habitable conditions. He therefore ruled that this building must be repaired and restored. Judge Wendt stated that a landlord could not simply abandon his building once the cost of repair exceeded the building's value.

The judge went on to state that the appropriate comparison of value was between the cost of restoring the building on the one hand and the cost of demolishing the building, relocating the stabilized tenants and satisfying the liabilities to tenant shareholders on the other hand. Such calculation, he ruled, should also take into account any income that the restored premises might generate. And under those standards, Judge Wendt found that the Scharfs did not show that restoration was infeasible.

In addition, Judge Wendt decided that because the Scharfs failed to maintain adequate insurance coverage, they were precluded from asserting the defense of economic infeasibility. Having created their economic hardship, they should not benefit from their inability to afford repairs.

Judge Wendt's decision was appealed to the Appellate Term of the Supreme Court, and following the same reasoning, the appellate court affirmed the decision.

Upon further appeal, the Appellate Division of the Supreme Court considered this case in June 1998.

At the outset, the Appellate Division held that the deficient insurance coverage has no bearing on the defense of economic infeasibility because the relevant issue is not the economic condition of the owners of the building, but rather the economic condition of the building itself. If the building is not worth repairing, repair should not be required. In this case, the Appellate Division ruled that the Civil Court and the Appellate Term were both mistaken in treating the cooperative corporation and the Scharfs as if the impracticality of the proposed repairs were their fault. They did not cause the damage, therefore whether they can afford to do so or not is irrelevant to whether the building should be restored.

The main issue before the Appellate Division was whether or not the owners could be compelled to restore a building if it was not economically feasible to do so. The court did not rule on the issue of whether the owner had an obligation to rent-stabilized tenants to compensate them for the loss of their tenancies or, in the case of cooperative apartment owners, for the loss of their shareholdings. Nor did the court rule on the issue of damages for the apparent breach of the insurance procurement clause of the cooperative offering plan. However it did rule that the option to restore the building after the fire should be left to the property owner itself, and should not be commanded by the court.

The proper method of evaluation is to compare the cost of repairing the building to the anticipated market value of the restored structure. Even the New York City Rent and Eviction Regulations (9 NYCRR [ss]2104.9 and [ss]2524.5) state that a landlord will be allowed to withdraw damaged housing from the market when the cost of removing building violations would substantially equal or exceed the assessed valuation of the structure.

Further, the court ruled that under the "takings" clause of the Fifth Amendment of the United States Constitution, the government may not compel a small class of people (landlords) to pay for public benefits (those of tenants) whose costs should be shared by the public as a whole. Such burden shifting amounts to a "taking" without just compensation if it denies an owner the economically viable use of his property.

Compelling the cooperative corporation and the Scharf family to restore the building and requiring them to spend over $4 million to create at most only $2 million of value, certainly denies the owner any reasonable return on his investment.

Additionally, notwithstanding the State's Legitimate interests in making affordable housing available for the general public, the order to restore the building merely bestows a State-enacted gift to the tenants at the expense of the property owner, and provides no benefit to the citizenry at large.

The Appellate Division reversed the order of the Appellate Term and the lawsuit was dismissed. (Bernard et. al. v. Scharf et. al. 675 N.Y.S.2d 64).