Shareholders vs. sponsors spells aggravation for all.

Many former apartment house owners converted their buildings to cooperatives during the 1980s. Because the New York State legislature generally has a tenant-oriented philosophy, they wanted to protect non-purchasing tenants. Therefore, laws were passed to allow conversion via a non-eviction plan that required the sale of only 15 percent of the units.

Once vacated by the original tenant, the law also takes the unit out from under the hated rent regulations, and provided an opportunity for investors and sponsors to at least keep up with payments on their own loans.

Throughout the last decade, these laws have created many problems for tenants, cooperative unit owners, management companies, lenders and sponsors.

When the bottom dropped out of the co-op market, many sponsors were left holding units that were not only unsalable, but were renting under stabilized leases for less than the actual maintenance costs for the unit costs that the sponsor now had to pay to the cooperative.

Co-op attorney Edward Braverman, who heads his own firm, Braverman & Associates, represents many boards. But he also counts as clients some sponsors that held apartments off the market - in one complex there are 100 vacancies and another 80.

"It was only when it became painfully obvious the market wasn't shifting, for self preservation, we had to rent them because there were terrible negative carries," he said. "Now that the rental market is better, it would be wrong to penalize the sponsor who can now rent them and have a positive carry."

In buildings all over the city, when units became vacant, sponsors found it easier and more financially viable to rent them out at the new market rents, rather than to sell them.

"There are a large number of sponsors, particularly in the outer boroughs, that may be accused of converting to get out from rent stabilization and have no intention to sell the apartments," said James G. Samson, who is representing a Gramercy Park board that is pursuing litigation against its sponsor.

All over the city, many purchasing shareholders have tied up their savings in units that don't now meet their family needs. "The people who bought can't get out," said Samson. "They can't sell or refinance [the underlying mortgage] and the value of the unit is worth considerably less."

In the last six months, the sales market has picked up enormously in certain areas of Manhattan and small pockets in the outer boroughs. But not so much for the plain vanilla apartment in a building that has high sponsor ownership, because the deal has to be all-cash - no bank will finance the unit's purchase.

At the same time, however, the luxury rental market has become lucrative, and even rent stabilized units are beginning to hit market pricing in some areas.

Thus, cooperatives where boards are now run or are trying to be run by tenant shareholders are finding themselves pitted once more against sponsors who don't have an incentive to sell apartments.

At Samson's upscale client, the fight has led to court where the cooperative shareholders are trying to compel the sponsor to sell.

Apartments in the neighborhood rent for $1,500 to $1,800, while sales of two bedrooms are pegged at $225,000. Studios go for around $60,000 to $75,000 in that neighborhood and one bedrooms in the mid $100,000 range.

Both sides believe they have the right argument for a dispute that is boiling into other buildings.

Already, at least one Yonkers sponsor has been hit with a similar suit at a small building where sales values have dropped tremendously but rental tabs are finally picking up.

Other sponsors are reporting being threatened with the same board lawsuit stick.

Meanwhile, at least one co-op left with a high bank mortgage has stopped paying and is hoping to avert a foreclosure by the lender.

But once foreclosed, the building would actually be worth more to the lender as a rental property that it could sell to get back its full mortgage amount. That story is still being played out in court and at the conference table.

Co-ops feel the sponsors should let go of their free market rental units, take advantage of the current sales market, and get out.

"In offering a building, we all assumed it meant the sponsor would sell, but nowhere in the law is there an absolutely clear mandate to complete the conversion," said Mary Ann Rothman, executive director of the Council of New York Cooperatives (CNCY), which counts most boards as members. "We don't want to prevent the sponsor from completing the conversion, but if the building isn't brought to the point where it's viable as a co-op, it's a disservice."

The Council has filed an amicus curiae brief in the Gramercy case that was penned by attorney Marc J. Luxemburg, president of the CNCY, and is being circulated through the co-op community bringing hope and fear to the various parties.

Co-op attorney Allen M. Turek, a partner with Schiff Turek Kirschenbaum & O'Connell, says there's no denying there is a problem because when a sponsor owns too many units, it can affect the underlying bank financing.

"There was talk about whether a sponsor has an obligation to continue to sell even before the market went bad in 1986," said Turek. "Whether or not you can force a sponsor to sell is a very sticky thing."

Turek warns there are also prosecutional issues regarding unfair takings, especially if the co-op can force the sponsor to sell in a bad market or at a loss.

At the Gramercy Park co-op, however, on of the issues is whether the sponsor, who did not sell a unit for many years, undertook an effort to sell. "I've never seen an offering plan that provided that a sponsor agrees to sell," added Turek.

"We said we would sell and we are selling," claimed David Rosenberg, a partner with Marcus Borg Rosenberg & Diamond, who represents the sponsor. "We even agreed to enter into a joint marketing campaign with the shareholders. They didn't want it. They wanted money and a fixed number of units per year to be sold."

Of the 194 units in the building, 40 had been sold at time the building was converted, and none for seven years after. Of the remaining 154 units, the sponsor has recently sold two and may have already closed on more, but there are also approximately 75 that are rent regulated and have a negative carry.

Luxemburg's brief guesses that since 2,000 sponsors still file annual amendments to update offering plans with the State Attorney General's office, there must be several hundred buildings containing over 10,000 unsold apartments where sponsors have not sold, but rented.

Says Samson, "Even if the sponsor started selling tomorrow, buyers don't buy where the mortgage is coming due or there is a question of the mortgage being refinanced or there are volatile interest rates."

Another big problem, he says, is that the cooperative corporation is not viable when the sponsor owns 70 percent and the tenant investors are defaulting, or move out or sublease.

Soren Management was recently brought on to manage the Gramercy property by the board, which has four directors elected by the building and three appointed by the sponsor.

Paul Gotsegen, president of Soren, said he would love the Attorney General's office to finish what it started when it advised changing the law from 50 percent to 15 percent on a non-eviction plan.

"It allowed buildings to be co-oped with very little participation from actual residents and that has allowed situations like this - where 80 percent of the building is not owned by residents - to occur," said Gotsegen.

Indeed, Luxemburg's brief cites security issues because rental tenants cannot be screened by the board - yet the legislature in changing the law was convinced it needed to protect rental tenants in place without regard to purchasing shareholders.

The brief continues: "The public is damaged, since the sponsor who continues to rent... on a free market basis is evading one of the long standing policies of the State of New York, i.e. the regulation of rent in multiple dwellings." Yet he doesn't question its validity when it comes to shareholders subleasing the apartments at these very same market rents.

His brief points out that shareholders are unable to sell their units, yet the legislature probably never contemplated that banks would not lend to this mish-mash entity for either underlying or end loans. In fact, the banks continued to lend on these units and buildings until the early 1990's credit crunch hit.

Luxemburg argues the sponsor cannot abandon selling the units that are listed for sale in the offering plan, refuse to sell vacant deregulated apartments, and continue to operate a rental business without disclosure and the filing an amendment to alert potential purchasers.

He advises the court that the "simplest remedy to compel the sale of apartments would be for the court to issue an injunction prohibiting further subletting of any apartment by the sponsor."

If there was an affirmative judgement that a sponsor could not rent, predicts Braverman, every board would bring an action against their sponsor. "Most don't like the fact the sponsor is still there and has clout, and has large blocks of unsold shares, and has people on the board of directors," he said.

But from a public policy point of view, Braverman believes, the court couldn't hold that way, and if it did, the decision would be reversed by the Court of Appeals. "If the sponsor loses it will go up on appeal," he predicts. "If the co-op loses, the sponsor may find a way not to fund the appeal."

Says one sponsor facing a similar hostile board action: "When I sue them back, I pay for all the legal bills. So it's a lousy position."

This sponsor complains that he fixed up his building, and carried it for three years in the late 1980's while the tenants tried to stop him from co-oping.

"They had teams of lawyers negotiating with my lawyers," he recalled. "Now they are saying, 'You overcharged me, you have a big mortgage, and you tricked me. I want you to lower the mortgage so I can sell the apartment.' But I'm not in the business of giving them presents."

With so many co-ops and sponsors in the same stew, the issue will only get spicier in the coming months.