The Business Judgment Rule was put to the test in a recent case where Sharie Graham, the owner of a co-op apartment on the Upper East Side, charged the Board with bad faith in refusing to approve the sale of her unit to the Soffens, two physicians from New Jersey, for use as a pied a terre.
Graham sued her 420 East 72nd Street residential cooperative apartment building's Board of Directors for refusing to approve proposed buyers of her unit. The main issue for trial was whether the Board acted in bad faith– because the proprietary lease for the coop provided that the Board could refuse to approve a sale for “any reason and no reason”. Both sides conceded, however, that the clause could not insulate the Board from decisions involving bad faith. After a trial, the Court found that Graham proved, by a preponderance of the evidence, that the Board acted in bad faith.
Graham testified first, and the Court found her to be entirely credible, although some of her testimony suggested she might be a difficult person with whom to be neighbors. For example, she found it annoying enough to mention at trial that balls from kids playing in the adjacent back yard ended up in her yard.
Stuart Levy testified for the Board, and the Court found him not to be a credible witness. He would lie repeatedly and then, when confronted with documentary proof that contradicted his position, would stick to his guns. For example, Graham testified that the Board wanted Grahan to hold off marketing her apartment, while the Board considered buying that apartment and turning it into a gym for the building. Levy testified that this never happened and accused Graham of being the one pushing the gym idea. Levy's testimony was simply not true. The minutes memorializing a previous July 21, 2014 board meeting stated: “There was discussion about the feasibility of the co-op to buy an apartment to create a gym”. Those minutes reflected Levy's presence at the meeting, even though he denied being there. Moreover, when confronted with his own email, Levy had to admit that he was trying to arrange a time to see Graham's apartment to assess its feasibility for a gym. That same document indicated that it was the Board, not Graham, who had pushed to convert the apartment into a gym.
Other documentary proof belied Levy's testimony. Indeed, the co-op's own managing agent, Anna Seddio, reported in an email to the Board that she told Graham the Board was considering a gym and asked her to keep it confidential. Why would Graham have to keep something confidential that was her own idea?
Levy also lied when he denied that the Board ever made an offer to purchase Graham's apartment. The meeting minutes from November 2014 indicated that the Board approved an offer for the apartment.
Levy even lied when answering the Court's own questions. For example, Levy was on the Board the entire relevant time period, and therefore in charge of approving sales of the shares of apartments, but when the Court asked why accepted offers appeared to increase on various apartments, Levy actually suggested the highly improbable theory that the price went up because the hallways throughout the building had been renovated. When specifically asked, “is it possible the board required a higher price,” Levy evasively answered, “no, it [meaning the apartment] could have been sold with the contents”.
Accordingly, the Court found Levy's testimony so riddled with falsehoods that it disregarded his testimony altogether under the doctrine in falsus unum; in falsus omnibus. The Court had no reason to doubt the remaining witnesses' credibility, but some may have had a better recollection of relevant events than others. For example, Board member Freedman's muddled recollection that the Board had rejected the Soffens' second application to sell did not stand up to the facts.
The sequence of events was largely not in dispute. It was the motivation of the Board that was at issue.
Graham owned apartment 1D in the building. She also acquired another, larger, apartment on the same floor: 1G. She closed on apartment 1G in August 2014. Graham wanted to sell 1D because she did not need two apartments, and 1D was now empty. However, the managing agent informed her that the Board wanted her to hold off selling because the Board may have wanted to buy 1D to turn it into a gym for the building. Graham gave the Board members access to 1D so they could assess the feasibility of that apartment for a gym. By September of 2014, Graham had not heard from anyone on the Board about buying her apartment. Therefore, she hired RealDirect as her sales broker. RealDirect started marketing the apartment at $499,000.
In November of 2014, the Board made an offer of $400,000 for the apartment. Graham rejected the offer because she suspected it was too low. She was right. Shortly after, in December 2014, Graham received an all-cash offer of $495,000 from the Soffens. The Board refused to approve the Soffens' offer. Despite the Board's own prior offer being $95,000 less, the Board claimed the price was too low. The Board informed Graham that they would approve nothing less than $535,000. So, Graham and the Soffens restructured the deal to raise the contract price to $535,000 with the Soffens receiving a rebate of $40k.
Then the transaction stalled. Despite the new $535,000 contract price, a Board interview for the Soffens was never scheduled, and no one from the managing agent returned calls to the brokers regarding the sale. Then, in April 2015, Graham learned from the managing agent that the Board now wanted the price to be $610,000 before they would approve the sale.
The Court did not permit the Board to introduce evidence that the rejection was based on anything other than price because the Board refused to answer questions at deposition regarding the reason for the rejection. Nevertheless, the rejection was not because the Board did not like the kickback arrangement. Rather, the board rejected the $535,000 but claimed it would now approve $610,000. That requirement seemed tangentially related to a recent price for another D line apartment, on a higher floor and better condition. Clearly, the Board was irrationally bent on a price higher for 1D than what it was actually worth. Moreover, the Board stalled so long on the Soffens' application that the market increased.
The Board had not acted on the Soffens' application. So Graham hired a lawyer to prompt them. The lawyer sent a letter to the managing agent on April 17, 2015. There was no response. Given the utter lack of response from the Board, Graham decided to sue in May 2015. Still, the Board did not act on the Soffens' application.
It was not until Graham obtained a Court order directing the Board to issue a response that the Board finally sent a letter through the managing agent rejecting the Soffens' application. The letter stated no reason for the rejection and Graham was never offered any explanation. Given the letter of October 2015 rejecting the second application, and Graham's motion to force the board to act one way or the other, the vague testimony of Board members, Levy and Freedman, that the Board had rejected the second application much earlier, was simply not credible. Indeed, had the Board already made a decision, the motion for an injunction would have been moot.
Graham refunded the Soffens' down payment and, with her now stale listing, attempted again to sell unit 1D. Eventually, she entered into a contract of sale at $530,000 with another couple. But, four months later, the Board rejected those purchasers as well. Graham then had to pivot to renting out 1D. She found a tenant in October 2017, nearly three years after the Soffens' first offer.
The only issue before the Court was the Board's bad faith. A coop board's right to consent to any proposed transfer “for any reason and for no reason” was not without limits. For example, consent cannot be withheld on the basis of religion or race. In addition, consent cannot be denied in bad faith, and an offer cannot be rejected for spite.
By a preponderance of the evidence, Graham proved the Board's bad faith. There was simply no other explanation for the Board making its own offer for $400,000, then refusing to allow repeated offers to go through well in excess of that. The overall facts– including: (1) Graham was told it would be in her interests to hold off marketing her apartment initially; (2) the Board's lowball offer; (3) the refusal to consent to the $490,000 offer, but indicating the Board would accept $535,000; (4) then refusing that number, while claiming $610,000 would do the trick; (5) delaying for months and months to take official action on the Soffens' application; (6) refusing to take action on the Soffens' application until forced to do so by Court order; and then (7) rejecting another offer well above $400,000–reflected bad faith.
Indeed, those facts reflected a Board that either did not like Graham and acted out of spite, or was so blinded by their own power and desire to obtain the apartment at a below market price, they lost all sight of how to exercise fiduciary responsibilities in a fair and good faith manner. Accordingly, the Board was liable to Graham for breach of fiduciary duty. Given that the Proprietary Lease required the Board to act in a reasonable period of time on the Soffens' application, and, given the covenant of good faith and fair dealing inherent in every contract, the Board was also liable to Graham for breach of contract.
Graham argued before trial that her damages should be the equivalent of what a moderately performing mutual fund would generate. The Court dismissed the claim for loss of investment damages as speculative. In her post-trial brief, Graham argued that she should receive statutory interest of 9% on $445,000, representing the lost time value of the money she should have received had she been allowed to sell her apartment. As of May 9, 2019, this amount was $164,380.00 plus $110 per day for every day thereafter.
The Court could not award statutory interest on the value of the apartment. CPLR 5001(a) authorized interest “upon a sum awarded” and, in contrast, New York's Uniform Commercial Code § 2-708 allowed for incidental damages. The Court was reluctant to award the time value of money under CPLR 5001, which was limited to interest on a “sum awarded.” And chose instead to consider the losses as “incidental”.
The Court found that Graham had not suffered damages from the two thwarted sales, as the evidence demonstrated that the New York City real estate had increased in value from 2014 until the time of trial in 2019. Thus, her apartment was worth more at the time of trial than when she first tried to sell the unit. The Court declined to award Graham the value of her apartment because doing so would result in a double recovery once Graham did sell. Therefore, there was no “sum” upon which to award interest either.
The Court found that Graham was entitled to damages for lost rental income. Graham claimed lost rental income of $81,725.00. From April 1, 2015, the latest date she would have transferred the apartment to the Soffens. Given the Board's course of conduct, that date was a reasonable starting point. Graham testified she only decided to take the apartment off the market and rent it in October 2016. Had she known in April 2015 that the Board had no intention of approving the Soffens, or that they would delay a decision until a Court order, she obviously would have rented the apartment earlier. Thus, the Court awarded Graham lost rent in the amount of $81,725.00.
The parties appeared to agree that the amount of Graham's carrying cost component of her damages was $19,476.00, which was Graham's carrying costs of $66,106.00 minus rent received of $53,820.00. Therefore, the Court awarded Graham $19,476.00 for out of pocket carrying costs.
As the prevailing party, Graham was entitled to reasonable attorney's fees. To the extent the Court found the case has been over litigated, it declined to award fees. Accordingly, the parties were encouraged to work out a reasonable amount for the Board to pay Graham as attorney's fees. Failing agreement, the Court expected Graham to initiate a motion for such relief.
The Court declined to award punitive damages. Punitive damages are permitted when wrongdoing was not simply intentional, but evinced a high degree of moral turpitude and demonstrated such wanton dishonesty as to imply criminal indifference to civil obligations.
The Court found that the Board's action was reprehensible—but did do not rise to the level or moral turpitude or criminal indifference sufficient for an award of punitive damages. Although Graham presented evidence that tangentially seemed to indicate that the Board may have illegally required higher prices for other apartments and Graham's, the proof did not rise to the level of clear and convincing evidence sufficient to support an award of punitive damages. For instance, no other shareholder testified about their experiences with the Board in relation to their sales price.
The Court rejected as speculative Graham's argument that she should be awarded damages based on what a moderately performing mutual fund would achieve if the sale had gone through and she had invested that way. And the Court also rejected the Board's attempt to offset damages based on a post-breach valuation. There was no way of knowing when and for how much Graham might sell her apartment in the future. Accordingly, the Court declined the Board's request to offset damages.
The Court awarded $81,725.00 + $19,476 = $101,201.00 to Graham as damages with 9% statutory interest from March 1, 2017, a reasonable interim date.
Originally Published by Smith Gambrell, January 2021
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