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BOARD OF MANAGERS OF THE CHARLES HOUSE CONDO. v. I

June 30, 1993

THE BOARD OF MANAGERS OF THE CHARLES HOUSE CONDOMINIUM, Plaintiff,
v.
INFINITY CORPORATION and SCHNURMACHER BROS., Defendants.



The opinion of the court was delivered by: CONSTANCE BAKER MOTLEY

 Plaintiff, the Board of Managers of the Charles House Condominium (the "Board"), brought suit against defendants Infinity Corporation ("Infinity") and Schnurmacher Brothers ("Schnurmacher") seeking declaratory judgment of the termination of all of defendants' rights, title, and interest in a parking garage pursuant to the Condominium and Cooperative Conversion Protection and Abuse Relief Act, 15 U.S.C. § 3601 et seq. (the "Act"). Defendants subsequently brought certain counterclaims and moved for summary judgment. For the reasons discussed herein, defendants' motion and counterclaims are granted.

 I. BACKGROUND

 Plaintiff is the Board of Managers of the Charles House Condominium. The Charles House Condominium was established pursuant to the provisions of the New York State Condominium Act *fn1" and is located in the City, County, and State of New York. The Board brought suit on behalf of the residential unit owners of the Condominium.

 Defendant, Infinity Corporation ("Infinity"), is a New York corporation and sponsor of the condominium conversion.

 Defendant, Schnurmacher Brothers ("Schnurmacher"), is a New York partnership.

 On October 5, 1955, Schnurmacher acquired title in fee simple absolute to a parcel of land located in New York County and in or about 1958 constructed a building thereon known by street number 40 East 78th Street, New York, New York (the "Property"). The building which was constructed consists of approximately 102 residential units, commercial space for retail stores and offices, and an underground garage. It is this structure which was subsequently converted to condominium use and which is the subject of this action.

 After the death of Charles Schnurmacher (one of the partners of Schnurmacher) the partnership embarked on a plan of net leasing partnership buildings and granting purchase options for cash payments so as to raise cash and settle the obligations of Charles Schnurmacher's estate. Toward this end, Schnurmacher entered into an agreement with 1001 Madison Corporation, a wholly owned subsidiary of Infinity, whereby the Property was net-leased to 1001 Madison Corporation subject to existing leases. Contemporaneously with the execution of the net-lease with 1001 Madison Corporation, Schnurmacher entered into an Option Agreement, also dated as April 5, 1984, with Infinity for a cash consideration of $ 6,600,000, whereby Schnurmacher granted to Infinity an exclusive and irrevocable option to purchase the Property subject to existing commercial and residential tenancies. Pursuant to paragraph 1.3 of the Option Agreement, the option may be exercised at any time during the period beginning with the death of Adolph and Irvin Schnurmacher, the two surviving partners, and ending ten (10) years from the date of the Option or, if Adolph or Irvin Schnurmacher are still alive, 47 years from November 25, 1986, whichever was earlier. *fn2"

 Fearing that the New York State Attorney General would reject the Cooperative Plan, the principals of Infinity and 1001 Madison Corporation requested a meeting with Schnurmacher in order to propose a restructuring of the transaction.

 The proposal for restructuring involved converting the Property to condominium use. The condominium would be comprised of residential units ("Residential Units") and one commercial unit ("Commercial Units").

 The parties then proceeded to negotiate, and the transactions were restructured so that:

 
1. Infinity would pay all of Schnurmacher's real estate taxes related to this Property.
 
2. Infinity would pay all of Schnurmacher's other expenses including fees for professional services and any real estate brokerage commissions.
 
3. Infinity would pay the New York State Real Property Gains Tax if the option to purchase the Commercial Unit were exercised in the future at the purchase price of $ 26,000,000.
 
4. Infinity would pay an additional $ 2,000,000 for the option on the Commercial Unit.
 
5. The lease and option transaction at other buildings would be restructured as absolute sales.

 The taxes and professional fees amounted to more than $ 6,000,000. Prior to the restructuring, Schnurmacher received $ 11,000,000 as option deposits. After the restructuring, Schnurmacher received $ 19,000,000 (sales proceeds) and $ 4,500,000 (option deposit) or a total of $ 23,500,000. Thus, as a result of the restructuring, Schnurmacher received an additional $ 12,500,000 not including the payment of their taxes and expenses.

 In accordance with the transactions as restructured, Infinity submitted an Offering Plan to the Attorney General of the State of New York pursuant to New York State General Business Law § 352. Under § 352, Infinity, as sponsor, sought to convert the building to condominium use. The Offering Plan was accepted for filing on December 27, 1985 by the Attorney General of the State of New York.

 On July 26, 1986, Schnurmacher executed a "Declaration establishing a plan for condominium ownership." On September 4, 1986, the Declaration of Condominium (the "Declaration") including condominium by-laws (the "By-laws") and floor plans with respect to the Property were filed with the City Register of the City of New York. *fn3" The Property, then owned by Schnurmacher, was thereby submitted according to the provisions of the New York State Condominium Act to create a condominium consisting of 102 residential units and 9 servant room/units which are collectively called the "Residential Units." A separate unit identified in the Declaration as the "Commercial Unit" consists of stores, offices, and the garage space which is the subject of this action.

 Pursuant to the Declaration and by deed dated November 25, 1986, title to the Residential Units vested in the Sponsor, Infinity, *fn4" and these units were then offered for sale to the public by the Sponsor, Infinity. *fn5" (Greenberg Aff. P 5) The offer to sell residential units in the Property was made by means of a Condominium Offering Plan, dated December 27, 1985 (the "Plan").

 Pursuant to New York law, the Plan was required to contain a full and accurate description of all terms of the offering and was to be distributed to all potential purchasers of units. The Plan incorporated the Declaration and the By-laws and set forth the terms and conditions governing the sale and purchase for the Residential Units.

 The Plan, including the Declaration, By-laws and other documents described therein, comprised an offer to sell to the public the Residential Units.

 Schnurmacher retained ownership of the Commercial Unit. The Declaration and the Plan also provided that a deed to the Commercial Unit, including the garage, would be issued to Schnurmacher. On November 25, 1986, Schnurmacher as optionor and Infinity as optionee modified the Option Agreement dated as of April 5, 1984 whereby Infinity obtained an option to purchase all of Schnurmacher's right, title and interest to that portion of the Property retained by Schnurmacher and designated in the Declaration as the Commercial Unit. The lease between 1001 Madison Corp. and Schnurmacher was modified by agreement dated April 25, 1986 making the lease subject to the Declaration of the Charles House Condominium and modifying the lease to be a lease of the Commercial Unit.

 In late 1986, 1001 Madison Corp. merged into Infinity. Thus, in addition to its option to purchase right, title and interest in the Commercial Unit, Infinity succeeded to the rights of 1001 Madison Corp. as the tenant under the modified lease between Schnurmacher and 1001 Madison Corp.

 On April 22, 1986, Irwin Schnurmacher and Adolph Schnurmacher appeared before and were examined under oath by the New York State Attorney General. The Attorney General found that the transaction between Schnurmacher and Infinity were arm's-length transactions.

 Subsequent to the commencement of the action in the State Court, the Attorney General, by letter dated June 25, 1986, rescinded his acceptance of the Offering Plan. Thereafter, Infinity intervened in the proceeding commenced by the Tenants' Committee and the residential tenants, seeking a judgment compelling the Attorney General to accept the Offering Plan for filing and directing the Attorney General to cancel and annul the letter of rescission of the Plan dated June 25, 1986.

 The matter was presented to Justice Robert E. White of the New York Supreme Court for a determination. *fn6" The court concluded that there was no collusion or self-dealing between Schnurmacher and Infinity. *fn7"

 A final judgment which, inter alia, dismissed the petition and directed the Attorney General to accept the Offering Plan for filing was entered in the office of the clerk of New York County on March 20, 1987. The petitioners served and filed a notice of appeal from the final judgment on April 21, 1987.

 Subsequently, the Tenants' Committee and Infinity entered into an agreement resolving all outstanding issues, which agreement was memorialized in the Eighth Amendment to the Offering Plan, which was accepted for filing with the Attorney General of the State of New York on or about July 17, 1987.

 The Eighth Amendment to the Offering Plan incorporates as Exhibit J thereof a letter agreement dated June 25, 1987 between the sponsor's attorney and the Tenants' Committee's attorney whereby the Tenants' Committee agreed to withdraw its objection to the Offering Plan, withdraw its appeal from the final judgment of the state supreme court, and recommend to the membership not to commence any further litigation. *fn8" As a result of the agreement culminating in the Eighth Amendment, the Tenants' Committee and the residential tenants withdrew the appeal of the final judgment entered in the state court litigation.

 Stanley Deutsch, as owner of one of the Residential Units, and the president of the plaintiff, The Board of Managers of the Charles House Condominium, commenced a proceeding before the New York State Division of Housing and Community Renewal ("D.H.C.R.") seeking a determination that the garage portion of the Commercial Unit was subject to the New York State Rent Stabilization Law which would result in some of the parking spaces being subject to rent regulation. By Order dated April 22, 1987, the D.H.C.R. denied the application. Subsequently, Deutsch petitioned the Commissioner of the D.H.C.R. for an administrative review of the Order denying his application to determine that the garage was subject to rent stabilization. The petition for administrative review was dismissed by the Commissioner of the D.H.C.R.

 By notice dated April 30, 1992, plaintiff served notice upon defendants (pursuant to the Condominium and Cooperative Conversion Protection and Abuse Relief Act (the "Act"), 15 U.S.C. § 3601 et seq.) terminating inter alia, (a) the Condominium Offering Plan; (b) the Declaration; (c) the By-laws; (d) the Option Agreement dated as of April 5, 1984; (e) the Lease between Schnurmacher Bros. and 1001 Madison Corp.; and (f) the Deed to the Commercial Unit of the Charles House Condominium.

 Plaintiff filed for declaratory judgment in July 1992 adjudging that all rights, title and interest of the defendants in and to the parking garage located on the Property have been validly and timely terminated under the Act. Defendants subsequently made certain counterclaims and moved for summary judgment.

 II. DISCUSSION

 Plaintiff's complaint alleges that defendants attempted to enter into an illegal, self-dealing conversion agreement in violation of the Act. The Act was promulgated to abate specific abusive practices occurring in the cooperative and condominium conversion process. See H.R. Conf. Rep. No. 1420, 96th Cong., 2d Sess. 4, reported in 1980 U.S. Code Cong. & Admin. News 3506, at 3707.

 "The primary purpose of the Act was to protect cooperative and condominium unit owners against overreaching by developers. Thus, the Act provided means for unit owners to challenge unconscionable leases and self-dealing contracts." King v. 415 Second Owners Corp., No. 86 Civ. 4800, 1987 U.S. Dist. LEXIS 15211 (S.D.N.Y. Nov. 12, 1987), *3.

 "Section 3607 of the Act, in particular, was a response to the activities of many developers in the 1970's who created "sweetheart" lease arrangements and self-dealing contracts as a condition of sale." Barnan Association v. 196 Owner's Corp., 797 F. Supp. 302, 304 (S.D.N.Y. 1992).

 The Act permits the unit owners or an association of unit owners to terminate, without penalty certain long-term self-dealing contracts. It provides in pertinent part:

 
(a) Any contract or portion thereof which is entered into after October 8, 1980, and which --
 
(1) provides for operation, maintenance, or management of a condominium or cooperative association in a conversion project, or of property serving the condominium or cooperative unit owners in such project;
 
(2) is between such unit owners or such association and the developer or an affiliate of the developer;
 
(3) was entered into while such association was controlled by the developer through special developer control or because the developer held a majority of the votes in such association; and
 
(4) is for a period of more than three years, including any automatic renewal provisions which are exercisable at the sole option of the developer or an affiliate of the developer, may be terminated without penalty by such unit owners or such association.

 15 U.S.C. § 3607(a). All four elements must exist for a contract to be terminated under the statute. West 14th Street Commercial Corp. v. 5 West 14th Owners Corp., 815 F.2d 188, 197 (2d Cir.), cert. denied, 484 U.S. 850, 98 L. Ed. 2d 107, 108 S. Ct. 151 (1987).

 "The Abuse Relief Act seeks to eliminate the potential for abuse to which the conversion process lends itself. Congress undertook the delicate task of deterring these abuses without preventing conversions from taking place. Section 3607 of the Abuse Relief Act targeted a particular form of abuse to which tenants were vulnerable, namely, self-dealing leases arranged by sponsors. Sponsors have an economic incentive to take advantage of the temporary control they exert over tenants' corporations to bind tenants to long term, self-dealing leases--leases that potentially deprive the tenants of valuable assets." 181 E. 73rd St. Co. v. 181 E. 73rd Tenants Corp., 954 F.2d 45, 47 (2d Cir. 1992) (citations omitted). See also Park So. Tenants v. 200 Cent. Park So. Associates, 748 F. Supp. 208, 211 (S.D.N.Y. 1990), aff'd, 941 F.2d 112 (2d Cir. 1991) (citations omitted).

 Plaintiff claims that defendants realized that the initial cooperative agreement would not succeed and restructured the agreement to escape the application of the Act. Plaintiff points to the provision of the Declaration allocating only 11.8596% of the Common Elements to the Commercial Unit as evidence of self-dealing nature of the transaction. Plaintiff contends that that allocation is disproportionate because on a square footage basis, the Commercial Unit constitutes 26.84% of the building and on a value basis, ...


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