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FEDERAL HOME LOAN MORTG. CORP. v. NEW YORK STATE D

June 3, 1994

FEDERAL HOME LOAN MORTGAGE CORPORATION, Plaintiff,
v.
NEW YORK STATE DIVISION OF HOUSING AND COMMUNITY RENEWAL, Defendant.



The opinion of the court was delivered by: I. LEO GLASSER

 GLASSER, United States District Judge:

 The parties to this declaratory judgment action seek a judicial determination regarding whether an apartment dwelling that was subject to New York's rent stabilization law prior to the building's conversion to cooperative ownership reverts back to rent regulatory status upon the demise of the cooperative. Plaintiff has moved for summary judgment pursuant to Fed. R. Civ. P. 56, while defendant has cross-moved for summary judgment. For the reasons set forth below, plaintiff's motion is denied and defendant's cross-motion is granted.

 FACTS

 Plaintiff Federal Home Loan Mortgage Corporation ("FHLMC") is a federally chartered corporation that was created by Congress for the purpose of providing liquidity to the mortgage market; FHLMC generally serves this purpose by purchasing investment quality mortgages from primary lenders, packaging the mortgages as securities and selling the securities to investors. Affirmation of Mitchell A. Rothken, Dated Dec. 1, 1993 ("Rothken Affirm.") P 2. Defendant New York State Division of Housing and Community Renewal ("DHCR") is an executive agency of the State of New York that is responsible for the administration and enforcement of the rent regulatory laws of the City and State of New York. Def.'s 3(g) Statement P 1.

 On July 28, 1986, FHLMC became the holder of a first mortgage lien in the amount of $ 1.45 million (the "underlying mortgage") on a multi-family apartment dwelling located at 101 Lincoln Road, Brooklyn, New York (the "Building"). Pl.'s 3(g) Statement PP 2-3; Def.'s 3(g) Statement P 8. It is undisputed that at the time FHLMC acquired its mortgage lien, the Building was a rental building subject to the provisions of the New York City Rent Stabilization Law, N.Y. City Admin. Code §§ 26-501 et seq. (the "RSL"). Pl.'s 3(g) Statement P 4; Affidavit of Karen L. Smith, Sworn to Jan. 28, 1994 ("Smith Aff.") P 1 n.5.

 A. The Conversion to Cooperative Ownership

 Subsequent to FHLMC's acquisition of the mortgage lien, the Building was converted to cooperative ownership in accordance with the provisions of N.Y. Gen. Bus. Law § 352-eeee, also known as the Martin Act. Rothken Affirm. P 4. As required under the Martin Act, prior to the conversion, a Cooperative Offering Plan (the "Plan") setting forth the terms of the offering was drafted and submitted to the New York State Department of Law for approval. See N.Y. Gen. Bus. Law § 352-e. The Plan was accepted for filing on April 27, 1988, and was declared effective by the Attorney General on July 11, 1989. Def.'s 3(g) Statement PP 3, 5. Title to the Building thereafter passed from the sponsor *fn1" to a cooperative apartment corporation named 101 Lincoln Tenants Corporation (the "Tenants Corp.") on November 15, 1989, *fn2" and shares of stock in the Tenants Corp. were allocated in varying amounts to all of the apartments in the Building. Rothken Affirm. P 5.

 On April 27, 1988, the Plan also was presented to all tenants in occupancy at the Building, who were given the option to purchase the shares allocated to their respective units. Rothken Affirm. P 5. The Plan expressly stated that tenants who chose to purchase the shares allocated to their apartments would be issued long-term proprietary leases, which would supercede their existing leases. Rothken Affirm. P 14; Smith Aff. P 8. It also informed potential purchasers that the Building was subject to the underlying mortgage, and that at the time of conversion, the Tenants Corp. would execute a $ 2 million wrap-around mortgage to be held by the Sponsor. Pl.'s 3(g) Statement P 9 & Rothken Affirm. Ex. B at 127, 148, 164. The Plan explained that the wrap-around mortgage payments received from the Tenants Corp. would be used to pay the underlying mortgage, Rothken Affirm. Ex. B at 200, and that in the event of a default by the Tenants Corp. on the mortgage payments, the lender had the right to demand immediate payment of the entire amount due under the mortgage and to institute a foreclosure action. Rothken Affirm. P 9 & Ex. B at 196-97. In addition, the Plan advised that a proprietary lessee's default on any of a number of obligations set forth in the proprietary lease would result in the termination of the purchaser's proprietary lease, and the concomitant loss of the purchaser's investment. Rothken Affirm. P 10 & Ex. B at 328-30; Def.'s 3(g) Statement P 12. However, the Plan did not specify whether or not a purchasing tenant would regain the protections of the RSL in the event of the dissolution of the cooperative. Def.'s 3(g) Statement P 12.

 Three tenants chose to purchase their apartments, while seventeen of the eighty-three other units in the Building were sold to persons who did not reside in the Building prior to conversion. *fn3" Smith Aff. PP 4-6 & Ex. E. Defendant maintains "on information and belief" that the purchase prices of the apartments ranged from $ 66,000 to $ 110,000, and that all of the proprietary lessees purchased their units with 90% financing offered by the Sponsor. Smith Aff. P 7 & Ex. F; Stewart Aff. P 5. Because the Plan was a "non-eviction plan," as defined in the Martin Act, N.Y. Gen. Bus. Law § 352-eeee(1)(b), those tenants who elected not to purchase their units and continued to live in the Building maintained their rent stabilized status. *fn4" Rothken Affirm. P 15 & Ex. B at 205. It is undisputed that during the period when the Building was converted to cooperative ownership, with the exception of the non-purchasing tenants, "the apartments were freed from the constraints of rent regulation." Rothken Affirm. P 16.

 It also bears noting, and counsel acknowledged at oral argument on May 13, 1994, that at the time the Building was converted to cooperative ownership, FHLMC -- the mortgagee -- had the right to demand payment of the principal and interest then due, but elected not to do so. Tr. 18-19. Rather, FHLMC approved the conversion on November 16, 1989. See Smith Aff. Ex. H. Moreover, no additional indebtedness was added to the underlying mortgage before, during or after the conversion. Smith Aff. P 16.

 B. The Default by the Tenants Corp.

 Subsequent to the conversion, a Board of Directors (the "Board") comprised of elected proprietary lessees was established to operate and maintain the Building. Pl.'s 3(g) Statement P 15; Rothken Affirm. P 6. Defendant alleges that the Sponsor controlled the Board by appointing a majority of its members; in addition, the Sponsor controlled Zeal Management Co., the entity that acted as managing agent for the Building. Def.'s 3(g) Statement P 13; Smith Aff. P 18. While plaintiff maintains that the Board breached its duty to set and collect maintenance charges in an amount sufficient to pay the mortgage, causing the Tenants Corp. to default on its mortgage payments in early 1991, Pl.'s 3(g) Statement PP 16-17, defendant attributes the default to the Sponsor's failure to make his maintenance payments. Def.'s 3(g) Statement P 14. Moreover, defendant submits that "the other non-sponsor shareholders knew nothing about either the sponsor default on the maintenance nor [sic] the apartment corporation's default on the mortgage until they were served with foreclosure papers on or about May 28, 1991." Def.'s 3(g) Statement P 15; Smith Aff. P 21.

 In any event, it is undisputed that FHLMC commenced a mortgage foreclosure action in this court in May 1991. On plaintiff's application, in June 1991, a receiver was appointed to manage the Building. *fn5" Def.'s 3(g) Statement P 16. A judgment of foreclosure was entered by the court on October 8, 1991 in the amount of $ 1,599,197, which later was adjusted to $ 1,805,416, inclusive of interest and fees. Rothken Affirm. Ex. C & Pl.'s 3(g) Statement P 19. A foreclosure sale was conducted in June 1993, at which time FHLMC purchased the Building. *fn6" Rothken Affirm. P 17.

 The parties agree that upon the foreclosure sale, the proprietary leases were cancelled; as a result, the purchasers ceased owning the shares allocated to their apartments, but remained liable on the personal loans they took out to purchase those shares. Def.'s 3(g) Statement P 18. At the time of the sale and currently, there are approximately five vacancies in the Building and approximately fifteen apartments that are occupied by former purchasers. Def.'s 3(g) Statement P 19; Stewart Aff. P 13. From the date of the foreclosure sale to the present, FHLMC neither has provided renewal leases to these purchasers nor attempted to collect rent from them. Def.'s 3(g) Statement P 19. FHLMC maintains that it is not in the business of owning and operating residential apartment buildings, and moreover, that it has been unable to run the Building because it does not know what rent to charge for the units that were freed from rent regulation when the Building was converted to cooperative ownership. Rothken Affirm. PP 19-20. As a result, the Building is not generating the revenue required to cover its operating expenses. Rothken Affirm. P 21. FHLMC alleges that "in light of these problems [it] desires to sell the Building as soon as possible so that it can satisfy the $ 1,805,416 judgment it obtained against the Tenants Corp. and devote its attention to accomplishing its intended purpose of facilitating home ownership." Rothken Affirm. P 22. FHLMC accordingly commenced this action by Complaint filed August 17, 1993, seeking a ruling as to whether the RSL again became applicable to the Building upon the foreclosure. FHLMC now moves for summary judgment pursuant to Fed. R. Civ. P. 56 "because the issue is solely one of law," Pl.'s Mem. at 8; DHCR, in turn, cross-moves for summary judgment.

 DISCUSSION

 This court is called upon to interpret New York law in an area about which the New York Court of Appeals has not yet spoken. However, because FHLMC is the plaintiff in these proceedings, the action properly is before this court pursuant to 12 U.S.C. § 1452 (f). *fn7"

 Plaintiff's argument essentially is as follows: because the RSL provides that a building owned as a cooperative is exempt from the RSL, and because there is no statutory provision addressing a change of a building's status from cooperative back to non-cooperative, once a building becomes exempt from the RSL, it remains exempt. Defendant alleges, by contrast, that all units in the Building and in comparable buildings that were subject to the RSL prior to conversion to cooperative ownership revert to rent regulatory status upon dissolution of the cooperative, whether by foreclosure or other means. While the court finds interesting the notion that a formerly exempt building, like a "phoenix arising from the ashes," reverts back to rent stabilized status, as discussed below, an analysis of the language of the applicable statutory provisions, as well as their underlying history and purpose, reveals that the interpretation urged by plaintiff is not a viable one. Thus FHLMC's motion for summary judgment is denied, and DHCR's cross-motion for summary judgment is granted.

 I. Relevant Statutory Provisions

 The legislative history of the RSL, including recent developments in the law, recently was described by the New York Court of Appeals as follows:

 
In response to what it found to be a severe housing shortage following World War II, the legislature enacted laws providing for rent control, and, later, rent stabilization. Perceiving that continuing need throughout the ensuing decades, the legislature has periodically extended rent regulation to the present day, most recently providing for deregulation only of apartments with monthly rents in excess of $ 2,000 (see, Rent Regulation Reform Act of 1993, L. 1993, ch. 253 [extending rent control and rent stabilization until June 15, 1997]).

 Rent Stabilization Ass'n of N.Y. City, Inc. v. Higgins, 83 N.Y.2d 156, 164-65, 630 N.E.2d 626, 608 N.Y.S.2d 930, 932 (1993), petition for cert. filed, 62 U.S.L.W. 3659 (U.S. Mar. 21, 1994). *fn8" The Court of Appeals further explained that in 1983, the legislature designated DHCR the administrative agency responsible for administering the regulation of rents under the rent control and rent stabilization laws. Id. In 1985, the legislature granted DHCR additional authority to amend the Rent Stabilization Code, N.Y. Comp. Codes R. & Regs. tit. 9 §§ 2520 et seq. (the "Code"). Pursuant to this grant of authority, DHCR enacted the current version of the Code -- applicable to the present case -- in May 1987. Id. at 165, 630 N.E.2d at 633, 608 N.Y.S.2d at 933; N.Y. Comp. Codes R. & Regs. tit. 9 § 2520.1.

 Hence all rents for eligible apartments in New York City currently are subject to regulation under the RSL and the Code. As relevant to the present case, the RSL generally is applicable to "Class A multiple dwellings not owned as a cooperative or condominium . . . containing six or more dwelling units which: (1) were completed after February first, nineteen hundred forty-seven . . . . " N.Y. City Admin. Code § 26-504 (emphasis added). The Code, in turn, applies to

 
all or any class or classes of housing accommodations made subject to regulation pursuant to [the RSL] . . . except the following housing accommodations for so long as they maintain the status indicated below . . . (1) housing accommodations ...

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