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The Limits of the Business Judgment Rule

Guzov's Good Advice, Real Estate Legality

The business judgment rule, adopted from commercial law, permits co-op and condo boards to make decisions without the fear of judicial inquiry. In the 1990 case Levandusky v. One Fifth Ave. Corp. the court held “[i]t is well settled that the business judgment rule protects the actions of a board of directors of a cooperative cooperation so long as the board acts for the purposes of the cooperative, within the scope of its authority, and in good faith.” However, what are the limits to this rule and when do a board’s decisions fall outside the scope of its authority? Case law brings to light the limits of the business judgment rule used by co-op and condo boards in Manhattan. These examples exemplify some of what your co-op and condo boards can and cannot do.

In Hersh v. One Fifth Avenue Apartment Corp., et al. the plaintiff, Ms. Hersh, experienced water leaking into her unit. The engineer evaluated the building’s structure and recommended the building make repairs to the exterior, but the board neglected to take action until there was significant water damage. The board used the business judgment rule as a defense for not initially mending the leaks into Ms. Hersh’s unit. The court held that although the business judgment rule “protects co-op boards from judicial inquiry into the efficacy of the decisions made within the scope of their authority … However, no court has ruled that the shield of the business judgment rule may be fashioned into a sword that cuts away proprietary lessees’ rights under statutory warranty of habitability.” Therefore, the business judgment rule cannot be abused by boards as a blanket defense to all their decisions. Boards cannot make decisions that breach the rights of the shareholders, owners, or tenants, particularly when infringing the warranty of habitability.

Similarly, a co-op or condo board is unable to make self-dealing decisions, or those not in the interests of shareholders, owners, and tenants. The business judgment rule can provide necessary protection, but it does not protect a board who abuses its power for self-serving purposes. In Sharie Graham v. 420 East 72nd Tenants Corp. et al. a co-op board sought to buy a shareholder’s unit and alter it into a gym. The shareholder initially listed the property for $499,000, and the board made an offer of $400,000. Another buyer, paying in cash, offered the listed amount, but the board denied the purchase. Co-op boards do have the authority to reject a transfer of shares, however, in the present case, the board’s reasoning was that the purchase price was below the market rate. The buyer increased his offer to the board’s assessment of the market value of $535,000, but the board rejected the offer and further increased the market price to $610,000. The board “wrongfully denied” the sale of the apartment and engaged in self-dealing by preventing the transfer of shares to a third party. Co-op and condo boards must act in good faith, without “discrimination, self-dealing or misconduct” (Auerbach v Bennett).

It is important to understand the authority of your co-op or condo board. Make sure that they are protecting your rights, but remember they also have the authority to make unpopular decisions for the interest of the building.

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