Criminal Prosecution and Civil Liability for Cooperative Officers and Directors


Housing cooperatives have a long history in New York City. These organizations have members who purchase a share that grants them the right to occupy one housing unit in a multi-unit building. Typically, a board of directors handles the day to day management of the building. If all goes well, the building runs smoothly. However, if management is lax in enforcing rules and laws, there can be unexpected and severe consequences. In the two examples below, members of the cooperative board were indicted for failure to enforce a New York City law and a cooperative paid a hefty damage award for sloppy record keeping and failure to conduct due diligence.

Failure to Enforce the Window Guard Law

Three officers of a Brooklyn cooperative were indicted by the Brooklyn District Attorney for failing to insure that their cooperative installed window guards in nine apartments at 1401 Ocean Avenue, Brooklyn, New York, where children under ten years of age resided. In People v. Premier House, Inc., Judge Kathryn M. Smith refused to dismiss the indictment against the individuals, finding that criminal liability provisions of the Window Guard Law (Sections 131.15(a) and 3.09 of the New York City Health Code) could be enforced against the cooperative and its officers and directors, if it is proven that the individuals were "in control" of the cooperative's building in their capacities as officers of the board and that they failed to discharge their duties as officers with regard to installation of window guards in the relevant apartments.

Holding Corporate Officer's Criminally Liable

The legal principles that a corporation acts through the individuals who act on its behalf and that a corporate officer cannot escape individual criminal liability for violations of the law, even though the corporate entity may also be a defendant, are well established. However, the decision by Judge Smith does not hold that every officer or member of a board of directors will be vicariously liable for another officer or director's acts or culpable inaction, or for the failure to act by a party, such as the cooperative's managing agent, to whom responsibility for compliance with the law has been properly delegated. There must be some affirmative conduct on behalf of the officer or director or a finding that the officer or director did not carry out his responsibility with respect to window guard installation before criminal liability may be imposed.

Two lessons are to be learned from the Premier House decision. First, officers and directors must know that they risk criminal liability if they ignore statutes that mandate certain actions. Second, to comply with the Window Guard Law, officers and directors must instruct their managing agents to comply with the Window Guard Law, to obtain affidavits at closings, to send the annual notices to tenants, to install window guards in apartments and common hallways where required and to inspect the installed window guards to assure that they are being properly maintained. When our firm acts as transfer agent for a cooperative, we require the completion of a Window Guard Affidavit by all purchasers as part of the closing documentation.

Finally, in the unlikely event an officer or director is prosecuted for violation of the law, many cooperative officer's and director's liability insurance policies will cover defense costs. Also, most cooperative by-laws provide for indemnification of officers and directors' legal fees, fines and other reasonable expenses. This indemnification is available if:

  1. the officer or director acted in good;
  2. for a purpose which he or she reasonable believed was in the best interests of the cooperative; and
  3. in criminal actions or proceedings, had no reasonable cause to believe that his or her conduct was unlawful.

Failure to Keep Adequate Records of Stock Certificates and Proprietary Leases

From time to time a cooperative is informed by a shareholder that he or she cannot locate an original stock certificate or proprietary lease for the shareholder's apartment and a request is made for delivery of a replacement certificate and lease. This most often occurs when the shareholder seeks to sell or refinance an apartment. The usual practice followed by cooperatives and managing agents had been to require the shareholder to deliver an affidavit and indemnity agreement to the cooperative, holding the cooperative harmless against any claim that may arise by reason of the issuance of a new stock certificate. Due to the fraud committed by one shareholder upon the cooperative at 136 West 64th Street, the usual practice is about to change.

As reported in the case Collins v. Douglas Elliman-Gibbons and Ives, Inc., a shareholder who had purchased his apartment in 1985 and financed part of the purchase with a $167,000 loan from Long Island Savings Bank requested that his cooperative issue to him a new stock certificate and lease. Although his original certificate and lease were in the possession of the bank, as security for its loan, the shareholder swore in his affidavit and indemnity agreement with the cooperative that he had lost his certificate. The managing agent, which was not the managing agent at the time that the shareholder purchased his apartment, did not have a copy of the recognition agreement entered into among the cooperative, the bank and shareholder at the time of his original purchase and had no record that the shares were pledged to the bank. It permitted the shareholder to sell his apartment for $400,000, issued a new share certificate to the buyer, prepared a consent signed by the cooperative which stated that the seller's shares were not pledged, and did not notify the bank of the transaction.

Approximately 22 months later, the original shareholder stopped making his loan payments to the bank, which then learned of the transaction and sued the cooperative and managing agent for its damages. Summary judgment for the outstanding balance due on its loan was granted to the bank against the cooperative.

How Can the Cooperative Protect Itself?

How can a cooperative protect itself from being victimized? Good record keeping is a must. Every cooperative should have a separate file for each shareholder in which the cooperative's copy of the proprietary lease, any assignment or assumption agreements and any recognition agreements are kept. In addition, the cooperative's records (rent roll and stock ledger book) should indicate if the shareholder's shares and lease are pledged to a lender. Such information is important in the event the shareholder breaches his lease obligations. A notice of lease default is required to be sent to the lender, as well as to the shareholder.

Second, when a shareholder asks for a replacement certificate, a lien search should be ordered on the shareholder and on his apartment. This will show liens of lenders who have perfected their security interest in the shares and lease by filing a UCC-1 financing statement in the County Clerk's office. Lenders are required to file such statements to perfect their security interest in shares and leases for loans made after October 1, 1988. The shareholder should pay for the cost of such search. Note that before October 1, 1988, lenders were permitted to perfect their security interest by taking possession of the shares and leases, so a lien search might not reflect a pre-October 1, 1988 loan.

Third, an affidavit of lost certificate and indemnity agreement should be obtained from the shareholder. Note that in the event a claim is made against the cooperative, the indemnity is only valuable if the shareholder has assets and can be located.

Fourth, some cooperatives are considering requiring the shareholder to purchase a bond in the amount of the market value of the apartment to indemnify the cooperative against claims. The cost of a bond is approximately $20 per thousand dollars of value. In the event of a claim, the bonding company would be called upon to hold the cooperative harmless. Most cooperative by-laws permit the board of directors to impose the requirement that a bond be provided as a condition to issuance of a replacement stock certificate. This practice is common in cases where marketable securities are lost and replacement certificates are requested.

Common sense should be used by a board of directors before imposing what could be a severe financial hardship upon a shareholder. Is the building one which does not permit financing? Did the shareholder's lender lose the certificate? Is there a recognition agreement in the file and does the lender consent to issuance of a new certificate? Was the apartment purchased after October 1, 1988 and does the lien search indicate no liens have been perfected against this shareholder or apartment? Do the cooperative's records show that the shares and lease are not pledged? All of these factors should be considered when deciding whether or not to impose a bond requirement upon a shareholder.

Summary

Persons who manage or control a multiple dwelling building have the obligation to ensure that the building is properly managed. This means that there is an obligation to ensure laws are followed. It also means that the cooperative has a responsibility for accurate record keeping or in the event that such records cannot be located, then proper due diligence. Failure to adhere to these basic tenaments can mean individual criminal liability and/or civil judgments.