Co-op in search of the White Knight

Real Estate Weekly, Feb 9, 1994 by Edward L. Schiff

The residential cooperative industry in the New York City Metropolitan area has, in recent years, suffered extreme financial difficulties. Many cooperatives have found their particular problems to be caused by their sponsor or other investors who hold large numbers of unsold shares to apartments which are occupied by rent controlled and rent stabilized tenants.

In almost all of these cases, the rents collected from the rent-regulated tenants are much less than the maintenance charges attributable to these unsold apartments which have, in turn, caused the sponsor and/or investors to default on their obligations to pay maintenance charges. This has caused these cooperative developments to raise maintenance charges to the limit and still not have sufficient funds to meet their mortgage obligations. The result has been mortgage defaults and consequently in some instances, bank failures.

In addition, many of these cooperative buildings are old. They require funds necessary for capital repairs and replacements which they cannot raise by assessing their already burdened shareholders.

Thus, this grim situation looks hopeless, with the mortgage holder seriously considering foreclosing on the property to stem its losses while the cooperative development contemplates filing a bankruptcy petition in an attempt to preserve the cooperative status of the property.

If this were a medieval fable, in face of this hopeless situation, one could look forward only to a white knight on his steed galloping to the rescue. In fact, this is just what happened to a Brooklyn cooperative rescued by a white knight, not clothed in shining armor, but having deep pockets of financial resources.

The 122-unit, six-story apartment building at 302 961h Street, Brooklyn, New York is a cooperative which was converted from a rental building in 1988. The sponsor of the cooperative was able to sell only 35 percent of the units. Sometime after the conversion to cooperative ownership, the sponsor pledged its unsold shares as collateral for a loan made by the same lender who held the underlying mortgage on the cooperative building, even though the unsold shares generated a negative cash flow (i.e., the rents collected from the rent-regulated tenants were less than the maintenance charges thereupon payable to the apartment corporation). When the cooperative sales market "dried up" in the late 1980s to early 1990s, the sponsor apparently decided that it would no longer fund the shortfall between the rents he collected and the maintenance he was required to pay, and abandoned these apartments. The effect was to cause the cooperative to go into a default of the $4 million mortgage which covered the building. In addition, the sponsor also defaulted on its unsold share loan and the mortgagee foreclosed on the unsold apartments which were pledge as collateral.

The mortgagee, having made similar loans with other sponsors in other cooperatives, ultimately failed and the Resolution Trust Corporation (RTC) acquired the mortgage. In this instance the RTC also acquired all of the unsold shares. The cooperative had not made a mortgage payment in over 18 months. To complicate matters further, the cooperative was also being audited by the City of New York for past due real property transfer taxes.

Somerset Investors Corporation, a Great Neck, New York real estate investor, came upon the scene with deep pockets. Jules Reich, a principal of Somerset who has extensive experience with cooperatives, including conversions, renovations, sales and management, made a thorough evaluation of the situation confronting the cooperative, its shareholders as well as RTC and decided to step in. He, with his lawyer Allen M. Turek, partner of Schiff, Turek, Kirschenbaum, commenced negotiations with RTC and with the cooperative, being represented by Dennis Greenstein, of Haas, Greenstein, Cohen & Gerstein, and ultimately fashioned a "work-out" which had the following results:

Somerset acquired the $4 million mortgage with accrued interest charges from RTC for less than 50 percent of its original principal amount and also acquired as part of the package from RTC all of the unsold shares which RTC was holding. In turn, Somerset came to an agreement with the cooperative which recast the mortgage at a principal sum substantially less than the original amount as well as a reduction in the annual interest rate. Somerset agreed to assume the responsibility of owning the unsold apartments and agreed to make up the shortfall while paying the full maintenance charges to the cooperative.

The negotiations were long and extensive because the competing interests of the RTC, Somerset and the cooperative had to be satisfied, while at the same time the transaction had to be structured so that a minimum of taxes became due on the Federal, State and City level.

The cooperative's participation in the negotiations, not only by its counsel but also by its president, Elizabeth Bulous, proved to be pivotal to the success of the entire work-out, since Somerset was not prepared to acquire the underlying mortgage unless it was assured that the cooperative would be financially healthy at the conclusion of the transaction.