FLIP TAX ADOPTED WITHOUT REQUIRED SHAREHOLDER APPROVAL HELD INVALID From the Ganfer & Shore, LLP Client Advisory June 2008
Many cooperatives charge their shareholders a fee, knows as a flip tax, on any sale of cooperative shares.These fees can be substantial and contribute significantly to the revenues of many cooperatives.It is well-settled that flip taxes are valid, but only when they are enacted pursuant to the legal requirements of a cooperatives governing documents.Failure to follow the required procedures led to the invalidation of a 2.5% flip tax in Pello v. 425 50 Owners Corp., 19 Misc. 3d 1125(A), 2008 WL 1869651, 2008 N.Y. Slip Op. 50849 (U) (Sup. Ct. N.Y. Co. Mar. 31, 2008).
In this case, a shareholder sued to invalidate her cooperatives flip tax, contending that it had not been validly adopted.At the outset, the court noted that flip taxes are valid where they are duly adopted in accordance with a cooperatives governing documents.Here, nothing in the original offering plan, by-laws, or proprietary lease authorized the Board to impose a flip tax.While the By-Laws authorized the Board to charge a fee on transfers to cover actual expenses and attorneys fees of the Corporation, a service fee of the Corporation and such other conditions as it may determine, the court held that this did not authorize the Cooperative to charge a flip tax, as opposed to requiring reimbursement for its expenses relating to the transfer.
The Cooperative contended that it has amended its By-Laws in 2005 to provide for a flip tax, but the court found that no such amendment has been validly adopted.The By-Laws required that all amendments must be approved by a two-thirds shareholder vote, yet the court found that the shareholders had not adopted any amendment by any vote.No meeting of the shareholders had taken place at which an amendment was voted upon, not was notice of the meeting waived by written consent.The Cooperative next contended that the Board President had spoken with all shareholders in the seven-unit building when the amendment was being considered and all of the shareholders, including plaintiff, had stated they supported the amendment.Plaintiff disputed whether this has occurred, but the court held that even if it had, such a procedure was insufficient.Although many small buildings are run informally, the court opined that this is not acceptable in the context of a flip tax.Rather, [w]hen notice to the shareholders is required, failure to provide such a notice to all shareholders, even in a small building such as the one at issue here, will nullify a vote to institute a flip tax even when it was approved by more than the requisite number of shares.
The court also rejected an alternative argument that the Board has validly amended the By-Laws itself, without shareholder action.The Court found insufficient evidence that such an amendment had actually been adopted by the Board at a meeting.But even if the Board had amended the By-Laws without a shareholder vote so as to authorize a flip tax, the court held that this would be invalid because an amendment to the proprietary lease could only be amended by vote of two-thirds of the shares.Although the provisions governing amendments to the various documents contained an apparent contradiction as to what approvals were required to institute a flip tax, the court concluded that [w]here, as here, the threshold set by the proprietary lease is higher than that set by the bylaws, the board cannot by mere resolution vest itself with the authority to impose a flip tax.
The court rejected an argument that plaintiff has acquiesced in the flip tax by never raising any questions about it in the two years since it had allegedly been adopted.Instead, the court held that the invalid flip tax was void ab initio, directed that the Cooperative not charge plaintiff the flip tax, and observed that the Board would be liable for any damages plaintiff might have suffered because his sale ofhis apartment had been disapproved when she refused to pay the tax.In light of this and other precedents construing the requirements for adopting flip taxes strictly, cooperatives should review their governing documents and minutes to ensure that their flip tax policies were properly adopted and that full documentation is available in the event of a challenge to the tax.