Mitchell-Lama Conversions and the Martin Act

Can a limited-profit housing company seeking to withdraw from the Mitchell-Lama program avoid supervision by the Attorney General if the withdrawal does not involve any transfer of property or physical exchange of shares? That question reached the Court of Appeals in East Midtown Plaza Housing Co. Inc. v. Cuomo (NYLJ 11/20/12, p. 23, col. 1). The court answered it with a resounding “no,” and simultaneously held that if the company's certificate of incorporation calls for voting on a one-apartment, one-vote basis, the same voting rule applies in determining whether the requisite two-thirds majority has approved withdrawal from the Mitchell-Lama program.

The Program

The Mitchell-Lama program, originally developed in the 1950s, provided government financing and tax breaks for construction of residential apartments for people who met the program's income limits. Many of the buildings were set up as co-ops. Tenant-shareholders bought shares in a limited-profit housing company, but were not permitted to sell them on the open market. Instead, if a tenant-shareholder wanted to sell, tenant could recover the equity tenant paid into the apartment, which would then be resold to another income-eligible tenant-shareholder.

Section 35 of the Private Housing Finance Law, however, enabled a limited housing finance company to withdraw from the program after 20 years of participation, so long as the company repaid all outstanding government loans. With the dramatic rise in the price of residential apartments, withdrawal appeared to be an attractive option for many limited housing finance companies. When the companies were organized as co-ops, withdrawal promised tenant-shareholders the prospect of dramatic gains from the sale of their apartments at market prices. But the cost-benefit analysis is not identical for all shareholders. For those who want to remain in their apartments, termination of the tax breaks associated with the program, together with increased costs that might result from substituting private financing for subsidized government financing, the increase in monthly costs would
outweigh any potential future gains that might arise at the time the tenant-shareholder wants to sell.

East Midtown

A dispute among tenant-shareholders provided the background for the litigation in East Midtown. A limited-profit housing company organized in 1968, East Midtown operates a 746-unit cooperative housing project located in six Manhattan buildings. Its certificate of incorporation specifies that each shareholder is entitled to one vote at corporate meetings, regardless of the number of shares associated with the shareholder's apartment. In 2004, the shareholders voted on a proposal to dissolve and transfer all of the corporate assets to a newly incorporated cooperative corporation, accompanied by an issuance of shares in the new entity. Owners holding more than two-thirds of the shares voted in favor of the proposal, but if votes were counted on a one-apartment, one-vote basis, the proposal failed to obtain the requisite two-third majority.

After the vote, the Attorney General informed East Midtown that a new vote was required because the Martin Act required a pre-vote filing of an offering plan with the Attorney General. He also indicated that the certificate of incorporation required the vote to be conducted on a one-apartment, one-vote basis.

In 2008, East Midtown filed, and the Attorney General accepted, a revised offering plan. The new plan, unlike the 2004 plan, did not involve any transfer of property or physical exchange of shares. Instead, East Midtown would amend its certificate of incorporation. Proponents of the plan informed shareholders that the city's Department of Housing Preservation and Development (HPD) had taken the position that votes must be counted on a one apartment, one vote basis, but East Midtown informed shareholders that it reserved the right to challenge that position. The voting results were the same as in 2004: Two-thirds of the shares, but not two-thirds of the shareholders, voted in favor of the proposal.

When the Attorney General refused to declare the privatization plan effective, East Midtown brought an article 78 proceeding contending that the Martin Act did not apply to the 2008 plan because the plan involved no transfer of assets or shares. East Midtown also contended that the plan was effective because votes were properly counted on a one-share, one-vote basis rather than a one-apartment-one-vote basis. Both Supreme Court and the Appellate Division rejected East Midtown's positions, setting the stage for East Midtown's appeal.

The Court of Appeals Opinion

In an opinion by Judge Victoria Graffeo, the Court of Appeals affirmed, holding that the Martin Act applies to Mitchell-Lama co-op privatizations even when the plan involves no transfer of assets or shares. The court acknowledged that the Martin Act, by its terms, makes it unlawful for someone to make or take part in “a public offering or sale” of securities, including participations interest in cooperative apartment buildings, unless an offering statement is filed with the Attorney General (General Business Law section 352-e(1)(a)). The East Midtown reorganization was to be accomplished by an amendment to the certificate of incorporation rather than by any public sale. But the court noted past decisions holding that the Martin Act, as a remedial statute, was to be liberally construed. And the court then invoked federal precedent interpreting the blue sky laws, noting that New York courts have often looked to federal cases in interpreting the Martin Act, which itself makes reference to the federal securities laws.

The court then cited federal cases indicating that the economic reality of the transaction should dictate whether the transaction is treated as a purchase or sale. The court quoted a Second Circuit opinion, Gelles v. TDA Indus, 44 F.3d 102, 104, explaining that the securities law should apply if there has been “a significant change in the nature of the investment or in the investment risks as to amount to a new investment.” Judge Graffeo's opinion then emphasized that privatization of a Mitchell-Lama project leaves shareholders with an investment significantly altered by, among other changes, the new ability to sell at market rates, and the loss of property tax reductions. As a result, the court held that the Attorney General properly required filing of an offering plan.

The court then rejected East Midtown's argument that the Business Corporation Law authorizes corporate dissolution upon a vote of two-thirds of the shares of the corporation. The court emphasized that BCL section 1001 authorizes dissolution by “two-thirds of the votes of all shares “entitled to vote thereon,” and interpreted that language to permit the certificate of incorporation to limit the number of shares a shareholder is entitled to vote, effectively imposing a one-apartment, one-vote limit.

The Bottom Line

Ultimately, then East Midtown establishes that the Martin Act will govern all Mitchell-Lama privatizations, regardless of the form the sponsors use. Substance rather than form will govern.

Can a limited-profit housing company seeking to withdraw from the Mitchell-Lama program avoid supervision by the Attorney General if the withdrawal does not involve any transfer of property or physical exchange of shares? That question reached the Court of Appeals in East Midtown Plaza Housing Co. Inc. v. Cuomo (NYLJ 11/20/12, p. 23, col. 1). The court answered it with a resounding “no,” and simultaneously held that if the company's certificate of incorporation calls for voting on a one-apartment, one-vote basis, the same voting rule applies in determining whether the requisite two-thirds majority has approved withdrawal from the Mitchell-Lama program.

The Program

The Mitchell-Lama program, originally developed in the 1950s, provided government financing and tax breaks for construction of residential apartments for people who met the program's income limits. Many of the buildings were set up as co-ops. Tenant-shareholders bought shares in a limited-profit housing company, but were not permitted to sell them on the open market. Instead, if a tenant-shareholder wanted to sell, tenant could recover the equity tenant paid into the apartment, which would then be resold to another income-eligible tenant-shareholder.

Section 35 of the Private Housing Finance Law, however, enabled a limited housing finance company to withdraw from the program after 20 years of participation, so long as the company repaid all outstanding government loans. With the dramatic rise in the price of residential apartments, withdrawal appeared to be an attractive option for many limited housing finance companies. When the companies were organized as co-ops, withdrawal promised tenant-shareholders the prospect of dramatic gains from the sale of their apartments at market prices. But the cost-benefit analysis is not identical for all shareholders. For those who want to remain in their apartments, termination of the tax breaks associated with the program, together with increased costs that might result from substituting private financing for subsidized government financing, the increase in monthly costs would
outweigh any potential future gains that might arise at the time the tenant-shareholder wants to sell.

East Midtown

A dispute among tenant-shareholders provided the background for the litigation in East Midtown. A limited-profit housing company organized in 1968, East Midtown operates a 746-unit cooperative housing project located in six Manhattan buildings. Its certificate of incorporation specifies that each shareholder is entitled to one vote at corporate meetings, regardless of the number of shares associated with the shareholder's apartment. In 2004, the shareholders voted on a proposal to dissolve and transfer all of the corporate assets to a newly incorporated cooperative corporation, accompanied by an issuance of shares in the new entity. Owners holding more than two-thirds of the shares voted in favor of the proposal, but if votes were counted on a one-apartment, one-vote basis, the proposal failed to obtain the requisite two-third majority.

After the vote, the Attorney General informed East Midtown that a new vote was required because the Martin Act required a pre-vote filing of an offering plan with the Attorney General. He also indicated that the certificate of incorporation required the vote to be conducted on a one-apartment, one-vote basis.

In 2008, East Midtown filed, and the Attorney General accepted, a revised offering plan. The new plan, unlike the 2004 plan, did not involve any transfer of property or physical exchange of shares. Instead, East Midtown would amend its certificate of incorporation. Proponents of the plan informed shareholders that the city's Department of Housing Preservation and Development (HPD) had taken the position that votes must be counted on a one apartment, one vote basis, but East Midtown informed shareholders that it reserved the right to challenge that position. The voting results were the same as in 2004: Two-thirds of the shares, but not two-thirds of the shareholders, voted in favor of the proposal.

When the Attorney General refused to declare the privatization plan effective, East Midtown brought an article 78 proceeding contending that the Martin Act did not apply to the 2008 plan because the plan involved no transfer of assets or shares. East Midtown also contended that the plan was effective because votes were properly counted on a one-share, one-vote basis rather than a one-apartment-one-vote basis. Both Supreme Court and the Appellate Division rejected East Midtown's positions, setting the stage for East Midtown's appeal.

The Court of Appeals Opinion

In an opinion by Judge Victoria Graffeo, the Court of Appeals affirmed, holding that the Martin Act applies to Mitchell-Lama co-op privatizations even when the plan involves no transfer of assets or shares. The court acknowledged that the Martin Act, by its terms, makes it unlawful for someone to make or take part in “a public offering or sale” of securities, including participations interest in cooperative apartment buildings, unless an offering statement is filed with the Attorney General (General Business Law section 352-e(1)(a)). The East Midtown reorganization was to be accomplished by an amendment to the certificate of incorporation rather than by any public sale. But the court noted past decisions holding that the Martin Act, as a remedial statute, was to be liberally construed. And the court then invoked federal precedent interpreting the blue sky laws, noting that New York courts have often looked to federal cases in interpreting the Martin Act, which itself makes reference to the federal securities laws.

The court then cited federal cases indicating that the economic reality of the transaction should dictate whether the transaction is treated as a purchase or sale. The court quoted a Second Circuit opinion, Gelles v. TDA Indus , 44 F.3d 102, 104, explaining that the securities law should apply if there has been “a significant change in the nature of the investment or in the investment risks as to amount to a new investment.” Judge Graffeo's opinion then emphasized that privatization of a Mitchell-Lama project leaves shareholders with an investment significantly altered by, among other changes, the new ability to sell at market rates, and the loss of property tax reductions. As a result, the court held that the Attorney General properly required filing of an offering plan.

The court then rejected East Midtown's argument that the Business Corporation Law authorizes corporate dissolution upon a vote of two-thirds of the shares of the corporation. The court emphasized that BCL section 1001 authorizes dissolution by “two-thirds of the votes of all shares “entitled to vote thereon,” and interpreted that language to permit the certificate of incorporation to limit the number of shares a shareholder is entitled to vote, effectively imposing a one-apartment, one-vote limit.

The Bottom Line

Ultimately, then East Midtown establishes that the Martin Act will govern all Mitchell-Lama privatizations, regardless of the form the sponsors use. Substance rather than form will govern.