Ground Lease Tsuris

This litigation dramatically illustrates some of the difficulties faced by ground lease co-ops and their shareholders. Most co-ops in New York City own the land on which their buildings are built, and most of those co-ops took title to the land at a time when property values were much lower than they are today. As a result, the equity in most co-ops resides in the individual apartments and are bought and sold among shareholders who can afford to pay premium prices for apartments. Ground lease co-ops, meanwhile, may include many shareholders who may not be able to pay the prices needed to acquire the land. It is no wonder that shareholders like the plaintiff are willing to go to court in hopes that a judge might relieve them of these difficult choices.

WHAT HAPPENED The Carnegie House is a cooperative apartment corporation located at 57th Street and Sixth Avenue in Manhattan.  Ordinarily, the shareholders of the co-op would be in the enviable position of owning apartments on “Billionaire’s Row.”  Carnegie House, however, is one of a class of cooperative known as a “ground lease co-op,” whereby the co-op does not own the land on which the building sits, but rather leases it on a long-term lease from a third party.   
Generally speaking, it makes financial sense for ground lease co-ops to try to purchase the land from the owner rather than continuing to rent, and the board of directors of the Carnegie House had been exploring that possibility for a number of years.  The co-op was not helped in its effort by the incredible appreciation of property values in Manhattan – and on 57th Street in particular – in recent years.  In 2014, an investor paid approximately $270 million for the land, which not only raised the price for the co-op to repurchase the land, but also, under the formula spelled out in the co-op’s ground lease, meant that the co-op’s rent would skyrocket from $4.4 million per year to $30.4 million beginning in 2025.
Taking advice from its real estate consultants, the co-op board entered into negotiations with the land owner, which eventually offered to sell the land to the co-op for $280 million.  In July 2019, the board presented this proposal to the co-op’s shareholders with the board’s recommendation to accept the offer, but the shareholders voted the proposal down.  Although the board has continued to negotiate with the land owner, incurring significant fees for consultants and attorneys in the process, no one has found a mutually acceptable solution, even as the rent escalation date approaches.  Meanwhile, units in the co-op are selling for a relative pittance as shareholders and purchasers are put off by the huge looming costs either to buy out the lease or pay the escalated rent.
For Birinder Madan, who has resided in the co-op since 2003, the starkness of the choice to buy the land or pay the higher rent was too much.  He sued the board members and the co-op’s real estate consultant, asserting that there was a third alternative – that the amount of the proposed purchase price or prospective rent increase was so disruptive to the established residents at the co-op that it must be unconscionable, and asked the court to reform the lease to impose more modest rent increases.  That novel theory, set forth in the plaintiff’s first cause of action, has not yet been reviewed by the court.
In addition to that reformation claim, the Madan also asserted five causes of action against the board members and consultant for equitable fraud, breach of fiduciary duty, and similar claims.  The defendants moved to dismiss all of these additional claims.
IN THE COURT The court granted the defendants’ partial motion to dismiss, dismissing all of the claims except for the plaintiff’s first cause of action for declaratory judgment (which the defendants had not moved to dismiss).  With respect to plaintiff’s second cause of action, for equitable fraud, the court noted several deficiencies in the claim.  Among other things, the plaintiff had not pled any fraud allegations against the defendants with particularity as required under court rule.  In addition, the plaintiff failed to allege that the co-op had suffered any damages from defendants’ actions because, after all, the co-op’s shareholders had voted not to proceed with the offer to buy the land that the defendants had negotiated.  The plaintiff’s third and fourth causes of action, for breach of fiduciary duty and for aiding and abetting breach of fiduciary duty, respectively, were also dismissed because they were based on “conclusory [allegations] and/or refuted by the documentary evidence.”  The court also rejected the plaintiff’s fifth cause of action for an accounting and sixth cause of action for breach of good faith and fair dealing.  Subject to any appeals of this decision, the only issue left in the case now is whether the court will reform the ground lease in the manner sought by the plaintiff.