Case Name: Northridge Cooperative Section No. 1, Inc., Respondent, v. 32nd Avenue Construction Corp. et al., Appellants, et al., Defendants
Court: New York Supreme Court, Appellate Division
Jurisdiction: New York
Decision Date: 1955-06-28
Citations: 286 A.D. 422
Docket Number: 
Parties: Northridge Cooperative Section No. 1, Inc., Respondent, v. 32nd Avenue Construction Corp. et al., Appellants, et al., Defendants.
Judges: 
Reporter: Appellate Division Reports
Volume: 286
Pages: 422–435

Head Matter:
Northridge Cooperative Section No. 1, Inc., Respondent, v. 32nd Avenue Construction Corp. et al., Appellants, et al., Defendants.
First Department,
June 28, 1955.
Paul W. Williams of counsel (David Morgulas and Irwin Schneiderman with him on the brief; Cahill, Gordon, Reindel & Ohl; M. Carl Levine and Morgulas & Foreman, attorneys), for appellants.
Bernard Buchwald of counsel (Bernard Nadel, Maxwell H. Tretter, Edmund B. Hennefeld and Irving Margolies with him on the brief; Hoffman, Buchwald & Hoffman and Maxwell H. Tretter, attorneys), for respondent.

Opinion:
Callahan, J.
This is an appeal involving the sufficiency of a complaint. The pleading may be summarized as follows:
In December, 1950, the defendants-appellants Winston and Muss promoted a project to construct a co-operative apartment house in the borough of Queens, city of New York. They caused plaintiff to be incorporated as a co-operative corporation under the laws of New York and arranged for a mortgage loan by a bank, which applied to the Federal Housing Administration for insurance of the mortgage under section 213 of the National Housing Act (U. S. Code, tit. 12, § 1715e, as amd. in 1950). The building was to be constructed on land leased to plaintiff by defendant E. & M. Greenway, Inc., for ninety-nine years at a net ground rent of $9,440 a year. It was to be erected by the defendant-appellant 32nd Avenue Construction Corp. for a sum represented by the aggregate of the amounts to be paid by tenants for their apartments, plus the mortgage loan in the sum of $3,091,200. The prices to be paid for the apartments by the tenants and the schedule of carrying charges were approved by the Federal Housing Administrator. Defendants-appellants Winston and Muss, the promoters, controlled all three of the corporations aforesaid, viz., the plaintiff-owner, the defendant-appellant 32nd Avenue Construction Corp. and defendant E. & M. Greenway, Inc., which was the landlord under the ground lease.
After the application for mortgage insurance was approved by the Federal authorities, and beginning late in December, 1950, the stock of plaintiff was placed on the market and sold to tenants, who signed subscription agreements to become effective when 90% of the apartments were sold. These subscription, agreements, among other things, stated that the tenants had exhibited to them and had read the ground lease and the construction contract.
After completion of the building and the making of payments under their subscriptions, the tenants took over control of plaintiff. It now brings this action against the promoters and numerous other defendants, who were agents of the promoters and involved in fostering the project.
The complaint contains three causes of action. The first is a complicated pleading that alleges numerous acts of misconduct by the individual defendants-appellants Winston and Muss. They are charged with dominating and controlling the other defendants, among whom are included the directors and officers of plaintiff at the time the ground lease and the building contract were entered into. The lease is attacked as calling for excessive ground rent. The defendant-appellant 32nd Avenue Construction Corp., and Winston and Muss who controlled the company, are charged with exacting an excessive price for erecting the building. Various corporate defendants are named as having been used as instrumentalities by Winston and Muss in accomplishing these ends, and various individual defendants are joined who were the directors of the said corporation.
The second cause of action is for breach of contract against defendant 92nd Street Building Corp. as assignee of the construction contract. The sufficiency of this cause of action is not presently questioned.
The third cause of action is on a performance bond given by the said defendant 92nd Street Building Corp. and defendants-appellants Winston and Muss.
The defendants-appellants moved at Special Term to dismiss the complaint for insufficiency, to strike various portions of the first cause of action as sham, etc., and for other forms of relief. Under one or more branches of the motion, affidavits were submitted showing the facts in connection with the subscriptions by tenants. All branches of these motions were denied. Some of the grounds of attack raised below are not pressed on this appeal. However, the motions to dismiss and strike portions of the complaint as sham are before us.
The first question to be considered is how far plaintiff, the co-operative corporation, has the legal right to attack the alleged excessiveness of rent under the ground lease and the excessiveness of costs under the construction contract.
In testing the sufficiency of the complaint in these regards, we must determine the legal duty owed to plaintiff company by its officers and directors before the issuance of stock to the tenants, and what right accrued to plaintiff as distinguished from those accruing to the subscribers for its stock. For the purposes of this appeal, we will assume that the tenants became the owners of plaintiff's stock upon the respective dates when they signed their subscription agreements, though, in fact, their stock was not issued until much later. The tenants subscribed on different dates, all after the construction contract was formulated and the commitment for the mortgage made. Up to the time the project was approved as to mortgage insurance, the stock of plaintiff was owned or controlled by the individual defendants-appellants as promoters of the project or by their nominees. They also owned the property contributed.
A perusal of section 213 of the National Housing Act and the regulations issued thereunder discloses that the law, while it relates principally to the insurance of mortgages by the Federal agency, contemplates a method for the promotion of the construction of co-operative housing units by private sponsors. This is to be done by the presentation of plans to the Federal agency by way of applications by mortgagees for insurance of projected mortgage loans on housing to be built. These steps involved submission of full details of the projected housing development, including the cost of land (or lease) and building construction, and, in addition, a schedule of proposed subscription prices and carrying charges to be met by tenants. Any loan on a projected development was required to be approved by the administrator as economically sound, before a commitment for the mortgage insurance would issue.
That the element of private sponsorship on a basis of profit to the promoters was contemplated as to the co-operative as well as the privately owned housing projects seems evident from a reading of the statutes and the regulations issued thereunder. Action by the sponsor in his own behalf, and at his own expense, up to a certain point was required. This involved acquisition of land, preparation of plans and specifications, arrangements with mortgagees for loans, and submission of the project to the Federal Housing Administration for insurance on the loan. It is apparent that until the tenants of a co-operative project came into the picture, the sponsor was acting on his own behalf and at his own risk. As the co-operative corporation was to be incorporated by the sponsor, the original directors of that corporation would have to be nominated by the sponsor. We fail to see how they would be under any fiduciary obligation to the future tenants in these initial stages. The proposal would not get into the nonprofit stage until the tenants came into control. It would be a legitimate profit-making venture for the promoter up to the point where the land was bought or leased, the building to be erected was planned and contracted for, and the mortgage commitment approved. If promoters were to make profits, and, concededly, they were entitled to do so, they would have to be made in connection with the sale or lease of the land and the arrangement of the price for construction of the buildings. Therefore, the allegations in the present complaint that the directors of plaintiff (and defendants who dominated them) in this initial period breached their fiduciary duty of undivided loyalty to plaintiff, etc., are erroneous conclusions.
The fact that a promoter was interested in the landlord company as well as in the plaintiff, when the ground lease was made, or in the building construction company, when the contract for the erection of the building was entered into, would add nothing to any cause of action based on breach of fiduciary duties. Self-dealing at this stage was proper. In fact, the promoter alone was interested, until the loan was approved and the tenants purchased their apartments. Protection of tenants against inflated costs might depend to some extent upon the administrator making a correct decision on whether a proposed mortgage was economically sound. Of course, any decision by the administrator to insure a projected mortgage loan could not be made without an estimate of the value of the land (or lease) and the cost of construction of the building. The purchase price of apartments and schedule of carrying charges were approved by the administrator. We may assume that the reasonableness of the ground rent and the building costs was given like approval. In any event, the directors of the plaintiff (and the defendants who controlled them) did not owe any fiduciary duty to future tenants at this stage. They did owe the duty of full disclosure of the terms of the deal to those to whom apartments were sold. But there can be no doubt in this case that the tenants were told of the existence of the ground lease and the building contract. Whether they actually examined the documents or considered the prices fixed would be immaterial, if they had notice.
Up to the time when the tenants subscribed for their apartments, the situation was legally the same as in the initial stages of corporate promotion work. To a point in such transactions no one is legally interested, except the organizers (Old Dominion Copper Co. v. Lewisohn, 210 U. S. 206; Blum v. Whitney, 185 N. Y. 232; Continental Securities Co. v. Belmont, 168 App. Div. 483, affd. 222 N. Y. 673; Hutchinson v. Simpson, 92 App. Div. 382).
It would not be equitable to permit plaintiff, after it came into the control of the tenants, to attempt to reduce the ground rent or show the excessive cost of the building on the theory that the directors of plaintiff at the time these costs were agreed upon owed fiduciary duties to tenants, whose rights had not come into existence, to secure lower prices (Capitol Wine Spirit Corp. v. Pokrass, 277 App. Div. 184, affd. 302 N. Y. 734).
It is questionable whether in face of the approval of the transaction by the Federal authorities that jurisdiction would exist to grant any relief that would relieve the tenants from any part of the subscription costs (Wasservogel v. Meyerowitz, 300 N. Y. 125). At least, any terms or condition that would affect the validity of the mortgage would be incontestable.
Questions somewhat similar to those now considered were present in Fieger v. Glen Oaks Vil. (206 Misc. 137, affd. 285 App. Div. 814). Though that case involved a privately owned project erected under sections 608 et seq. of the National Housing Act (U. S. Code, tit. 12, § 1743 et seq.), we see no essential difference between the privately owned and the co-operative project as to the obligations of sponsors up to the time that co-operative tenants have subscribed for apartments. The holding there that the rents might not be readjusted would seem applicable here to the ground rent and construction costs.
The terms of the deal, when they were made, appear to have been fully disclosed to the present subscribers. They were bound by the subscription agreements, as were those they contracted with. The tenants were engaging in an arms-length real estate transaction, when they purchased for a specified sum apartments in a building to be erected at a specified cost on a piece of land leased at a specified rental. The government agency had sanctioned certain features of the transaction, and the sponsors in erecting the building acted upon the tenants' agreement. Such tenants may not now attack that deal on the theory that they were entitled to better terms or to place reliance upon the belief that the directors of the corporate owner had a duty to act as their fiduciaries (New York Trust Co. v. American Realty Co., 244 N. Y. 209). Such claims are without support in law, and sham. For the purpose of ascertaining the sham nature of the claim we may not only consider the effect of the Federal statutes, but ascertain the giving of notice from the subscription agreement set forth in the affidavits. The portions of the complaint relating to the ground rent and the cost of construction will be stricken, without leave to replead.
We have a different situation as to the performance of the building contract, or as to any alleged acts of misconduct by defendants, after the tenants subscribed. The portions of the complaint based on these features of the first cause of action could not, at least, be regarded as sham.
The complaint also alleges that in connection with soliciting subscription agreements defendants made certain representations with respect to certain refunds known as " patronage refunds " that would be effected as the result of anticipated savings during the operation. Defendants attack this portion of the complaint on several grounds, including the claim that any right of action based on any such representations (assuming that they were actionable) would accrue to the stockholders, and not to the corporate plaintiff. We agree with that contention. Any refunds, if they accrued, would be payable by plaintiff to the subscribing tenants. Therefore, plaintiff would benefit from nonpayment. It may not recover from defendants not only because it had suffered no injury by the nonpayment, but because in its corporate capacity it does not own any claim. In fact, the present stockholders of plaintiff may not be the ones to whom the representation was made. This portion of the complaint must also be stricken, without leave to replead.
The first cause of action also alleges wrongful acts by the individual defendants as conspirators to make a profit in causing the defendant 92nd Street Building Corp. to render defective performance of the building contract. We do not understand the complaint to charge that these defendants tortiously induced any breach of contract. The contract was not terminated. Assuming that the individual defendants were connected with the building corporation, they would not be individually liable for a breach of contract by that corporation. As presently alleged, these charges of conspiracy add nothing to the complaint.
As to the third cause of action, we feel that the denial of the motion was proper. The claim of prematurity should await production of the undertaking on which it is based. The motion in this respect may be renewed later.
The order appealed from should be modified, with $20 costs and disbursements, and the motion granted to the extent indicated herein, with leave to replead.