COOPERATIVE HOUSING


Just like a consumer's cooperative gives a consumer greater purchasing power through collective purchasing, a cooperative housing project allows an apartment dweller greater control over his or her home through collective ownership. Instead of renting from a third party who seeks to profit from ownership of the building, each tenant is given a personal property interest in his or her apartment and pays a share of the building's operating costs.


Prior to statutory changes that made purchasing a condominium more attractive, cooperative housing projects were a popular alternative to leasing from a landlord. Even though their popularity has dropped off, cooperative buildings still exist, making it important to recognize their unique features and problems. This article will discuss the characteristics of cooperatives, how cooperatives are created, and how interests in a cooperative may be terminated. Cooperatives are rarely used in Indiana and Wisconsin and there is a lack of case law concerning cooperatives in these states, therefore this article will primarily focus on Illinois law.


Cooperative housing allows the tenants of a multi-unit building to share common expenses, without outside parties profiting from ownership of the building. Generally, a cooperative corporation holds title to the entire building, each resident is given an ownership interest in the corporation and a leasehold interest in their particular apartment.

Characteristics of a Cooperative


Organization - The organization of the cooperative may take a variety of forms, including a general for-profit corporation, a not-for profit corporation, or a land trust. Though the law allows a for-profit corporation to be formed for the purpose of providing cooperative housing (see The Illinois Business Corporation Act of 1983, 805 ILCS 5/3.05: "Corporations for profit may be organized for any lawful purpose."), it is more common for a cooperative building to be owned by a not-for-profit corporation (NFP). Sinnissippi Apt Inc v Hubbard, 114 Ill App 3d 151, 156, 448 NE2d 607, 609, 69 Ill Dec 889, 891 (2d D 1983).


The corporation holds the title to the entire property and the building's occupants own shares of stock in the corporation, which are equal to the value of the apartment they occupy. The corporation issues the occupant a proprietary lease or occupancy agreement for a particular unit in the building in conjunction with the purchase of stock. Quality Management Services v Banker, 291 Ill App 3d 942, 945, 685 NE2d 367, 369, 226 Ill Dec 264, 266 (1st D 1997). Proprietary leases contain many of the same provisions contained in other leases; however, instead of paying "rent," tenants are required to pay monthly maintenance charges that are used to pay estimated operational costs, taxes, and debts of the cooperative. Sinnissippi at 156, 448 NE2d at 610, 69 Ill Dec at 892.


In smaller cooperative buildings, it is often preferable for a land trust to hold title to the property. Brandzel v Koretzky, 66 Ill App 3d 717, 718, 384 NE2d 128, 130, 23 Ill Dec 492, 494 (1st D 1978). Under a trust arrangement, the land trustee holds title to the property and the occupants hold a beneficial interest in the trust proportionate to the value of their respective units. Brandzel at 718-19, 384 NE2d at 130, 23 Ill Dec at 494. Pursuant to an agreement among all the beneficiaries, each beneficiary is granted a right of exclusive occupancy to a particular unit in the building.

The Financial Structure - Unlike condominium ownership, the tenant-shareholders in a cooperative are financially interdependent. There is usually a single blanket mortgage covering the entire property and taxes are assessed against the entire property. Therefore, each member must pay monthly maintenance charges for the cooperative corporation to fulfill its continuing financial obligations to third parties. If one member fails to pay the monthly maintenance fees, the corporation must pay that member's portion of the operating costs. Every member of the cooperative risks losing their respective unit if the corporation cannot pay the taxes or other debts. Consequently, potential purchasers may be required to disclose an extensive amount of financial information. Because of the risks associated with cooperative housing, prospective purchasers often prefer condominium ownership.

The Relationship between the Tenant-Shareholder and the Owner-Cooperative - Because occupants in a cooperative housing project are both owners of stock in the corporation and tenants, it is not easy to define the relationship between the managing-entity and the building occupants. The cooperative has been called a "legal hybrid" because residents own both a portion of stock and a lease. Sinnissippi at 156-157, 448 NE2d at 611, 69 Ill Dec at 893. However, even though each tenant owns a piece of the cooperative "[t]he primary interest of every stockholder in such a corporation is the long-term proprietary lease." Id.


To determine the relationship between cooperative and tenant shareholder, one must read "together the certificate of incorporations, stock offering prospectus, the stock subscription agreement, and the proprietary lease." Id. Generally, where the proprietary lease "is the basic document entitling a member of a cooperative the right to occupy a particular dwelling unit and setting out the member's rights in relation thereto" and such a lease "contains many of the provisions found in long-term residential leases ... the relationship between a cooperative and its members is, in part, that of a landlord and tenant." Quality Management Services at 945, 685 NE2d at 369, 226 Ill Dec at 266.


However, there may be a more unusual cooperative organization where a landlord/tenant relationship will not be recognized. For example, in Central Terrace Cooperative v Martin, the court held there was no landlord-tenant relationship between the cooperative and its members. There, the parties entered into an agreement titled a "Mutual Ownership Contract," in which leasing property was not included as one of the stated purposes in the cooperative's bylaws and members were granted "perpetual use of each particular dwelling." Central Terrace, 211 Ill App 3d 130, 133-34, 569 NE2d 944, 946-47, 155 Ill Dec 467, 469-470 (2d D 1991).

Creation of Cooperatives


Creating a cooperative begins with finding a suitable building or undeveloped property. An organization must be created to take title to the property. While a for-profit corporation or a land trust may hold title to cooperative property, more commonly a not-for-profit or nonprofit corporation will be formed to take title. State law will determine what steps are necessary to form the corporation.


Once the cooperative corporation is formed, promoters of the project recruit individuals to purchase stock in the corporation in exchange for a proprietary lease or occupancy agreement. If an existing apartment complex is being transformed into a cooperative, the tenants will be asked to purchase an interest in the cooperative.


Because membership requires the purchase of shares of stock, there are questions concerning whether federal and state security regulations are applicable to cooperative housing associations. The Supreme Court has held in transactions involving the sale of shares of a cooperative "in which the purchasers were interested in acquiring housing rather than making an investment for profit, is not within the scope of the federal securities laws." United Housing Foundation, Inc v Forman, 421 US 855, 860, 95 S Ct 2051, 2064 (1975). Members of a state-subsidized and supervised non-profit housing cooperative, brought an action alleging developers violated federal securities laws by fraudulently representing that developer "would bear all subsequent cost increases due to factors such as inflation" and misled resident into purchasing shares by "fail[ing] to disclose several critical facts." United Housing at 844. The court held that federal courts lacked jurisdiction because shares of stock in the cooperative were not "securities" as defined under federal securities laws. United Housing at 860.


The sale of stock in a cooperative may also be subject to state security regulations. The Illinois Security Act of 1953 defines "security" as "any note, stock ... investment contract." 815 ILCS 5/2.1. In Brothers v McMahon, a down payment paid by a purchaser toward the purchase of an interest in a planned cooperative that had not yet been constructed was held to be a real estate contract and not a "security" within the scope of Illinois Blue Sky Law. Brothers, 351 Ill App 321, 328-329, 115 NE2d 116, 118 (1953).


The content of the corporate bylaws will address the corporate structure of the cooperative. Generally, the bylaws will provide that the shareholder-tenants select a board of directors. The board of directors will either directly manage or hire an agent to manage the cooperative. Bylaws may also grant powers to the board to set annual maintenance, set house rules, and amend bylaws with the approval of the stockholders.


The proprietary lease will also contain certain rules and regulations binding upon the cooperative's occupants. These provisions are often similar to those provisions found in typical leases and address such things as restrictions against pets, use of common areas, and in general a responsibility to not disturb other occupants. Other common restrictions in a proprietary lease are those requiring approval by the cooperative's board of directors prior to assigning or subletting the apartment. Generally, such restrictions will be upheld where the board "reasonably exercise[s] their power to withhold consent to a proposed sublease upon consideration of the sublessee's qualifications in light of the economics and social reasons justifying the restraint itself." Logan v 3750 North Lake Shore Drive, 17 Ill App 3d 584, 591, 308 NE2d 278, 283 (1st D 1974). In Logan, the court found a board's refusal to allow tenant to sublet due to long-established policy arbitrary and unreasonable when the board failed to consider the sublessee's qualifications. Logan at 590, 308 NE2d at 282.

Termination of Interests in a Cooperative

Restrictions upon Transfer of Interest - The proprietary lease will place certain restrictions on a tenant's ability to transfer his or her interest in the cooperative. A tenant must transfer the proprietary lease along with the sale of stock in the cooperative corporation. This ensures that tenants are also shareholders of the cooperative corporation. If the occupant of a particular unit is no longer a member of the cooperative, the lease may also provide for the termination of the right of occupancy.


Generally, the proprietary lease will also give the cooperative the right of first refusal. Therefore the individual tenant may have to sell the stock back to the corporation for the amount originally paid. Rights of first refusal in cooperative agreements have been upheld as a valid restraint on alienation: "[t]he restrictions on transfer of a membership are reasonably necessary to the continued existence of the cooperative association." Gale v York Center Community Cooperative, 21 Ill 2d 86, 93, 171 NE2d 30, 33 (Ill 1960).


If the corporation declines to repurchase the stock, the cooperative agreement may also require the Board's consent before the tenant may transfer his or her interest. This gives members of a cooperative the ability to ensure the creditworthiness of other tenants and a voice in the selection of other tenants.

Remedies upon Tenant's Default or Breach of Covenants - Because members of a cooperative are financially interdependent, it is important that a cooperative have a quick and effective remedy to remove breaching tenants. The legal remedies available to the corporation are dependent upon the relationship between the tenant and the corporation as created in the cooperative agreement.


In Quality Management Services v Banker, an Illinois court held that Illinois' Forcible Entry and Detainer Act applied to cooperatives. Quality Management at 945-46, 685 NE2d at 369-70, 226 Ill Dec at 266-67. A management company brought an action under the statute against members of a cooperative who were delinquent in paying monthly carrying charges. Id at 943, 685 NE2d at 368, 226 Ill Dec at 265. The court examined the Occupancy Agreement to determine the relationship between the members and the cooperative. Id at 945-46, 685 NE2d at 369, 226 Ill Dec at 266. The agreement stated that "the Cooperative hereby lets to the Member, and the Member hereby leases from the Cooperative" and provided that there was a landlord-tenant relationship between the member and the cooperative. Id at 946, 685 NE2d at 369-70, 226 Ill Dec at 266-67. Because a landlord-tenant relationship existed between the parties the management company was allowed to bring an action under the Forcible Entry and Detainer Statute. In contrast, where the cooperative agreement does not create a landlord-tenant relationship, an equitable action must be brought against the occupant.


Cooperative housing associations are rarely used under Indiana law, but one recent case addressed the relationship between the parties under such agreements. The cooperative filed an action for ejectment, damages, and termination of the agreement after a member sublet her cooperative apartment without the approval of the corporation, which violated the occupancy agreement. Cunningham v Georgetown Homes, Inc, 708 NE2d 623, 624-25 (Ind Ct App 1999). Recognizing that the relationship of the cooperative to its members is a legal hybrid, the court found "that neither statutory foreclosure nor forfeiture through eviction is an appropriate remedy to protect the interest of both parties .... Rather ... we think it appropriate that the remedy as well be of a hybrid nature." Id at 627. The court held the cooperative may file an ejectment action under IC 32-6-1.5-1. Upon finding that the member breached the occupancy agreement, "the trial court may direct proceedings for the sale of [the member's] interest, which will insure that her rights are adequately protected." Id.

Conclusion


The cooperative housing association is a unique form of common ownership. Members of the cooperative simultaneously own stock in the corporation and lease a particular unit in the cooperative building. Even though there are features and provisions common to most cooperative arrangements, there is no standard form for creating a cooperative. Therefore, in a transaction involving a cooperative housing association, it is important to look at the documents that govern the particular cooperative.

EDITOR'S NOTE: If you are asked to write a title insurance policy on an interest in a cooperative, please first contact the Underwriting Department to discuss our guidelines and requirements. We may be reached at 800.252.0402 or legal@atgf.com.

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