While not the intended target of the recently passed Housing Stability and Tenant Protection Act of 2019 (the “Act”) Part M of the act contains a number of provisions that adversely affect how cooperatives review and approve potential shareholders.
Under the Act, landlords are not entitled to take security deposits in excess of one month’s rent. As a consequence, a standard way of dealing with prospective shareholders who may not fully meet the cooperative’s financial standards, the use of a maintenance security agreement, is no longer allowed. Previously shareholders who may have difficulty qualifying financially could ensure the cooperative’s security by executing an agreement whereby a large number of maintenance payments, usually six months to a year but in some cases much larger was placed into an escrow account that could be drawn on should the shareholders default. While not legally challenged as of yet, this provision would clearly appear to fall under the prohibition regarding security deposits. Therefore potential applicants have lost a tool by which they could qualify to purchase.
As an alternative to a maintenance escrow, a potential alternative would be for a creditworthy individual to execute either a full guarantee of the maintenance payments or at least a partial guarantee. Under such a guarantee another individual places their credit as an asset that may be drawn against for the payment of maintenance thereby addressing the co-op’s concern about maintenance payments. In cases when a guaranteeing party does not wish to have unlimited liability a limited guarantee can be created. This type of guarantee which is common in commercial leasing is often referred to as a Good Guy guarantee and it is structured in a way that the guarantor is liable for maintenance payments until such time as legal and physical possession of the premises is delivered to the landlord. Using this type of guarantee virtually assures full payment of all maintenance as the apartment would either have to be sold or surrendered to relieve the guarantor from liability. Typically a cooperative collects all of its fees at the time of closing.
The problem with a guarantee versus in escrow is that it requires legal pursuit of the guarantor to secure payment rather than simply withdrawing the funds from the escrow which is typically held either by the co-op itself or by co-ops legal counsel. Further, the guarantee creates another legal relationship that the cooperative is required to deal with. One alternative we have utilized is to have a third-party place funds in escrow as a guarantor which addresses the issue of collection without violating the law as that individual is not the tenant.
When the legislation was hastily drafted and passed, most legislators did not even realize that it affected co-ops much less what those effects were. As a consequence, there are several pieces of legislation being drafted to address the numerous problems created for cooperatives by the act. However, in the meantime, these problems, such as security deposit limitations, will continue to burden cooperatives unnecessarily.