Not-for-profit corporations and religious corporations own a considerable amount of real property in New York City and are increasingly more active in real estate transactions. These real property transactions are likely subject to regulations which impose unique considerations. These unique considerations are important for purchasers, real estate brokers, and legal counsel to understand in advance of executing transactional documents as they affect how the real property is valued and the overall structure and timing of the project.
Applicability of the Regulations:
Under Section 510 of the New York State Not-For-Profit Corporation Law and Section 12 of the New York State Religious Corporations Law, charitable not-for-profit corporations and religious corporations must often petition the New York State Supreme Court (“Supreme Court”) and/or the New York State Office of the Attorney General (“OAG”) for approval to transfer real property.
Specifically, a charitable not-for-profit corporation must seek approval when the real property asset, which is the subject of the transfer, is “all or substantially all” of the corporation’s assets and in contrast to religious corporations which must seek approval for a sale, lease, mortgage of any of its real property, excluding a purchase money mortgage or a lease with a term of less than five years. Notably these statutory requirements apply even to those organizations formed outside of New York State which operate and seek to transfer real property in New York State. Further, despite arising from different laws and different factual triggers for when the statutory requirement for approval applies (noted above), not-for-profit corporations and religious corporations are held accountable to the same regulatory regime arising out of those statutes , despite some procedural nuances to approval. While not the subject of this article, these nuances may add additional steps to those which generally apply to both not-for-profits corporations and religious corporations, and such general requirements are discussed below. Hereafter the selling not-for-profit corporation or religious corporation will be referred to as the “Charity.”
These laws and corresponding regulations exist to protect New York Charities from entering into unwise bargains—which might harm their mission or cause waste to charitable assets—and to ensure that the Charity’s board members are complying with their fiduciary responsibilities under New York law.
Important Considerations When Filing a Petition
When the Charity petitions the Supreme Court or OAG, the petition for approval of the transfer must include certain relevant facts about the Charity and the transaction, including its corporate documents, financial statements, and the executed transaction agreements. In addition, the petition must also state that the Charity reviewed the transaction in accordance with their governing documents and New York law and found the “consideration and terms” of the transaction to be (i) “fair and reasonable to the corporation” and (ii) “that the purposes of the corporation, or the interests of its members will be promoted thereby.”
Purchasers should be aware of the requirement that Charity must find an affirmative determination of these two prongs. This is especially true because such determination will be reviewed by the Supreme Court or OAG and without an adequate affirmative finding of these prongs the contemplated transaction (regardless that the transactional documents are already executed) will not be approved, and the transaction will be unable to proceed. Neither prong is sufficient by itself to satisfy the regulatory requirements.
What is Fair & Reasonable?
A potential purchaser must recognize that the finding of fair and reasonable is the most crucial component of this regulatory regime when transacting with a Charity as both the Supreme Court and OAG interpret this requirement to mean that the Charity must receive at least fair market value in consideration in exchange for the real property, and the fair market value must be supported by an appraisal valuing the real property no more than six months prior to the contract date.
During the marketing and negotiations of the deal and prior to any contract being executed, the Charity should be negotiating with potential purchasers with an appraisal as a basis for its negotiating position on adequate consideration. In the event that marketing and negotiations take longer than six months, an update to the appraisal should be ordered prior to the execution of any agreement to ensure that the deal terms are still in accordance with the market value. If the purchase price is no longer at market value, the terms of the deal will need to be adjusted accordingly.
Another common pitfall arises when in-kind consideration is a portion of the consideration received by a Charity in development transactions. For instance, the Charity may transfer its real property to a purchaser who intends to develop the real property with a new structure on the site, and as a part of the Charity’s consideration, the Charity will receive space in the completed development (e.g., a condominium unit). In those situations, the market value of the completed space should not be used in this consideration received analysis, rather the actual cost of constructing the space to be deeded back to the Charity should be utilized as if the Charity paid the purchaser directly to construct the space.
Promotion of the Mission and Interest of the Members
The second finding requires that the Charity determine that the transfer of assets promotes its mission or the interest of its members. The mission is the charitable purpose for which the entity was formed. If the entity has members, the members are the equivalent of shareholders in the not-for-profit corporation or religious corporation context – they are the stakeholders in the Charity. While often less of a direct concern than the fair and reasonable prong for a potential purchaser, this prong impacts transactions, especially development projects where the Charity is receiving in-kind consideration and/or where the real property intended to be transferred is critical to the mission and members of the Charity (i.e., the property is the main or sole location for its mission). In these situations, the Charity will need a detailed plan in place for how they will replace the mission space in order to demonstrate successfully in the petition how the transfer promotes the mission and/or interest of the members. Any proposed in-kind consideration should be suitable for the actual needs of the Charity, and components of the space-back’s design, like entrance to the space, parking, or size of the space in light of the membership of the Charity (both too much space or too little space), should be considered. As inadequate space or too extravagant space may not be deemed to promote the mission or interests of the Charity’s members during the course of the OAG and/or Supreme Court’s review of the petition.
The timing effects of the petition process should also be noted. The petition approval process routinely takes several months (after the negotiation and execution of the transactional documents which must be attached to the petition) after the initial filing of the petition approval for approval and often consists of multiple rounds of questions with the Supreme Court or OAG about the petition and facts surrounding the transaction in accordance with their regulatory responsibilities to protect New York Charities. It should also be noted that the real property which is the subject of the petition may not be transferred until the Charity receives Supreme Court or OAG approval, and, if the transaction contains in-kind consideration (space-back for the Charity), the transfer may only occur after the purchaser has secured adequate financing for the overall project, including any improvement in which the space-back will be located. A mere promise to finance that portion of the transaction is deemed insufficient by OAG.
Understanding the regulatory process described above and preparing in advance for its requirements is the best way for Charities and purchasers to work together on real property transactions; thereby, maximizing the benefits to all parties and reaching a closing of the transaction as quickly as possible. Therefore, it is paramount that Charity retains their own attorney and other consultants, who are familiar with the intricacies of this approval process, and purchasers should confirm these consultants have been retained prior to undertaking detailed negotiations.