Lost stock certificate

When a shareholder in a cooperative sells his unit, yet cannot locate the stock certificate and/or lease, the typical procedure is to ask him to sign a lost stock affidavit, which states that he misplaced the documents and that no lender has an interest in the unit.

However, a recent court case reviewed by the law firm of Schecter & Brucker, P.C. has highlighted potential danger to housing cooperatives. The case involved the following facts: an apartment was purchased in 1985, and at the closing, the stock certificate and proprietary lease were taken by the bank as collateral for the loan it made to the purchaser. Prior to 1988, this was the only way the bank could "perfect" its interest in the collateral. The bank also signed a recognition agreement with the cooperative which said that the cooperative would not permit the shareholder to sell the apartment without the bank's permission.

In 1995, the shareholder informed the cooperative that the stock and lease were lost. The recognition agreement was nowhere to be found and there was no indication in the corporate records that a loan was outstanding. The cooperative (not realizing that the bank had these documents) issued another stock certificate and lease after the shareholder signed a lost stock affidavit. The shareholder then sold the apartment, yet continued to pay the loan. Thus, the bank never realized that it lost its collateral.

Months after the sale, when the shareholder stopped paying the loan and the bank got in contact with the cooperative, it became obvious that the cooperative made a major mistake: it was not supposed to allow the sale of the apartment without notice to the bank. The bank sued the cooperative for $140,000 and won a judgment against the corporation for this amount.

Clearly, the shareholder perpetrated a fraud on the cooperative when he signed an affidavit swearing that the stock and lease were lost, and that there were no outstanding liens. However, the cooperative should have known about the loan because it had signed the recognition agreement. The cooperative tried to escape liability based upon wording of the recognition agreement, which seems to limit the liability of the cooperative if it neglects to notify the bank. However, the court did not agree.

The chance of such a fraud being perpetrated was significantly eliminated for loans made in or after October 1988. Since that time, the law requires that a bank which holds a cooperative unit as collateral must file a Form UCC-1 in the county in which the cooperative is located. By doing this, the public record tells the world of the security interest in the collateral. The cooperative can protect itself against fraud by requiting a search of the public records if a shareholder claims his stock and lease are lost.

The 1988 change in the law, however, did not change the requirements for perfecting the bank's lien when the loan was made before October 1988. As a result, if the loan was advanced prior to that date, there was no sure way to determine if a cooperative unit was collateral, and an affidavit by the shareholder may not adequately protect the cooperative against a fraud.

It is possible to protect the corporation against this type of fraud by requiring the shareholder whose stock certificate and lease are lost to provide a bond for the full value of the apartment to secure the corporation against any loss occasioned by issuing a replacement for the missing stock and lease. An investigation by Schecter & Brucker has disclosed that such bonds are available for approximately 3 percent of the value of the apartment.

As a result of the recent case, many cooperatives have begun to require that bonds be posted when the stock certificate and proprietary lease have been lost. In most cases, bonds are required only for stock certificates issued prior to October 1, 1988. Some cooperatives, however, require a bond for any lost stock certificate and lease, on the theory that the public records (or the search itself) may be inaccurate.

"We suggest that each board consider this issue and make a judgment as to whether it will require that a bond be posted when the stock and lease are lost," said attorney Howard Schecter, a founding partner of the firm. "The board should consider the following issues when considering whether it should require a bond in addition to an affidavit when a shareholder claims to have lost his stock certificate:

* The reliability of the corporate records (i.e. is the existence of a loan and recognition agreement constantly clear in the stock books);

* Whether to require a bond only for stock issued prior to October 1, 1988;

* Whether the potential exposure of the corporation (due to a shareholder defrauding the cooperative) is outweighed by the 3 percent cost which each honest shareholder who lost the stock and lease would be required to pay, and;

* Whether it is advisable to accept an affidavit and indemnification from an outgoing shareholder (who may be moving to points unknown) without the posting of a bond.