Dealing with the Realities of the Recession Default Protection

 Consider the (fictional) couple, Mr. and Mrs. Smith. They love their co-op  apartment, and have lived in their comfortable and convenient New York City  neighborhood for the last seven years, moving in when Mr. Smith took a job as  editor of a prestigious magazine. He was making a great salary, and Mrs. Smith  was enjoying her new career as an elementary school teacher. When the economy  took a hit last year, Mr. Smith’s magazine took a major hit— advertisers bailed and the magazine folded. Mr. Smith has had a hard time  finding a job ever since, and Mrs. Smith’s salary isn’t enough to make ends meet. The couple has been struggling— and they’ve missed several maintenance payments.  

 Their cousins, the Jacksons, own a condo in New Jersey. Unfortunately, they are  experiencing some of the same struggles as their Big Apple relatives. The  Jacksons have also experienced layoffs from their jobs and, as a result, have  fallen behind on their bills. They’ve exhausted every avenue of financial help and have defaulted on their mortgage—missing several payments as well as monthly dues payments to their homeowners’ association. Both couples are now facing foreclosure on their homes.  

 All Too Common

 Unfortunately, this is a common scenario these days, both in New York and around  the country. More than 1.5 million foreclosure actions occurred last year and  at the time of this printing, there was tax help for struggling homeowners,  which could slow down the problem. Unfortunately, when a homeowner misses a  payment, they aren’t the only ones affected. The entire building and homeowners association feels  the effects when one homeowner misses a payment. That effect multiplies when  there are more delinquent residents.  

 “Foreclosures on co-ops and condos affect the buildings because in order for the  buildings to run they need to receive a certain amount of rent or common  charges from their tenants,” says Joseph Colbert, a partner at Kagan Lubic Lepper Lewis Gold & Colbert, LLP in New York.  

 “The impact of a foreclosure in a condominium is often more severe than a  foreclosure in a cooperative,”says attorney Eric Goidel, a partner with the New York-based law firm of Borah  Goldstein Altschuler Nahins & Goidel, PC. “While the lien of a cooperative for unpaid maintenance is superior to the liens  of all lenders, the lien of a condominium board of managers is subordinate to  the lien of a first mortgage of record.”  

 This presents a superior challenge for a condominium association in light of  home values that have drastically depreciated well below initial purchasing  prices. “Particularly in this depressed real estate environment, the amount of the  outstanding balance of the first mortgage can often exceed the market value of  the apartment; let alone the foreclosure sales price of a unit,” says Goidel. “Accordingly, while a cooperative apartment corporation will ultimately either  recover the arrears due it, or recover the unit, frequently, a condominium  board of managers finds that some, or all of the arrears, are lost.”  

 In reality, foreclosures really aren’t the preferred way of doing business. Nobody wants to see a homeowner fail at  making their mortgage payments and ultimately lose their home. Banks and  associations want to work with a delinquent customer to bring them up to date  and save what could be a financial loss. After all, foreclosures aren’t just a mark on the homeowner’s record, but also on the building as well, affecting how lenders view the co-op  or condo, and impacting its ability to borrow.  

 The Process

 That being said, sometimes there’s simply no choice. No matter what the Smiths or Jacksons do, there may be no  opportunity to save their homes from foreclosure. How these foreclosures are  handled and the impact of any charges which remain in arrears will, however,  differ.  

 When a unit owner defaults on their payments in a co-op building, Ronald L.  Perl, a partner and head of the community association law practice group with  the Hill Wallack law firm in Princeton, New Jersey, says that it’s easier to foreclose because the shares are not real estate—they are shares of stock. Thankfully, co-op owners can get a little extra  assistance in the process.  

 “The banks are more likely to bring the account current because the shares can be  taken back by the association,” he says. “Under the terms of the loan with the building—which is really a loan secured by shares of stock, as opposed to a real estate  mortgage—the lender is entitled to make an advance to the delinquent unit owner’s association. If the unit owner still can’t pay after the advance, the lender is not going to pay forever.”  

 Curing any arrears is also a time-consuming process, according to Goidel. “Although a board of directors can simultaneously maintain a nonpayment  proceeding, in court, to recover possession of the unit,” explains Goidel, [the process to collect any maintenance in arrears] requires  that a notice to cure for the nonpayment of maintenance be served under the  proprietary lease, followed by service of a notice of termination. A foreclosure lien search is ordered and a notice of a sale is given to all  parties with interests subordinate to the cooperative as their liens can be  extinguished by the foreclosure. An auctioneer is engaged by the apartment corporation, and a notice of sale is  published in a local newspaper in accordance with Uniform Commercial Code  Rules. Where, however, a bank has loaned against the shares and proprietary  lease, the lender will typically step forward, pay the arrears and conduct its  own foreclosure.”  

 The unit owner will then be declared delinquent and evicted and shares will then  be sold. “While not the absolute rule, typically in a cooperative, where a lender takes a  unit back in foreclosure, the lender is often afforded holder of unsold share  status, and has the right to sell the apartment without board approval, or is  accorded a modified status and has the right to sell the apartment with only  managing agent approval with such consent not to be unreasonably withheld,” says Goidel.  

 This doesn’t go on indefinitely. If a unit owner declares bankruptcy, it can slow the  process down, cautions Perl. The exact details of the process are written in  the building’s governing documents.  

 A condominium foreclosure is different. When someone buys a condo, they own the  unit they are living in outright and pay a mortgage to the bank. In addition, a  unit owner is required to pay association dues, which are used to maintain and  upgrade the common areas of the property. If a unit owner fails to make either  payment, they can lose their property. Unlike a co-op foreclosure, foreclosing  a condominium offers less alternatives to collect outstanding association dues.    

 Goidel notes that “a condominium foreclosure is very similar to a mortgage foreclosure, with a  foreclosure proceeding being maintained in the Supreme Court of the county in  which the unit is located, to foreclose a lien for unpaid common charges, which  has either been filed out with the city register or with the county clerk (if  outside the City of New York). A summons and complaint is served, and dependent upon whether a unit owner  appears or defaults an answer may or may not be served. Any parties with liens subordinate to the lien of the board of managers must  also be served with process, as their interests in the unit may be wiped out in  a foreclosure. Upon application by the board of managers, a referee is appointed by the court  to compute the sums due and owing to the board of managers. A motion for a judgment of foreclosure and sale is thereafter filed and upon  judgment, the court appoints a referee to conduct the foreclosure sale.”  

 Perl agrees. “A condo foreclosure process is the same as what a bank would go through with a  mortgage of any property,” says Perl. “A notice goes out, and a foreclosure needs to be filed. This means that the bank  is terminating the owner’s interest in the real estate and the property will be sold at a sheriff’s sale to settle the debt.” And in a condo, says Goidel, the successful bidder is entitled to the deed for  the unit without any interference from a board of managers.  

 A Last Resort

 “I don’t prefer foreclosure in most association situations,” Perl continues, “although some lawyers are regularly doing foreclosures now instead of just suing  people. Foreclosures are more time consuming and expensive than a lawsuit for a  money judgement. They can get a wage execution or levy on bank accounts and  exhaust all other assets. Unfortunately, if this isn’t enough it can still force the sale of the unit.”  

 Something to consider, however, is that a foreclosure lawsuit can take a long  time. “When a condominium unit owner falls behind on his or her end loan, the lender  must commence a foreclosure lawsuit in state Supreme Court,” says Stephen M. Lasser, a partner with the law firm of Stark & Stark in New York. “A foreclosure lawsuit can take several years to complete. When a condominium unit is finally sold at a foreclosure sale, the proceeds are  first applied to the amounts owed to the lender, then to the amounts owed to  the condominium—assuming the condominium recorded a lien against the unit and there is money  left.”  

 There are examples of foreclosure that still may not work out to the benefit of  the building or the association. “For example, says Perl, say a unit owner buys a home for $250,000. They mortgage  $200,000 and put $50,000 down. Unfortunately, now the home is worth $180,000  and the unit owners don’t even have enough to pay that first mortgage. Where does the building’s board or association go?  

 The only steps that a board can take to assist a struggling resident is with  some type of deferral of the maintenance or common charge obligation, says  Goidel. “In either situation, this agreement should be memorialized in a court proceeding  with some severe implications for the resident if the terms of agreement are  not honored. Unfortunately, where a lender foreclosure is involved, there is little, if  anything that a board can do to assist.”  

 The bank will typically give a board or an association up to six months of  delinquent assessments, but in some cases, you can make a deal with the owner. “Boards have fiduciary duties that all owners pay their pro-rata share of  maintenance or common charges,” says Lasser. And they can also help a struggling resident by setting up a  repayment agreement, he says. The board also can offer to waive some late fees  or interest on unpaid amounts at the end of the repayment term if all payments  under the agreement are paid on time.  

 Lasser recommends that boards act quickly when condo owners fall into arrears  and encourage them to utilize the small claims part of the city or town court  if the amount owed is less than the court’s jurisdictional threshold, which is typically $5,000.  

 “Once a lender commences its own foreclosure action against a condo owner, it  rarely makes sense for a condo association to start or continue its own  foreclosure action because the bank’s loan that is being foreclosed will typically have priority over the condo’s foreclosure action,” he says.  

 It’s also important for managers to keep good payment records, so if a problem  arises, you have exact documentation of payments made. “If a unit owner fails to pay their dues, send a reminder notice, then another  warning letter 35 to 60 days later and then, finally, turn it over to legal,” says Colbert.  

 The Manager’s Role

 Managers may run into complications when dealing with a unit owner. For example,  the unit owner may be falling behind financially, but might have a rental  tenant occupying the unit. The owner—not the tenant—is responsible for the maintenance payments to the building. The tenant might be  paying the unit owner, but the owner might not be paying the association. If  that’s the case, says Colbert, “file a common charge lien, and notify the tenant that they have to pay the board  directly. You may have to make some difficult decisions.”  

 In some cases, just initiating any kind of foreclosure, liens or legal paperwork  is enough for an owner to pay the back payments. They may borrow from family or  friends to get themselves caught up. However, this isn’t always the case and the owner may choose to take the loss. “It gets them out and forces the sale of the unit,” explains Perl. “This is good for the building because the next owner is more likely to be a  performing owner when it comes to paying association fee.”  

 Of course, most buildings are going to encounter a defaulting resident every  once in awhile, and usually it’s not the end of the world. And Goidel points out that while there should not be  any long term implications for a cooperative’s ability to borrow, “a significant number of foreclosures at any given point in time, may have a  temporary impact, as lenders look at the available cash flow in determining  whether to commit funds to a building, and if so, in what amount.” Therefore, he adds, that it may be necessary in the short term to temporarily  assess shareholders in good standing to make up a likely shortfall in  maintenance income.  

 Conversely, a condominium is different. “A condominium,” says Goidel, “by its nature does not have the ability to mortgage any common property, and  only has the ability to borrow money from a bank, with the security being a  pledge of the cash flow in the form of common charges and other payments due  the condominium. Accordingly, a diminution in the cash flow to a condominium will have impact on  the willingness of a lender to make a loan, as well as on the amount that a  lender is willing to make available.”  

 Too many defaults can actually affect the association’s borrowing ability down the road. “Banks look at delinquency rates,” says Perl, “and in most cases an association has a line of credit with a lender set in  advance. However, they may need some kind of credit later and a bank may look  at these delinquencies as a credit risk. If 50 percent of the units are in  collections, who would allow that association to borrow money?”  

 Sometimes all the unit owner needs is time to get through a difficult period. It’s important for the association to weigh the pros and cons of an arrangement  with the unit owner versus the traditional methods of foreclosures. What steps  can a board take to assist a struggling resident while still protecting the  building’s interests?  

 “Someone might just be in hard times, and we’ve had times when someone can’t afford to live in the building, so we’ve agreed to a standstill while they put their home on the market for a range of  prices. They try to get market price, but if they don’t then they’ll go to foreclosure and have it auctioned.”  

 It’s a unique time in this world which calls for unique solutions to unique  problems. There are more Smiths and Jacksons out there, so be prepared as to  how to handle them without jeopardizing the day-to-day operations of your  building or association.  

 Lisa Iannucci is a freelance writer, author, and a frequent contributor to The Cooperator.

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