Condominium associations hit hard by foreclosures consider bankruptcy
Journal of Property Management, May-June, 2010 by Joseph Dobrian
With the recent proliferation of condo foreclosures and owners falling behind on their monthly assessments, many condo associations are struggling to find a way to pay their bills and vendors. They are even considering bankruptcy.
“When people start to go under financially, they stop paying condo assessments before they stop paying the bank,” said Evan C. McKenzie, attorney and associate professor at the University of Illinois at Chicago. “By the time they get foreclosed on by the bank, they’re already deeply in arrears to the association. And when banks foreclose on a condo unit, they routinely refuse to pay assessments, past or present. That’s breach of contract, but they do it anyway.”
While it’s not the norm for condo associations to file Chapter 11 bankruptcy, it is a recourse that’s increased in the past couple of years, particularly in overbuilt markets. California, Arizona, Nevada and Texas are the markets where most condo foreclosures are occurring, McKenzie said.
At first glance, it would appear that Chapter 11 wouldn’t be available because associations are pass-through vehicles, not property owners. Still, more and more associations are finding ways to test bankruptcy law–and their efforts could lead to considerable litigation over the next few years.
DILATORY, DISALLOWED OR DISASTROUS
The tipping point whereby associations start considering bankruptcy is often when the remaining solvent owners in a building have to pay far more than their proper share in assessment fees, pushing more owners into delinquency. McKenzie said when more than 20 percent of owners are delinquent it becomes practically impossible for the association to borrow money. It also becomes impossible to get FHA or Fannie Mae insurance on sales of units.
Ultimately, he said association bankruptcy “is a disaster,” and should only be used as a last resort–in extremely rare situations. In general, the effect of association bankruptcy is merely dilatory, and courts often disallow the filing. Some associations have stopped just short of bankruptcy, asking the courts to appoint a receiver to collect fees from individual owners. But in most cases, the bankruptcy process is too complicated and costly to be useful to a condo association.
Robert Kaye, partner at the law firm of Kaye & Bender in Pompano Beach, Fla., which represents about 700 communities in southern Florida, said it’s difficult for a condo or homeowners’ associations to declare bankruptcy because they are almost never in a situation where its liabilities outweigh its assets, especially with its power to require a special assessment in order to lessen debt.
“There are a few situations where a condo association might have liabilities greater than its assets. For example, if a large judgment has been entered against it,” Kaye said. “We saw a case recently where an association was locked into a long-term recreation lease which, due to significant foreclosure issues, became unmanageable. That 50-plus-year liability was draining the resources of the remaining owners, so the association filed for bankruptcy to get out of it.”
SHOULD WE OR SHOULDN’T WE?
Fort Lauderdale, Fla.-based attorney Mark Schorr represented Maison Grande, a condo association in Miami Beach involved in a long-term recreation lease case. He said the seeds of disaster were sown in the 1970s, when the condo association failed to buy or negotiate its way out of the onerous lease after Florida courts outlawed escalation clauses. As a result, an assessment of $40 per unit, per month rose to $224 by early 2010–at a time when 25 percent of Maison Grande’s 502 units were delinquent on their fees.
Schorr said it was useless to put a lien on a unit because the bank was about to foreclose on the first mortgage. As a result, the condo association filed a petition for Chapter 11, in order to get out of the lease. He said the lessor is opposing the bankruptcy, as well as the motion to release the lease, because the condo association doesn’t have any assets in its name, and the unit owners as a whole still have assets.
“These are issues that have never been raised before, that need to be raised,” Schorr said.
So far, the judge in the Maison Grande case has ruled that each owner is liable for his pro rata share of the recreation lease–but not for what’s owed by delinquent owners. The association is thus relieved of its obligation to go after the delinquencies, and it’s possible the judge will also rule that the remaining unit owners aren’t liable, which would make bankruptcy very worthwhile, Schorr said.
Other cases, however, might not be as worthwhile. Another condo association bankruptcy that’s been attracting attention lately is tied to the Boca Village Association, also in southern Florida. The association proposed to file Chapter 7 bankruptcy to dissolve the organization, then create a new association that would take over the condo
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