Protecting a Condo from Undesirables - Kurzman Karelsen & Frank

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Phyllis H. Weisberg, Partner, Kurzman Karelsen & Frank. What options does a condo board have for screening the finances of purchasers?

BACKSTORY Several of our condominium board clients have been grappling with problems caused by defaulting unit-owners. These problems can be significant because, unlike in a co-op, where the co-op’s lien for unpaid maintenance comes first, a condominium’s lien for unpaid common charges comes third – behind the first mortgage and real estate taxes. The bank’s priority means that the bank must be paid in full before the condominium sees any money. If the unit-owner is in default (presumably to both the bank and the condominium) and if the condominium unit is underwater (that is, if the bank’s lien exceeds the value of the unit), the bank’s priority poses a significant problem for the condominium.

If the bank has already instituted a foreclosure proceeding, because of the recent slow pace at which foreclosures move through the courts, the condominium may have to wait years until the arrears issue is resolved. During this period of delay, the hole in the condominium’s budget caused by the defaulting unit-owner will continue to grow. Barring a settlement and reinstatement of the mortgage, only when the bank sells the unit at a foreclosure sale does the bleeding stop. And only then does the condominium finally have a unit-owner who will pay common charges on the unit going forward. But unless there is a surplus at the foreclosure sale, the condominium will get nothing for the arrears in common charges; nor will the new unit-owner be responsible for paying them. Short of obtaining a personal judgment against the defaulting unit-owner and collecting against other assets (usually a dead end), no good way exists for the board to recoup the arrears that have built up.

Even if the bank has not instituted a foreclosure, the board will typically not view foreclosure of its common charge lien as a viable option, since any purchaser at the condominium’s foreclosure sale would either have to satisfy the first mortgage or take subject to that first mortgage and work out new payment terms. In most cases, neither option makes sense, and therefore it is likely no one will buy at the foreclosure sale.

In discussing these situations with our clients, we suggest possibly obtaining an asset search. We review purchase applications to see if the defaulting unit-owner has other assets that may be used to satisfy a judgment, so that pursuing the individual might be worthwhile.

Often, however, the applications are not helpful since they are merely perfunctory. When asked why, the boards will say that since the board has only a right of first refusal, that is, a right to purchase the unit, why bother? Notably, for a board to exercise the right of first refusal, the bylaws often require it to obtain unit-owner approval by a super-majority – unfortunately, to call and hold a meeting and to obtain the necessary super-majority vote, all within the 20 days that the board typically has to exercise the right of first refusal, is a virtual impossibility.

Even if the board does require a detailed application, however, board members frequently do not even bother to review the package and simply sign off on the waiver of the right of first refusal. (This is out of a sense of futility or the mistaken belief that if a deal is all-cash, the condominium’s lien will retain its priority – mistaken because the board is without power to prevent a substantial mortgage from being placed on the property even the day after closing.) As a result, the board might miss potential problems down the road. And if those potential problems exist, the board will probably miss potential solutions to them. The most obvious problem is one caused by a purchaser that is financially marginal or a single asset entity, often offshore.

COMMENT Condominium boards can and should review purchase and lease applications. Boards often neglect to consider that the bylaws typically give them broad rights – the right to require not only the submission of a formal application, including financial information, but also the right to require additional information if, upon review, the application is insufficient or raises questions. Significantly, while the bylaws give the board a limited amount of time within which to exercise the right of first refusal, the time within which to exercise or waive the right of first refusal does not even begin to run until the application is complete. The board is well within its rights to request additional information – and if necessary, go back a second or third time for additional information. Until the board gets all the requested information, the application remains incomplete.

The board should require each applicant to fill out a detailed application. The board should then review the application carefully. And, if on its face it appears that the applicant does not have the funds to make the purchase or to make monthly payments of common charges and real estate taxes, or perhaps the intended use would violate the bylaws, the certificate of occupancy, or the zoning, then an issue may exist whether this can even be considered a “bona fide offer.” And, if it is not, the right of first refusal is not triggered and the application cannot proceed.

Even if the application is a bona fide offer, the board may still have recourse other than to purchase under its right of first refusal. For example, sometimes the applicant does not have a Social Security or federal I.D. number, as is often the case with foreign buyers, or any financial background or history, such as a single-asset entity formed for the purpose of this purchase. If that is the case, the board cannot obtain a credit report, an item that many boards require – and that we believe should be routinely requested. If the board cannot obtain the credit report, then the application is incomplete. In that case, a board can and should request a guaranty and/or an escrow deposit or letter of credit in lieu of the required credit report. If there is to be an escrow deposit, we recommend the deposit include not only the amount of the common charges, but also the amount of the real estate taxes so that the board is protected in the event those taxes are not paid.

If there is to be a guaranty, the financial wherewithal of the guarantor should be reviewed, and if the guarantor is not a New York resident, a designation of agent for the service of process should be executed.

While rejecting an application as not being a bona fide offer or requiring an escrow or guaranty are not viable options in every situation, boards should be mindful that there are situations where they are. They should also be mindful that in other situations, by having obtained a detailed application, if the unit-owner subsequently falls into arrears, the information provided in that application may prove invaluable in ferreting out assets from which a personal judgment against the unit-owner can be satisfied.

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