BANKERS TRUST VS. PAL
Condo boards should be very concerned about foreclosures and non-paying unit-owners. I know this can be hard because the defaulting unit-owner may be your next-door neighbor or your best friend, but you have to put friendship aside and deal with your fiduciary duty to all the unit-owners. You have to find a way to get the common charges paid. In a down market, after the mortgage, the interest, and the default interest are paid, there will not be sufficient funds to do this. That can be a major problem.
The situation arises out of Section 339-z of the Condominium Act and two cases, Bankers Trust vs. Pal and Bankers Trust vs. 900 Park Avenue. Until either of the decisions are reversed, which is unlikely, or the Condominium Act is amended, which is also unlikely, these three items will be a huge impediment for condo boards when unit-owners default.
Section 339-z provides that the holders of first mortgages on the units have lien priority over the condominium association. This means that when an owner stops paying and defaults, the apartment will be sold and the bank gets paid first (principal interest, default interest, and fees, plus collection expenses). Since foreclosures in New York can take four to five years, the condominium will not be receiving common charges and assessments for this apartment – even if it’s occupied – for quite some time.
Before Bankers Trust vs. Pal was decided, we were able to convince judges that in order to maintain the asset so that it could be sold at foreclosure and raise the maximum amount of money, the board needed a way to collect its common charges. We argued that it was in everyone’s best interest for the court to allow the condominium to collect use-and-occupancy charges from an occupant – or have the apartment rented, if it was vacant, and collect the useand- occupancy charges from the new tenant.
Bankers Trust vs. Pal involved a Park Avenue condominium in which a unit-owner leased his apartment for a substantial amount of money and did not pay $50,000 in common charges. After Bankers Trust began the lien foreclosure, the apartment was sold but only for enough to repay the bank. The condominium received none of the common charges that had accrued over the years.
The condominium sued and lost in state Supreme Court. As their attorneys, we tried to talk them out of appealing. But they ignored our advice and lost two subsequent appeals. This is now the law in New York.
It’s one thing if a single unit-owner defaults in a 300-unit building. But in the last bad recession, dozens of unit-owners defaulted, the banks separately foreclosed on the units, and condominiums were not getting 20, 30, 40 percent of their common charges while these foreclosures proceeded. Strangely, in situations like this, the lenders do not urge their attorneys to foreclose as quickly as possible, which slows the process down tremendously. If you’re on a board and you have one or more defaulting unit-owners, what you do not want to do is to go into the foreclosure action and fight the lender – because you will just generate tens of thousands of dollars of legal fees to slow the foreclosure down and and not get satisfactory results.
The alternative course is to separately begin an action to have a receiver appointed to keep the apartment occupied – and for the receiver to pay use-and-occupancy charges that are not part of the foreclosure. The lenders can usually be convinced that this is in their best interest, and because you were not involved in the original foreclosure action, there’s less of a problem with Section 339- z. Since he or she is a court officer, the receiver can get the occupant to pay something toward operating expenses. This doesn’t always work, but it’s far better than trying to fight the foreclosure.
Other states give condo boards the ability to either collect a six-month lien priority or get something toward the expense of operating the building. But those are states where foreclosure can occur, and they have a power of sale built into their laws. The condominium can be foreclosed upon in a couple of months. In New York, we have an extremely complex practice to foreclose a mortgage, which requires 13 separate motions. A contested foreclosure can last perhaps five years. What has to happen is that 339-z needs to be amended, and all of the condominium unit-owners who are reading this should immediately contact their state legislators and have that done.
Stuart Saft is a partner at Holland & Knight.