Getting More Than You Bargained for in Foreclosing on Townhomes and Condos
By: LARRY J. BERG & MARK W. VYVYAN
The last few years has produced many foreclosures of mortgages on units in common interest communities (CICs) such as townhomes and condominiums. The increased number of foreclosures involving CICs is expected to continue for some time. There has been some confusion on the part of foreclosing lenders as to their rights and obligations after a foreclosure. This confusion occasionally results in unexpected liability. This article is intended to clarify some of the rights and obligations of lenders who become the owner of a unit in a CIC following a foreclosure of a mortgage.
Here are some matters for a foreclosing lender to consider:
Payment of Common Expense Assessments
What Obligation Does a Foreclosing Lender Have to the Owners’ Association Following a Foreclosure?
If the foreclosed property is subject to the Minnesota Common Interest Ownership Act (MCIOA), MCIOA describes the obligations and potential liability of a lender who acquires title to property through foreclosure (a Lender-Owner). The first step is to determine whether or not MCIOA applies.
MCIOA applies only if there is a CIC. MCIOA defines a CIC very broadly: Real estate that is subject to a document that obligates the owner of a parcel of real estate to pay for a portion of the real estate taxes, insurance, or the cost of maintenance/construction of improvements, on another parcel of real estate. Thus, even projects that assess a share of the cost of maintaining entrance monuments would be considered a CIC. Not all CICs are subject to MCIOA, however.
MCIOA divides CICs into three categories: condominiums, cooperatives, and planned communities. Any CIC that does not fit the definition of a condominium or cooperative is considered a planned community. All condominiums are subject to MCIOA (although certain older condominiums may be dealt with under provisions of MCIOA that apply laws that predate MCIOA). Some cooperatives and planned communities are exempt from MCIOA, but planned communities created after 1994 are subject to MCIOA unless they fit into a specific statutory exemption. Even an otherwise exempt planned community will be subject to MCIOA if the owners have made an election to be governed by MCIOA.
For purposes of this article, let’s assume that as a result of foreclosing a mortgage the Lender-Owner has become the owner of a unit in a CIC that is subject to MCIOA.
What Obligation Does the Lender-Owner Have to Pay Present and Past Common Expense Assessments? Generally, if a first mortgage on a unit is foreclosed and the unit owner/borrower does not redeem, the Lender-Owner or its successor takes title to the foreclosed unit subject to a lien in favor of the CIC’s owners’ association for: (i) unpaid assessments that became due, without acceleration, during the six-month period that ends on the day after the end of the owner’s redemption period; and (ii) assessments that come due thereafter. If the Lender-Owner does not pay these assessments, the association’s lien may include interest, late payment charges, and attorneys’ fees, to the extent provided for in the declaration. If not paid, the association has the ability to foreclose its lien. MCIOA permits the association to recover costs and disbursements of foreclosure and attorneys’ fees beyond those that would ordinarily be payable in a foreclosure.
Please note that the association’s lien on a unit becomes effective on the date the common expense assessments on that unit become due. If the assessment is payable in installments, the association has a lien for the entire assessment from the date the first installment becomes due. If an installment of a common expense assessment is not paid within 60 days after it is due, the owners’ association has the right, upon 10 days’ notice to an owner (including a lender who becomes an owner by virtue of foreclosing a mortgage on a unit) to cause the entire amount of the assessment to become immediately due. The act of recording the declaration is the only action necessary to create a present, perfected lien. It is not necessary to record any notice of lien (although some associations do record such notices). Interested parties have a duty of inquiry, and owners’ associations are required to provide certificates containing important information, including a statement regarding the amount and status of assessments on a unit. That certificate will be considered binding on the owners’ association and the recipient, including a Lender-Owner.
Practical Considerations. Most Lender-Owners would prefer to defer paying the common expense assessments against the units it acquires through foreclosure until the closing of the resale of those units. This would be possible only if the owners’ association agreed, and such an agreement is unlikely because the association needs those funds to carry out the operations of the CIC for which the association is responsible, including performing certain maintenance and keeping required insurance in effect. The costs incurred by the owners’ association in performing its obligations are funded from the common expense assessments payable by the unit owners, including Lender-Owners. If too many owners do not pay the common expense assessments on their units, there will not be sufficient funds available to pay these expenses. This could result in a lapse of insurance or loss of necessary utility services, which could adversely affect the ability of a Lender-Owner to resell a unit acquired through foreclosure. In addition, MCIOA requires that certain disclosures be made to prospective purchasers, which will contain a description of the insurance coverage provided by the association and copies of the association’s budget and balance sheet. If these disclosures reflect adverse conditions, many prospective purchasers will exercise the statutory right to rescind their purchase agreement. Although it is understandable that a Lender-Owner would prefer to delay paying assessments on units acquired through foreclosure, doing so may make it more difficult to resell such units.
Receiving Special Declarant Rights and Limiting Liability
The units acquired by a Lender-Owner may include units that, prior to the foreclosure, were owned by the CIC’s developer—referred to in MCIOA as a Declarant. MCIOA permits the Declarant to include in a CIC’s declaration certain special rights that are for the benefit of the Declarant. These Special Declarant Rights include, among other things, the right to: (i) complete improvements in a CIC and use easements for that purpose; (ii) add certain additional real estate to the CIC; (iii) subdivide or combine units; (iv) maintain marketing offices and signage; and (v) control the owners’ association during a Declarant Control Period by appointing the board of directors. To the surprise of many unsuspecting Lender-Owners, a mortgagee who forecloses a mortgage on units owned by a Declarant, or who accepts a deed in lieu of foreclosure, automatically succeeds to the foreclosed Declarant’s Special Declarant Rights unless the Lender-Owner takes certain actions provided for in MCIOA. Succeeding to Special Declarant Rights may impose liability on the Lender-Owner that goes beyond liability for the Lender-Owner’s own acts. Thus, it is important for a Lender-Owner to have a strategy for dealing with the Special Declarant Rights.
A Lender-Owner could provide in a mortgage or deed in lieu of foreclosure that the Special Declarant Rights will not transfer on a foreclosure or deed in lieu of foreclosure. MCIOA provides for a right to transfer Special Declarant Rights by voluntary transfer. A “voluntary transfer” of Special Declarant Rights requires the Declarant and the person to whom the Special Declarant Rights are being transferred to record a document, signed by both parties, specifically transferring the Special Declarant Rights. That document must be recorded in every county in which any part of the common interest community is located. For purposes of transferring Special Declarant Rights, MCIOA provides that a foreclosure of a mortgage on a Declarant’s units or acceptance of a deed in lieu of foreclosure on the Declarant’s units will not be considered a voluntary transfer.
It is uncommon for mortgages to contain provisions dealing with the transfer of Special Declarant Rights. Limiting the Special Declarant Rights that would otherwise automatically transfer to the Lender-Owner by including language in a deed in lieu of foreclosure would be a successful way to prevent the automatic transfer of such rights. If the foreclosed mortgage or deed in lieu of foreclosure did not contain language limiting the automatic transfer of Special Declarant Rights, the Lender-Owner could sign and record a document that provides for fewer than all Special Declarant Rights to transfer to the Lender-Owner. A document of this kind must be recorded within 60 days after the Lender-Owner acquires title in order to be effective.
Accepting a transfer of Special Declarant Rights, whether voluntarily or through foreclosure, could result in the Lender-Owner taking on certain potential liability originally imposed upon the Declarant under MCIOA. Because taking on such liability is undesirable to many Lender-Owners, it is important to weigh the advantages of obtaining the Special Declarant Rights against the disadvantage of significant potential liability. If the mortgage or the deed in lieu of foreclosure do not limit the Special Declarant Rights that will otherwise automatically transfer to the Lender-Owner, the Lender-Owner, in order to limit its liability, will have to declare its intention, in a recorded instrument either to:
- Acquire the Special Declarant Rights, to hold solely for transfer to another person, in which case the Lender-Owner can not use the Special Declarant Rights unless and until a document is recorded permitting exercise of those rights. The Lender-Owner may, however, exercise the right to control the owners’ association by appointing the members of the board of directors during the remainder of the Declarant Control Period provided for under MCIOA. So long as no other Special Declarant Right is exercised, the Lender-Owner and its successor has no liability or obligation as a Declarant other than liability for its own acts and omissions; or
- Limit the Special Declarant Rights the Lender-Owner receives to maintaining models, sales offices, and signs. If the Lender-Owner limits the Special Declarant Rights it receives in this way, the Lender-Owner will not be subject to any liability or obligations as a Declarant, other than its own wrongful acts, except the obligation to provide a statutory disclosure statement and any liability arising from that obligation. However, the Lender-Owner then will not be entitled to exercise any other Special Declarant Rights.
Although MCIOA provides for the right of a Lender-Owner to limit its rights and liability in the manner described in this article, it does not describe the liability incurred by a Lender-Owner that does not limit its rights. The liability incurred by a person who accepts a voluntary transfer of a Declarant’s Special Declarant Rights is, however, clearly described by MCIOA, and it is unlikely that the liability or a Lender-Owner who does not limit the Special Declarant Rights it acquires would be greater. This means that a Lender-Owner will not become liable for any of the following: (i) misrepresentations by the initial/former Declarant; (ii) warranty obligations on improvements made by any initial/previous Declarant or made before the CIC was created; (iii) breach of any fiduciary obligation by a previous Declarant or the Declarant’s appointees to the board; and (iv) any liability arising out of a Special Declarant Right that was not transferred.
What Should a Lender-Owner Do After Foreclosing a Mortgage or Accepting a Deed in Lieu of Foreclosure?
- The holder of a Sheriff’s Certificate of Sale has the right to give written notice to the owners’ association requesting a statement setting forth the amount of unpaid assessments currently levied against the foreclosed unit. The owners’ association must provide that statement within 10 business days after receipt of the request. The information in that statement is binding upon the owners’ association and can be relied upon by the holder of the Sheriff’s Certificate.
- If the holder of a Sheriff’s Certificate has concerns about the accuracy of the information in the statement, it should formally notify the owners’ association and request verification or supporting documentation, especially to determine if it is being asked to pay amounts that predate the six-month period that ends on the day following the end of the six-month period prior to the end of the owner’s redemption period.
- A lender who acquires title to a unit in foreclosure or by deed in lieu of foreclosure should be aware that if the unit is in a CIC that is subject to MCIOA, the lender will take title to the unit subject to the owners’ association’s lien for: (i) unpaid assessments that became due, without acceleration, during the six-month period that ends on the day after the end of the borrower’s redemption period; and (ii) assessments that become due thereafter. Withholding payment may result in significant increases in the amount of the lien upon the foreclosed unit and could result in loss of the asset if the owners’ association forecloses its lien on that unit.
- If the foreclosure involves units owned by a Declarant, the holder should determine what, if any, Special Declarant Rights it needs in order to operate and resell the foreclosed property. If the holder desires to limit its liability, it should sign and record a document against the title of each part of the CIC that it is not acquiring as a result of the foreclosure, in which it limits the Special Declarant Rights it would otherwise acquire as a result of the foreclosure. If the Special Declarant Rights are appropriately limited to holding the Special Declarant Rights for transfer to another person, or accepting only those Special Declarant Rights to maintain models, sales offices and signs, the holder will be able to limit its liabilities in the manner described above. The trade-off is that certain rights that would be helpful in completing the development of the CIC—administering the owners’ association, or marketing the property obtained in the foreclosure—may be affected.
Changes to MCIOA are presently under discussion that may provide additional courses of action for potential Lender-Owners to consider as well as greater clarity regarding the rights and obligations of Lender-Owners.
There are many issues for a lender to consider when foreclosing on property that is part of a CIC. While this article discusses some of the more common issues, proper planning is important to achieve desired and expected results.