Aligning the Stars in Mortgage Foreclosures Navigating the Association s Options in the Delinquent Owner s Foreclosure

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1 Aligning the Stars in Mortgage Foreclosures Navigating the Association s Options in the Delinquent Owner s Foreclosure Allan Goldberg Arnstein & Lehr LLP Phone: agoldberg@arnstein.com

2 Allan Goldberg 120 S. Riverside Plaza Suite 1200 Chicago, Illinois (312) Mr. Goldberg is the co-chair of the Real Estate group at Arnstein & Lehr LLP, where he is a partner. He concentrates his practice in the area of real estate, including real estate development, real estate litigation, condominium and community association law and practice, lender representation, directors and officers liability defense litigation, and affordable housing matters on behalf of for profit and nonprofit developers and condominium converters. He regularly handles a wide range of issues on behalf of condominium and other community associations, and chairs Arnstein & Lehr s Community Association practice group, which involves the representation of hundreds of Illinois and Florida community associations. Copyright 2011, Allan Goldberg All Rights Reserved 2

3 Condominium association boards are aware of the so-called six (6) month lien protection available to Illinois condominium associations. This six (6) month period captures delinquent assessments following a unit owner s foreclosure case. Few experts in the field, however, understand that the lien is not automatic, that the association must undertake certain affirmative steps to place itself in a position where it might recover assessments and, most of all, that the stars must align just right for the association to recover a portion of its unpaid assessments. This article reviews the relatively new law regarding foreclosure relief for condominium associations. We will walk through the analysis of how the association may be protected in asserting its lien position for at least a partial recovery of an owners assessment delinquency. The Problem In these challenging financial times, condominium associations are increasingly faced with the effects of mortgage foreclosures. Typically, the owner in a foreclosure suit is likely delinquent with the payment of their condominium assessments as well as their home mortgage loan. As a greater number of unit owners are facing the loss of their units to bank foreclosure, more and more associations feel the drain on their revenue stream. Basically, all first mortgage loans are superior to the condominium association s lien. Thus, the condominium association is in greater than ever financial jeopardy. When a condominium is sold to a new owner at a foreclosure sale, the first mortgage holder, typically a bank, must be paid in full before the condominium association can receive any proceeds from the sale to apply against unpaid, and accrued, assessments. If the net proceeds of sale do not exceed the amount owed to the bank, the association receives nothing from the sale of the unit. To add insult to injury, prior law also prohibited the association from pursuing the new owner for any assessments owed by the prior owner. This is further compounded by the continuing accrual of unpaid assessments during the foreclosure case, usually lasting at least eight (8) to nine (9) months before the unit is auctioned off at the public foreclosure sale. Thus, the condominium association suffers severe financial hardship in these ever increasing number of situations. A Possible Solution Effective January 1, 2007, Illinois condominium associations obtained the ability to recover losses sustained when unit owners default on their mortgages. Section 9(g)(4) of the Illinois Condominium Property Act provides that the purchaser of a unit at foreclosure sale must pay the association up to six (6) months of unpaid assessments owed by the prior owner if several conditions are met. First, the condominium association must file a lawsuit to collect unpaid assessments to be entitled to this special relief. Next, the purchaser of the unit must be someone other than a mortgage holder. If a bank or other mortgage holder purchases the unit at sale, the special obligation to pay assessments shifts to the person who buys the unit. Most frequently, the foreclosing bank ends up with the unit as no one else bids at the auction. Third, where there is a successful buyer at the auction, the new owner is liable to pay past assessments only to the extent that the assessments have not been otherwise paid. Finally, a person who buys from a mortgage holder is liable for payment of up to six (6) months of pre-foreclosure 3

4 assessments provided the condominium association s paid assessment letter and Section 22.1 disclosures specifically disclosed that liability. So, while the law can help minimize losses when units are sold in mortgage foreclosure sales, the law is not self-executing. Boards must be proactive in protecting the association s recovery potential. The next section explains how clients may persue of the recovery of assessments in these situations. As discussed below, each situation is fact specific, and each must be analyzed from a cost-benefit analysis. Recommended Options When a lawsuit has been filed to foreclose a mortgage on a condominium unit, the lawsuit asks the court to have the unit sold at a foreclosure auction sale to generate money with which to satisfy the unit s owner s mortgage debt. As previously noted, the foreclosure process typically takes eight (8) to nine (9) months, or longer, to complete. It is likely that the unit owner will not pay assessments during that time. In order to protect the Association s interests in the foreclosure process, and to maximize the potential for recovery of unpaid assessments, a number of steps need to be taken: 1. First, an appearance should be filed on behalf of the association by counsel in the foreclosure proceedings. By doing so, all future court filings will be sent to the law firm appearing. This step will enable the attorney to track the progress of the foreclosure case, and will give the attorney advance notice of when the unit is scheduled to be sold at public auction. 2. The next steps depend on the likelihood of the unit selling at auction for more than the unit s mortgage debt. In foreclosures, Illinois law provides generally that the proceeds generated from the auction sale of a condominium unit must first be applied to pay off mortgage debt before the association can receive any proceeds of sale. Moreover, even if a unit sells at auction for more than its mortgage debt, the association will not receive any money from the auction sale unless it has protected its claim position by filing an answer to the foreclosure lawsuit, supported by an affidavit as to the amounts owed. 3. Thus, when looking at the allegations of the foreclosure complaint, the attorney should examine the unit s mortgage debt as stated in the complaint to evaluate the likelihood that, if sold, a surplus will be available to a third party. 4. If the association believes that the unit might sell at auction for more than the amount of debt alleged in the complaint, it is usually worthwhile for the association to have an answer prepared and filed on its behalf. Thus, the association needs to make a decision whether or not to file an answer supported by affidavit. We assist our association clients in this regard to make the best, informed, decision for the association considering a number of factors, including running through a cost-benefit analysis to determine the value of spending additional legal fees and costs to position the association for a six (6) month potential recovery. 4

5 In the event the association believes that the unit could sell at a foreclosure auction for more than the mortgage delinquency, the attorney should prepare an affidavit for the board or manager to complete for filing with the court. The affidavit requires a current account ledger reflecting the balance due. (If a special assessment is currently payable in monthly installments, future installments cannot be included, even where the association s governing documents contain the right to accelerate future monthly installments in the event of a payment default.) Without such an affidavit, the association will not share in any foreclosure sale surplus proceeds. 5. Where there is a second mortgage on the unit, additional steps should be taken by the association s attorney. A special provision of the foreclosure law provides that if the foreclosure sale of a condominium unit with two mortgages generates net proceeds of sale greater than the amount owed to the holder of the first mortgage, the association can receive some of the proceeds of sale otherwise payable to the holder of the second mortgage by giving a special notice to the holder of the second mortgage. That notice entitles the association to receive auction sale proceeds, otherwise payable to the holder of the second mortgage, equal to all assessments and related charges first accruing within ninety (90) days after the special notice is sent. In order to take advantage of this special right, the attorney must prepare and issue the required special written notice to the holder of the second mortgage on the unit. As noted, even if the foreclosure sale does not generate any proceeds of sale for the association, Illinois law now makes it possible for the Association to recover up to six (6) months of assessments owed by the current unit owner from the person who buys the unit at the mortgage foreclosure auction. So What Does it All Mean? At the risk of repetition, but in the interest of clarity, to recover up to six (6) months of unpaid assessments on the sale of a foreclosed unit to a new owner, the following conditions must be satisfied: (1) the Association must file a lawsuit against the current unit owner to collect unpaid assessments before the unit is sold at a foreclosure sale, (2) every paid assessment letter issued for the unit must state the amount for which the new owner will be responsible, and (3) disclosures to prospective buyers made pursuant to Section 22.1 of the Illinois Condominium Property Act for the unit must also specify the amount for which the new owner will be responsible. It is the association s responsibility to make sure that paid assessment letters, and Section 22.1 disclosures for the affected unit, provide all required information. If collection action is not already in process, the association should issue a 30 Day Notice and Demand, and then file a forcible entry and detainer lawsuit against the unit s current owner to establish the association s right to collect up to six (6) months of unpaid assessments from the unit s future owner. The mortgage foreclosure process is complicated and difficult. The Illinois Condominium Association does have the opportunity, if the stars are aligned just right, to recover at least some, if not all of past due assessments. 5