Gotcha! Associations Corner Mortgagees For Past Due Assessments

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1 Gotcha! Associations Corner Mortgagees For Past Due Assessments Peter P. Hargitai Under Florida law, expect to see more and more associations refusing to record and enforce liens. Peter P. Hargitai is a trial lawyer in Holland & Knight s Jacksonville office, focusing on real estate and complex commercial litigation. He has extensive trial experience in both traditional and alternative dispute resolution tribunals, and has handled complex matters involving real estate disputes, business torts, restrictive covenants, trade secrets and anti-competitive practices. Mr. Hargitai also has developed a banking operations practice and currently represents many national and regional banks. He advises both condominium developers and lenders in connection with the Florida Condominium Act and is recognized by The Best Lawyers in America and Florida Trend s Legal Elite as a top attorney in his field. He can be reached at peter.hargitai@hklaw.com. Today, and for the last several years in the wake of the foreclosure crisis, Florida condominium owners associations have struggled to collect monthly assessments from delinquent unit owners. Assuming that a typical owner s unit was financed, once in default for non-payment of the note and mortgage, the unit owner usually also defaults in his or her obligations to pay the association s regular monthly assessments. The usual remedy for the association would be to record a lien on the unit and, if that did not convince the unit owner to pay, initiate an action to foreclose the lien. In today s condominium environment, that strategy is simply a waste of time and money inasmuch as the mortgagee will invariably have a superior lien on the property which often has no equity, or is under water, leaving the association with nothing left to satisfy the lien, and an invoice for attorneys fees. The safe harbor provisions of section (1), Florida Statutes discussed herein, have no application when the unpaid assessments sought to be recovered by the association are secured by a lien recorded prior to the mortgage. See Fla. Stat (1)(f). Section , Florida Statutes, provides some protection for the association, but the language of the statute The Practical Real Estate Lawyer 19

2 20 The Practical Real Estate Lawyer January 2013 is outdated and creates confusion for the association and the foreclosing lender (or its assignee in the case of a note sale), even when the lender intends to fully comply with the law. In short, the drafters did not envision a condominium market saturated with 100 percent financing, negative equity, and underfunded associations. This article will explore the arguments being made by both condominium associations and financial institutions after a delinquent borrower s unit goes into foreclosure. THE STATUTE First, the obvious: A unit owner, regardless of how his or her title has been acquired, including by purchase at a foreclosure sale or by deed in lieu of foreclosure, is liable for all assessments which come due while he or she is the unit owner. See Fla. Stat (1)(a). In other words, if you own the unit, you are responsible for condominium assessments. After the real estate bubble burst, this edict was quickly ignored by unit owners who could not make monthly mortgage payments, much less association dues. When owners stop paying their mortgages, and after time-consuming workout efforts, the banks foreclose. That process, too, often takes months, if not years, to complete, due to judicial congestion and dilatory tactics of homeowners and counsel (resulting in a substantial period of free rent for the unit owners). And all too often, banks are in no hurry to complete the foreclosure, obtain title to the unit, and begin paying assessments, taxes, insurance, and other traditional expenses of condominium ownership. While banks work through the foreclosure process, they seek out note purchasers, or to otherwise approve a short sale of the property and stem their losses. The end result of this delay is costly to the associations, which rely on monthly assessments as their economic life blood. A unit purchaser is jointly and severally liable with the previous owner for all unpaid assessments prior to transfer of title. See Fla. Stat (1)(a). However, the statute further provides that [t]his liability is without prejudice to any right the owner may have to recover from the previous owner the amounts paid by the owner. Id. Section (b), however, provides a safe harbor for the first mortgagee or its successor or assignees (defined to include only a subsequent holder of the first mortgage) who acquire title to a unit by foreclosure or by a deed in lieu of foreclosure: (1)(b)(1) The liability of a first mortgagee or its successor or assignees who acquire title to a unit by foreclosure or by deed in lieu of foreclosure for the unpaid assessments that became due before the mortgagee s acquisition of title is limited to the lesser of: a. The unit s unpaid common expenses and regular periodic assessments which accrued or came due during the 12 months immediately preceding the acquisition of title and for which payment in full has not been received by the association; or b. One percent of the original mortgage debt. The provisions of this paragraph apply only if the first mortgagee joined the association as a defendant in the foreclosure action. Joinder of the association is not required if, on the date the complaint is filed, the association was dissolved or did not maintain an office or agent for service of process at a location which was known to or reasonably discoverable by the mortgagee. Simple, No? Or Simple? No. At first blush, the statute seems straightforward: The mortgagee bank (or its foreclosing successor) owes the association the lesser of 12 months of regular assessments or one percent of the original mortgage. However, the confusion comes into play with the modifier (often described as the safe harbor exclusion ) awkwardly inserted into subsection 2., that the provisions of this paragraph apply only if the first mortgagee joined the association as a defendant in the foreclosure action. Which paragraph? As written, the modifying language seems

3 Past Due Assessments 21 to apply only to subsection 2. On the other hand, it could be argued that the paragraph is (1)(b), and that subsections 1. and 2., which are the lesser of limitations, are merely subsections of that paragraph. The associations and banks obligations shift materially depending upon the correct interpretation. Confused, the banks must make a decision within 30 days of acquiring title, or be subject to a lien against the property for unpaid assessments, late fees and interest. See Fla. Stat (1)(c) ( The person acquiring title shall pay the amount owed to the association within 30 days after transfer of title. Failure to pay the full amount when due shall entitle the association to record a claim of lien against the parcel and proceed in the same manner as provided in this section for the collection of unpaid assessments. ). Interest (up to 18 percent) and late fees (the greater of $25 or five percent of each delinquent payment) may also be recoverable. See Fla. Stat (3). THE ASSOCIATIONS ARGUMENT Associations have been starved of monthly assessments, and are looking to replenish their balance sheets and reserves for critical maintenance expenses. Condominium properties are dilapidated. Without contributions from delinquent unit owners, monthly assessments for the shrinking pool of paying unit owners invariably increase. When reserves are too low to cover necessary improvements, or repairs to existing improvements, the paying unit owners also receive special assessments at the discretion of the condominium board of directors. All of this results in disdain for the delinquent unit owners (who may still live in their units) and foreclosing banks (which may be in no hurry to acquire title and become a paying unit owner ). Associations are angry and aggressive. Assuming that a unit s monthly assessments are $1,000, the 12-month safe harbor provision for the first mortgagee is hardly sufficient to compensate the association for two or more years of delinquency. It is not unusual for assessments to remain delinquent for three years before title is obtained by the mortgagee or its successor. If the foreclosing bank is only responsible for $12,000, the association will generally never recoup the $24,000 of unpaid assessments. The situation is even worse if the original mortgage debt is the lesser of the two options (i.e., assuming a $1,000 monthly assessment on a unit with a mortgage for $500,000, the bank would only be liable for $5,000). When multiple units in a condominium development are in foreclosure, the associations would argue that the loss can be devastating. Application Of The Safe Harbor Provision With this backdrop, the associations argue that the mortgagee safe harbor exclusion applies to all of paragraph (1)(b) that is, if the mortgagee does not name the association as a defendant in the foreclosure proceeding, it is liable as any other person for all past due assessments. The associations argue that, if they are not made a party to the foreclosure, and thus do not have an opportunity to protect their rights, there should be no safe harbor. (Limited legislative history seems to support the associations position.) In today s economic climate, however, this statutory construction makes little sense because even if the associations were named parties in the foreclosures: (i) the associations liens will invariably be inferior to the mortgagees ; (ii) there will be no equity in the property to satisfy the junior liens; and (iii) the association will be saddled with attorneys fees and costs for defending the lawsuit. In most cases, the associations gain nothing more than a spectator s seat by participating in the foreclosure. Associations and their counsel have grasped at the ambiguity in this statute in an attempt to recoup their losses. In essence, the associations are seeking to use the protections of section as a sword to claim entitlement to all past due assessments from the deep pockets of the mortgagee or its assigns. Rather than enforcing its rights against delinquent

4 22 The Practical Real Estate Lawyer January 2013 unit owners, associations are advised to simply allow the unpaid assessments to pile up. Why should an association record a lien against the property of a delinquent unit owner when, because of negative equity, a subsequent foreclosure action will never result in recovery of assessments? Instead, a savvy association will quietly sit on its hands and refrain from recording a lien that would cloud title, which a mortgagee would identify with the initiation of its foreclosure action. Without such a title issue, the mortgagee might not name the association as a defendant. (Why should it?) Then, once title changes hands, the association can swoop in and for the first time claim that the mortgagee or its assignee is responsible for all past assessments for failure to name the association in the foreclosure. THE LENDERS ARGUMENT Mortgagees and their successors contend that the safe harbor exclusion applies only to the one percent of the mortgage debt option in section (1)(b)1.b. As a matter of logic and statutory construction, they would appear to be correct, since the modifying language appears only within the text of section (1)(b)1.b. See, e.g., Barnhart v. Thomas, 540 U.S. 20,26 (2003) (adopting the grammatical rule of the last antecedent, according to which a limiting clause or phrase should ordinarily be read as modifying only the noun or phrase that it immediately follows). More importantly, such a construction is abundantly more persuasive when considering: (i) the purpose of naming the association in the foreclosure action in the first instance; and (ii) that the association has alternative remedies to recover assessments (which, unfortunately, are underutilized). The mortgagee should not be penalized, and the association should not benefit, as a result of the association s calculated inaction, followed by a gotcha. First, why would the Legislature intend to exclude the safe harbor provisions in section (1)(b) only when the association had been named in the foreclosure? Remember, the statute was enacted well before the Florida condominium boom and subsequent bust, before the sustained wave of wildly imbalanced loan-to-value financing, and before condominium values saw historic declines. Before all of that, a mortgagee that identified an association s recorded lien would name the association as a defendant in the foreclosure. Generally, there would be equity in the property, and the association could be made whole after satisfaction of the senior mortgage lien. Thus, when an association was able to participate in the lawsuit, it could protect its lien rights and the bank s liability for past due assessments would be limited to one percent of the mortgage which would almost always be less than six months of assessments (under the pre-2010 version of the statute). It made sense for the safe harbor exclusion to apply only to section (1) (b)1.b, because in the normal course the association would be made whole, or nearly whole. On the other hand, were the association not added as a defendant (generally because no lien was recorded), then the mortgagee would be liable for six months of assessments, and wouldn t otherwise be able to take advantage of the lesser of the two options. Today, the market situation is much different, but the equities still favor the mortgagee. First, foreclosure benefits the associations. The process puts new owners in the units who pay assessments, and bring back the sense of community that condominium living promotes. Non-delinquent unit owners generally care for their units. But more importantly, there is no reason why the association should receive a windfall at the expense of the lender or its assignee. Why should the lender, rather than the association, be responsible for tracking down, and attempting to recover from, delinquent former unit owners under section (1)(a)? The association is in the best position, pre-foreclosure, to attempt to recover from the delinquent unit owners by recording a lien and enforcing its lien rights (which would almost always ensure that

5 Past Due Assessments 23 the association is named in the foreclosure action due to the cloud on title), rejecting leases, and forcing the direct payment of rent from tenants under leases with delinquent unit owners. For instance, section (4) authorizes the association, under certain circumstances, to reject the proposed leases of delinquent unit owners. See Fla. Stat (4) ( If the association is authorized by the declaration or bylaws to approve or disapprove a proposed lease of a unit, the grounds for disapproval may include, but are not limited to, a unit owner being delinquent in the payment of an assessment at the time approval is sought. ). Moreover, section (11) permits the association to, in essence, garnish rents from delinquent unit owners to satisfy past due assessments. Section (11), which became effective on July 1, 2010, provides that [i]f the unit is occupied by a tenant and the unit owner is delinquent in paying any monetary obligation due to the association, the association may make a written demand that the tenant pay to the association the subsequent rent payments and continue to make such payments until all monetary obligations of the unit owner related to the unit have been paid in full to the association. The tenant must pay the monetary obligations to the association until the association releases the tenant or the tenant discontinues tenancy in the unit. Fla. Stat (11) (effective, as rewritten, July 1, 2011). By failing to enforce those rights, and failing to record a lien prior to foreclosure (and thus failing to alert a foreclosing lender of the cloud on title), an association s claim to all unpaid assessments under section (1)(b) simply rewards complacency. In order to avoid the gotcha tactic, a lender is advised, without further clarification from the courts or Legislature, to name the association in every foreclosure matter whether or not there has been a lien recorded by the association. CONCLUSION At a minimum, the Legislature should revisit section and clarify that the safe harbor exception: (i) only applies when a lien has been previously recorded by the association; or (ii) only applies to the one percent of mortgage debt option under section (1)(b)1.b. Under the first scenario, a lender that failed to add an association with a recorded lien would, and should, be responsible for all past due assessments. By naming the association, the lender can take shelter under both safe harbor provisions. Under the second scenario (that is, if the Legislature meant paragraph when it used the word paragraph ), whether or not the lender named the association as a defendant, it would be responsible, at most, for 12 months of regular assessments. However, if the lender does add the association as a defendant, the association has the opportunity to participate in the foreclosure (and potentially to be made whole in the rare case where there is equity in the unit), the lender may opt to pay only one percent of the original mortgage, which is generally the long end of the stick. Without such clarification, we should expect to see more and more associations refusing to record and enforce liens for unpaid assessments, for fear of losing the post-foreclosure gotcha sword under an ambiguous statute. To purchase the online version of this article, go to and click on Publications.