The Case of the Reckless Russians: The Lawyer's View

Steven Shore is a partner in Ganfer & Shore, a law firm specializing in co-ops and condos.

The sale of mortgage-backed derivatives and the lax lending standards that infected the housing market made it possible for unqualified buyers to obtain mortgages on properties. These loans were behind a fraudulent scheme in which over $200 million in bogus mortgages were obtained and the perpetrators literally were able to take the money and run. One of the victims of this scheme was a client of my firm. What was our strategy in this case? What did we do?

While the overall scam included securing mortgages at inflated values based on overstated appraisals and other alleged wrongdoings, the portion that affected our client – a New York condominium – concerned a situation in which ten units occupied by rent-stabilized or rent-controlled tenants were purchased and the occupied units were then resold to fictitious and/or “straw-men” purchasers at significantly inflated values. Mortgages were then taken out on these units based on the inflated valuations and the mortgage proceeds were taken by the conspirators. The purported owners vanished and the condominium was faced with a situation in which no one was paying the common charges or the cost of repairs required in these units. The perpetrators were able to significantly inflate the values of the subject units by neglecting to advise the lending institutions that the units were not vacant and were being leased to rent-controlled and/or rent-stabilized tenants. The lenders apparently did not inspect the units (or else they would have found people living in them) and, as occupied units, the apartments had a value significantly less than what the units would have been worth had they been vacant.

Unfortunately, because the mortgages had been secured through subprime facilities and then sold off, the identity of the holders of the interest in the mortgage could not be readily ascertained in all cases, and accordingly, the lenders did not promptly begin foreclosure proceedings. The result was that the condominium was faced with the prospect of a relatively long period of time during which it would not be able to collect common charges from the “bogus” unit-owners. Because we anticipated that it would take years for all the foreclosure proceedings to be started and then proceed to foreclosure, and because the condominium’s lien on each unit was subordinate to the lenders’ lien, the condo was faced with the prospect of never collecting its common charges.

In addition, the condominium also had to deal with its obligation to repair dangerous conditions that existed in some of the units, as well as to deal with the federal criminal investigation that ultimately resulted from this scheme. Because our client was a condominium and the mortgages secured on the units had priority over any lien the condominium would have for unpaid common charges and/or unreimbursed repair costs and unpaid legal fees, the condominium was faced with a situation in which it would not only suffer a serious reduction in the collection of common charges, but at such time as foreclosures on the units were completed, any claims that it possessed would be wiped out. As these units represented a substantial percentage of the total number of units in the condominium, the loss of common charges on them and the incurring of costs to deal with problems in these units created a financial emergency for the association.

Although the condominium association had an excellent claim for significant sums of money that would have been tripled under the Racketeer Influenced Corrupt Organizations (RICO) act – and would also have entitled the condo to recover its legal fees – we recommended that it not start a RICO action. Among other things, that would have taken time and would probably have resulted in the condominium’s securing a substantial but noncollectable judgment. We anticipated that the authorities would institute criminal proceedings and freeze and ultimately take all of the wrongdoers’ assets. Our concerns were ultimately proven justified when the federal authorities indicted many people in connection with this fraud and subsequently secured guilty pleas and control of their assets.

Given our concerns that it would take years for all the foreclosures to come to fruition and the urgent cash flow needs of the association, we suggested an alternative strategy that would enable the condo to secure some cash flow during the time it was waiting on the foreclosures. We recommended that proceedings be instituted for unpaid common charges and legal fees in the civil court where judgments could quickly be secured. Once the condo had judgments, restraining notices could be served upon the tenants in the subject units to be followed by securing turnover orders directing the tenants to pay their rent directly to the condominium.

As a further part of our strategy, once an initial judgment on each unit was satisfied we would go back into court and secure additional judgments and continue with such process until the subject unit had been foreclosed. As a result of this strategy the condominium was able to secure all of the rent that the tenants in the subject units owed to the conspirators and their “straw men.” The money recovered was in the six figures and along with a special assessment enabled the condominium to meet the shortfall caused by these defaults.

Because of this situation, we have advised a number of other condominiums on ways to better shield themselves in the future from situations of this nature. Among alternatives that we have discussed are bylaw changes to provide for more rigorous application procedures, approval of new purchasers, security deposits, and a mortgage for common charges.