Deadbeats & Devils

Q

My condo in Brooklyn has two unit-owners who don’t pay their monthly charges. One seems to be having financial problems, but we’re not sure about the other. Our property manager told us that we need to file a lien against the units, but I heard from somebody else that this could be very expensive and we still might not get paid. We are not a big condo, so we don’t want to waste money, but we also can’t afford to have some unit-owners who are not paying. What should we do?

A

Collecting arrears on condo units is problematic mainly because the lenders holding first mortgages on condo units, as well as real estate taxing authorities, have priorities over condos. That means that a condo will suffer the time and expense of filing and foreclosing upon its lien on a unit in default, but can sell the unit at foreclosure sale only subject to, at the very least, what could be a very large first mortgage, plus real estate tax arrears, on the unit. If the amounts of those priority claims exceed or even approach the market value of the unit, then there will be little value left to entice a purchaser to pay anything for the unit. And that doesn’t include what is necessary to satisfy the arrears to the condo, as well as the legal and other fees and expenses that the condo incurred when it foreclosed.

As an aside, a co-op does not have this problem because its claim to the proceeds of a foreclosure sale of an apartment has priority over a shareholder’s lender. This allows the co-op to sell the apartment at a foreclosure sale not subject to what is properly called the security interest – not the mortgage – of the lender. As another aside, the New Jersey legislature perceived at least some inequity for condos taking a back seat to lenders in 1996 by establishing a “super lien” of condos ahead of unit lenders for six months’ worth of arrears. But, given the time and expense that it takes for a condo to bring a unit foreclosure lawsuit to the point of foreclosure sale, this provides little relief, or even leverage, to a condo.

The condo should file a lien against the unit without delay, and indeed the board is typically obligated to do so under the condo’s bylaws. This is not very expensive, and, at the very least, will establish the condo’s priority over creditors (other than the first mortgage lender and the taxing authority) who have not yet caused the recording of judgments or liens against the unit.

If the value of the unit substantially exceeds the amount of any first mortgage, about which the condo can get a good sense by searching the public records for a copy of any mortgage recorded against the unit, then the condo should proceed with haste to foreclose. This will put maximum pressure on the unit-owner and best assure that, if the case is not resolved, the condo will be able to recoup the amounts due and its expenses from the foreclosure sale proceeds.

If the value of the unit does not exceed the value of any first mortgage, then the condo’s task is far more complex because it has no ideal options. The condo must reach out to determine first hand precisely why the unit-owner is not paying and what, if anything, the unit-owner is willing to do. The condo also could try to induce the unit-owner’s lender to prosecute foreclosure proceedings because a default to the condo is a default to the lender even if the unit-owner is making loan payments to the lender. The condo also could pursue the foreclosure itself even if the loan on the unit is close to or exceeds the value of the unit. Then, there is at least hope that, in the foreseeable future, the condo could strip the unit-owner of ownership and occupancy of the unit, so that it can be sold to a unit-owner willing and able to pay.

Q

At my co-op, we have a shareholder who is wreaking havoc in the building, making nasty statements to staff and residents alike, and loitering in the lobby. She is quite unkempt, and we suspected that her apartment was unclean and cluttered. Then we had to enter the apartment to repair a leak and discovered that our worst fears were true. We don’t believe that we can ever get her under control. Is there some way that we can kick her out?

A

There are two main courses of action to consider, each of which is potentially potent but not without possible pitfalls. The first is an “objectionable conduct” termination of the offending shareholder’s proprietary lease, following the 2002 New York State high court case of 40 West 67th Street v. Pullman. If available and done properly, this could lead to eviction of the shareholder and the sale of her apartment, with the proceeds first applied to any amounts due to the co-op, including attorneys’ fees. Given the stakes to the shareholder, however, the court indicated that courts must “exercise heightened vigilance” in examining whether the board’s action meets the standards of the “Business Judgment Rule,” deemed applicable to co-op board decision-making in the ground-breaking case Matter of Levandusky v. One Fifth Ave. Apt. Corp.

Simply put, a co-op can terminate a shareholder’s proprietary lease by this route provided that the shareholder cannot establish that the board acted:

Outside the scope of its authority, i.e., the typical proprietary lease requires the co-op to send notice of the “objectionable conduct” of the shareholder, or those occupying or visiting the shareholder’s apartment, with the warning that, if it is repeated, the co-op will consider and vote upon a resolution to declare the tenancy “undesirable” and thus terminate the lease;

In a way that did not legitimately further the corporate purpose, i.e., the co-op seemingly cannot just choose some meaningless conduct, like wearing a purple dress in public areas, for objection; or

In bad faith, i.e., the co-op should not have ulterior reasons for acting, like vindicating a personal grudge of a board member.

There are at least two additional considerations. The Pullman court seemingly decided to defer to the co-op to make the lease termination decision in part because the court was impressed that all shareholders in attendance at a meeting (constituting shareholders owning three-quarters of the co-op’s shares) voted in favor of the termination. That shareholder vote occurred because that co-op’s proprietary lease demanded it.

Most leases require only board (and not shareholder) vote for an “objectionable conduct” termination, and a subsequent case of the well-respected New York Appellate Division, First Department, Trump Plaza Owners, Inc. v. Weitzner, held (though without discussion) that this is good enough. I have some reservations about whether New York’s high court would agree, which presents the vexing problem about whether a co-op considering an “objectionable conduct” termination should seek shareholder approval, even if the lease does not require it. This would eliminate the possibility of leaving the door open to an appealable issue that could go against the co-op after years of expensive litigation.

The other consideration is that it is well accepted that the co-op must give the shareholder facing “objectionable conduct” termination a full and fair opportunity, with the assistance of an attorney, to hear and respond to the co-op’s charges. This was implicit in the Pullman case, because the shareholder was notified of the shareholders’ meeting at which the co-op conducted the termination vote.

But for board-only terminations, the co-op must make sure to properly invite the shareholder to attend the meeting, with an attorney, and present a defense before the vote. Indeed, even for terminations requiring shareholder approval, I believe that the board should consider inviting the shareholder to make a presentation first to the board in advance of the board’s vote to ask the shareholders to approve the termination. They should then meet again at the shareholders’ meeting before their vote.

If the co-op would like to avoid a shareholder vote (assuming one is required), it could forgo “objectionable conduct” termination, and instead declare the shareholder in default of the proprietary lease (including some house rules) and provide the shareholder with the standard 30 days to cure, in the absence of which the co-op could terminate the lease. One deficiency of this route, however, is that, under New York State Real Property Actions and Proceedings Law 753(4), even after the court awards the co-op legal possession of the apartment, the shareholder would have at least 10 days to cure the default and retain possession. One further consideration is that, in some cases, it might make sense for the co-op to proceed simultaneously under both the default and “objectionable conduct” provisions.

The good news is that co-ops have substantial power to respond, as they see fit, to nuisance and worse conduct by shareholders and others occupying or visiting their apartments. The cautionary note is that the courts will hold co-ops to high scrutiny in exercising those powers.