Exploding Toilets, Imploding Mortgages

In the wake of a terrible accident, Fannie Mae gets tough on a Brooklyn co-op.

Exploding toilets – it sounds like the punchline for a bad joke. But to the residents of Caton Towers, a 283-unit high-rise co-op in the Kensington section of Brooklyn, it was no laughing matter. A string of recent toilet explosions in the building injured three people – two received minor cuts, a third claims to have lost the sight in his left eye – and now the co-op is facing three lawsuits. Terrible as that is, the problem is compounded by actions Fannie Mae, the federal loan agency, has taken because of the lawsuits. It has declined to back new mortgages in the building, a surprise move that so far has caused half a dozen sales to fall through.

Caton Towers suddenly finds itself trapped in a most unpleasant limbo. This is the story of how bad plumbing led to rough times and what the co-op is doing about it.

Shut Down and Lift Off

The trouble began on October 2, 2013, when it was announced that the water in the building would be shut down for about eight hours while workers did a scheduled cleaning of the water tank and installed a city-mandated backflow control valve, which keeps outgoing sewage from flowing back into the building’s plumbing system. It looked like a bit of routine housekeeping.

But after 10 o’clock that evening, long after the work should have been completed and the water turned back on, Chris Forte, president of the co-op’s board of directors for 17 years, was surprised to see water spewing out of the toilet in his apartment. Forte, a retired lawyer with the federal government, knew something was wrong. He soon found out how bad it was.

“At some point after the plumber turned the water back on, the pressure caused the toilets to explode,” Forte says. “The bowls just gave. Unfortunately, one of the sublet tenants was in his apartment when it happened, and he was very severely injured in the eye.”

As is to be expected in such events, the co-op’s insurance carrier, Greater New York Mutual Insurance (GNY), and a small flotilla of lawyers were soon in action. The injured residents started talking to attorneys, and the GNY appointed a lawyer to defend the co-op in the inevitable lawsuits. So while the three lawsuits that were eventually filed were not unexpected, they omitted a crucial piece of information: a dollar amount of damages, compensatory and punitive, that the injured parties were seeking.

On the day the toilets exploded, six sales were in progress in the building, with financing secured. Closings appeared to be a mere formality. Then the board got a surprise.

“Brokers who thought they had done deals discovered that the banks weren’t going to go through with the loans because Fannie Mae wouldn’t buy the mortgages,” Forte says. “We learned about this through the brokers. I was surprised. I knew we were going to be sued, but I didn’t know that would interfere with the way business gets done.”

Judi Friedman, a real estate broker, has lived in Caton Towers since 1991, and in that time has brokered dozens of sales in the building, including ones of sponsor apartments. On October 2, she had several transactions pending. “Even though four of the loans had been approved,” Friedman says, “mortgage brokers told me that Fannie Mae had [refused to back] the loans because of the litigation. The brokers were shocked. The upshot was that the lenders would no longer lend to these buyers. The buyers could go into a less desirable, more costly loan from a portfolio lender, and if they did, they would have to go through the loan process all over again.”

Buyers weren’t the only ones affected. “Owners are suffering, too,” Friedman notes. “One shareholder moved out, and now they’re paying maintenance on an empty apartment. Besides being psychologically straining, it’s expensive.”

Adds Forte: “I’m more interested in finding out why Fannie Mae did this.”

The Heart of the Matter

The answer to Forte’s question is tucked deep inside a thick document known as the “Selling Guide,” which lays out which loans Fannie Mae deems eligible for purchase and which loans it does not. Fannie Mae will not buy a loan in a condo or co-op “for which the homeowners’ association or co-op corporation is named as a party to pending litigation, or for which the project sponsor or developer is named as a party to pending litigation that relates to the safety, structural soundness, habitability or functional use of the project.”

There are exceptions. If the lender determines that the pending litigation involves “minor” matters, such as a noise complaint, Fannie Mae does not consider the loan ineligible. Now comes the crux. “Minor” matters, according to the guide, include “litigation for which the claimed amount is known, the insurance carrier has agreed to provide the defense, and the amount is covered by the association’s or co-op corporation’s insurance.”

Caton Towers appears to meet two of these three criteria. GNY has agreed to provide legal defense, and the corporation appears to have adequate insurance coverage – a $50 million umbrella policy, in addition to liability coverage, according to James Flaherty, director of management at Century Management Services, the co-op’s property manager since 1997.

Two out of three is pretty good, but the co-op lacks a critical piece of the puzzle. Through no fault of its own, the board is unaware how much money the three lawsuits hope to collect in damages. Without such numbers, there is no way to know with certainty if the co-op’s insurance is adequate. It’s a classic catch-22, and it was a deal-breaker for Fannie Mae.

“The bottom line is that we allow lenders to determine if litigation is minor,” says Fannie Mae spokesman Andrew Wilson. “At Caton Towers, the lenders determined it was not minor. The lenders asked us for a waiver of ineligibility. We declined to grant that waiver.”

Why?

The decision came about because the amount of damages sought is unknown. “The other factor is that there were some fairly serious injuries,” Wilson notes, adding that even in a case where serious injuries are involved, a lawsuit could still be classified as “minor” if all three of the criteria were met: legal counsel was appointed by the insurance company, the amount of damages sought was spelled out, and it was covered by the co-op’s insurance policy. He says that Fannie Mae’s decision to decline the waiver is not irreversible. “We’re always willing to take another look if circumstances change,” he says. “This decision is not a final decision.”

With that in mind, the co-op’s legal team is already working to get that decision reversed. “I’ve been advised by counsel that they’re going to try to get a specific damage demand, then take that to Fannie Mae, along with the fact that the co-op has a $50 million umbrella policy,” says board president Forte. “Whatever happens, we’re sufficiently insured.”

Many of those involved attribute Caton Towers’s woes to the close adherence to the letter of the law that Fannie Mae and Freddie Mac have practiced since they were placed under government conservatorship in 2008, during the subprime mortgage crisis and ensuing financial meltdown. Wilson, the Fannie Mae spokesman, says reality is not so simple.

“Yes, across the board, everyone in the mortgage industry has taken a look at their rules and statutes since 2008,” he says. “But I don’t think the Caton Towers case is part of that. Our guidelines used to say that if a building was in litigation, that was it; the loan wouldn’t be eligible for sale to Fannie Mae. Now, if the litigation is a minor matter, the loan is still eligible. We want to give the lender the leeway. We don’t want minor issues to impede loans being sold to Fannie Mae.”

Meanwhile, as the co-op’s attorneys work to get the litigation reclassified as “minor,” bringing Fannie Mae back into play and reviving the co-op’s stalled sales market, the three lawsuits continue their long grind through the machinery of the court system.