Condo Sponsor Defaults: How to Prepare for a Chilling Possibility

Above all, veteran real estate observers agree, this is a time for boards to get aggressive. A "this-too-shall-pass" attitude is not an option. "The first thing to do is find out what kind of mortgage the sponsor has, who holds it, how big it is and if you can buy it," says attorney James Samson, a partner at Samson Fink & Dubow. "Also, find out if the real estate taxes are being paid. If not, that's real trouble. And find out if the sponsor's defaulting at other properties."

The most common and obvious sign that the sponsor is in dire straits is that it suddenly stops paying common charges and defaults. Study the offering plan, which must be amended periodically as long as apartments are selling, and look for a financial disclosure, which will tell you the amount of rental and common charges collected monthly, whether there's a surplus or shortfall, and whether or not sponsor apartments have been pledged as collateral for loans. Boards can also run a credit check on the sponsor.

"That [financial disclosure] gives you a way to evaluate the sponsor's cash flow," says attorney Steven Wagner, a partner at Wagner Davis. "It tells you how much is coming in and how much is going out."

Snowball in the Big Chill

The most likely cause of a reduced cash flow is that unsold apartments are suddenly having a hard time finding buyers. Without income from sales, the sponsor is suddenly squeezed, and this can have a snowball effect. "Developers who are having difficulty selling apartments still have to pay their construction loans and other expenses," says Wagner.

Sometimes, he notes, even when the sponsor is able to keep up with his debts, the lending institution may have a change of heart — or cash flow problems of its own. "If the lenders want out," Wagner says, "they're going to have to give the developer time to find a new lender. That can be a big problem" because borrowing money is no longer the breeze it used to be, even a few months ago. In the case of getting new financing for something as big as a half-finished condo tower, it can be downright harrowing.

"Of course," Wagner adds, "if the sponsor is in default [on a bank loan], the lender is under no obligation to give the sponsor time to do anything."

Policy No Evil

Under the New York State attorney general's Cooperative Policy Statement #6, co-op corporations and condo associations began receiving "special treatment" that expedites their takeover of a financially troubled sponsor's stake in a property. But the foreclosure process works much more slowly for condos than for co-ops.

Even if a condo board is able to purchase and sell a troubled sponsor's apartments at a profit, there are limits to Policy Statement #6. The attorney general cannot, for example, force the sponsor to meet his financial obligations. And if the board has not done its homework and foreseen the coming financial crunch, there's a strong possibility that the lending institution will start foreclosure proceedings and begin collecting rent on the sponsor's units instead of you.

"Aggressively fight the bank for the rents," Samson advises, noting that a sponsor is in default when he fails to pay common charges. "File the lien for the [sponsor's] unpaid common charges as soon as they stop showing up. Then you can start collecting the rent from the sponsor's units. Even if you can't get the rents, you can go to court and apply for reimbursement for the cost of providing essential services, such as heat and elevators."

In the opinion of attorney Stuart Saft, a partner at Dewey & LeBoeuf, it's usually wise to try to negotiate a settlement before hauling the sponsor into court. "A full-scale litigation against a sponsor will drag on for five years or more," he says. "It will cost hundreds of thousands of dollars — and you have no guarantee you'll be successful or that the sponsor will have any money to pay you."

Even if negotiations prove unsatisfactory, Saft believes boards should file a complaint with the enforcement bureau of the attorney general's office before filing a lawsuit. A lawsuit, he believes, should be a last resort.
"Boards have to be vigilant and prepared to act quickly," says Saft, because this chill is big.

Illustration by Danny Hellman

Adapted from Habitat December 2008. For the complete article and more, join our Archive >>