When a Shareholder Is About to Default, Should the Co-op Buy the Apartment?

In those circumstances it is tempting for you to simply say no and let nature take its course. The lender presumably will begin foreclosure proceedings against the shareholder, and co-ops have the great advantage of getting paid past-due maintenance and other amounts from foreclosure sales before payments to the lender. So in this scenario, the co-op might decide to suffer the rest of its shareholders' subsidizing this shareholder's unpaid maintenance until the foreclosure sale proceeds are realized. At least the co-op would know that someday it will likely get paid in full.

The Terminator

In the meantime, the co-op should take steps to terminate the shareholder's lease, and to so notify the lender — as is usually required, but also to prod the lender to action. This also will benefit the co-op in case the shareholder is keeping current with payments to the lender but not to the co-op.
 
 The co-op purchasing the apartment gets far more tempting if the shareholder has no loan, or a loan that’s substantially less than the value of the apartment. In this case, you need to consider why the shareholder simply does not sell the apartment himself. If the co-op feels confident, however, that the price is a good deal (i.e., there is real potential for profit on resale, whether currently or in the future), then the co-op might ask few, if any, questions and simply proceed with the transaction.

If no lender is involved, the co-op might want to purchase the apartment. Even if the price reflects little discount from current market value, or current market conditions make it hard to evaluate the apartment, buying the unit will eliminate the need for the co-op to invest funds in taking legal action against the defaulting shareholder. It also allows the co-op the option, before trying to resell it, of renting the apartment for a period, which should yield a rental in excess of the maintenance due on the apartment.

Leave-Taking: Don't Take for Granted

This assumes that the shareholder will promptly vacate the apartment so that it can be prepared and shown for resale or rental. Co-ops should not take this for granted, or even accept the selling shareholder's assurances in this regard except under a properly structured and drafted agreement to this effect. In fact, your co-op should resist the temptation to save money by trying to do this transaction without legal counsel.
 
 Typically, for example, the selling shareholder will want or need to stop paying maintenance immediately, if he has not already stopped, but to remain in possession for at least a month or two to make arrangements to move elsewhere, and to clean out an apartment in which the shareholder may have resided for years. The co-op needs to deal with this carefully to avoid a protracted period without getting maintenance or rent.

One option is for the co-op to accept ownership of the apartment at the earliest possible date, and allow the then-former shareholder to stay in occupancy pursuant to an agreement that has serious consequences for the former shareholder if he does not vacate by certain date. If the co-op is paying a substantial amount for the apartment (even if discounted from market rate, as it should be), you can manage this by the deposit of all or a portion of the purchase price in an escrow account upon which the co-op can draw to compensate for lost rent and any costs of having to evict a former shareholder who does not vacate when agreed.
 
 I could go on from here about the details of the actual transfer of ownership from the shareholder to the co-op, and from the co-op to the new owner (assuming that the co-op chooses to sell instead of rent). Instead, just let me say that the co-op should purchase only with all of the protections standard for any other purchaser (e.g., securing a proper lien and judgment search to assure that the shareholder's lender and other creditors have no ongoing claims on the apartment), and should sell only after making sure that the purchaser receives information and documents about the financial and physical condition of the co-op.
 

Robert D. Tierman, a longtime co-op and condo attorney, is a partner at Litwin & Tierman.

From the December 2011 issue of Habitat magazine. For print-magazine articles back to 2002, join our Archive >>