Dealing with a Sponsor Default

The most significant problem in a sponsor's default is the sudden shortfall in the building's cash flow, which requires the non-defaulting owners to make up the difference. When the sponsor owns 75 percent of the units, this means that each non-defaulting unit-owner must pay four times the previous common charges.

Because the sale of the cooperative or condominium interests are subject to the jurisdiction of the attorney general, one way of dealing with the problem (prior to the sponsor's default triggering a general default and the loss of all of the unit-owners' equity in their homes), would be to file a complaint with the AG. Unfortunately, the AG cannot force the sponsor to find funds to meet his obligations, and usually, by the time the unit-owners and the AG learn of the situation, the sponsor's lenders have taken over the sponsor's interest in the unsold units.

Although the condominium is, in many ways, better off than a cooperative sponsor defaulting — because there is no mortgage on the building and everyone pays his or her own real estate taxes — the lender does not have to complete the building according to the offering plan, does not have to sell unsold units and does not have to pay common charges until it actually takes ownership of the units. It is therefore incumbent on the board to act quickly and decisively.

Move Quickly

The board should quickly place a common charge lien against the unsold condominium units to protect your interests in the event the mortgagee does foreclose. This way, the condominium is next to line to be paid, and would be reimbursed from any excess proceeds of the foreclosure sale.

Alternatively, if the lien was not in excess of the property's value, the board can foreclose the lien and sell the apartment, subject to the mortgage. If the lender's lien is significantly greater than the value of the unit, you should begin a lien foreclosure action and seek to have a receiver appointed to rent the unit or collect use and occupancy charges from a non-paying occupant and pay the common charges to the board, rather than the lender, in order to preserve the value of the unit.

A board should never proceed with a foreclosure of its common charge lien, since you'll always come behind the lender and will not receive any money until the bank is fully paid. Since a foreclosure in New York involves 13 separate motions and is a very expensive task, you could be spending tens of thousands of dollars with no hope of recovery. Neither does it generally work to sue the sponsor, since the it may be only a paper entity with no assets, designed to shield the sponsor from personal liability.

Finally, open discussions with the lender to convince it to finish the building and sell the unsold units, which will be worth more if the building is completed and operating. Threatening the lender is not a good way to open that negotiation. Alternatively, if the building is finished, the board could also negotiate to buy the unsold units from the lender at a discount and then rent them until the market improves.

Regardless of your approach, let your owners know what you are doing, maintain open lines of communication, and seek their advice. This is a very difficult situation, and fighting with your residents while attempting to deal with the overall situation is not a good idea. The board should focus on solving the problem without antagonizing the unit-owners. Good advice, by the way, in any situation.

Stuart Saft is a partner at Dewey & LeBoeuf.

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