Fannie and Freddie Litigation Guidelines a Minefield for Condo Boards

When deciding whether to lend money to potential buyers or to unit-owners who want to refinance their mortgage in a condominium, lenders follow guidelines issued by federally backed Fannie Mae and Freddie Mac, which buy mortgages from lenders. Those guidelines were updated last year, and they contain a minefield of pitfalls for condo boards. One of the most treacherous is when a condominium is involved in litigation.

The guidelines essentially blacklist condominiums that are named as a party to pending litigation, as well as those whose developer is a party to pending litigation relating to the building’s safety, structural soundness, functional use, or habitability. Under the guidelines, it doesn’t matter if the condominium is the plaintiff or defendant. Even if the litigation could be financially beneficial, the condominium could still be blacklisted. 

There are exceptions. They include three types of litigation: when the amount of potential liability is known, and insurance covers both liability and the cost of defense; when the amount of potential liability is unknown, but an attorney letter is submitted explaining the reason for the litigation, and avowing that insurance will cover the cost of defense and any potential judgment; or when the litigation involves “minor matters.” Such matters include non-monetary and right-of-quiet-enjoyment disputes; a board’s action to foreclose or collect past-due common charges; and a board’s action seeking reimbursement for repairs that do not significantly affect the condominium’s financial stability or solvency.

If the litigation calls into question the condominium’s safety, structural soundness, functional use, or habitability, most lenders will deny lending. However, many lenders will, upon receiving a written opinion letter from counsel, rely upon New York City’s Department of Buildings' issuance of a permanent or even temporary certificate of occupancy as evidence of the condominium’s safety, structural soundness, functional use or habitability.

Since insurance coverage is an important factor in qualifying for one of the three exception categories, boards should take care to maintain comprehensive general liability and directors-and-officers coverage. And they should place their carriers on notice immediately upon becoming aware of a pending or threatened litigation. 

Boards should also take steps to resolve litigation quickly, and they should consider mediation or arbitration to prevent it, when possible. If the bylaws do not already contain a mandatory arbitration clause, boards should consider amending the bylaws to add such a clause so that disputes with unit-owners do not threaten the condominium’s lending viability. If a mandatory arbitration clause already exists, boards should enforce it. Additionally, property managers should be aware of the exceptions for “minor matters,” and they should add explanation on lender questionnaires if any pending litigation falls under one of those exceptions. 

If a lender blacklists a condominium because of pending litigation, it may reconsider based upon a written request for a waiver. The recent amendment to the guidelines provides that where an established condominium shows adequate collateral despite failing to strictly comply with the guidelines, further exceptions can be made. 

The Fannie Mae and Freddie Mac guidelines on litigation are a minefield. Condo boards and their attorneys and property managers need to become familiar with the guidelines – then watch their step.

Leni Morrison Cummins, a member of the law firm Cozen O’Connor, specializes in condominium and cooperative law. Rebecca Eschen, an associate at the firm, assisted in the preparation of this article.