Stuart Saft, Partner, Holland & Knight

I know how popular condominiums are these days, but when Bankers Trust vs. Pal was decided in the late 1980s, there were probably only 100 condos in the state of New York. Condo boards should be very aware and concerned about foreclosures and particularly non-paying unit-owners. I know this can be hard because the defaulting unit-owner may be your next-door neighbor, your best friend, or a fellow dog walker, but the reality is that you have to put friendship aside and deal with your fiduciary duty to all the unit-owners. You have find a way to get the common charges paid. In a down market, there will not be sufficient funds to do this – after the mortgage, the interest, and the default interest are paid. This is a major problem that arises out of Section 339-z of the Condominium Act and two cases, Bankers Trust vs. Pal and Bankers Trust vs. 900 Park Avenue.

This section of the act and the decisions in these two cases created huge problems for every condo board. Until either the decisions are reversed, which is unlikely, or  the Condominium Act is amended, which is also unlikely, these three items will be a huge impediment for condo boards when unit-owners default.

Section 339-z of the Condominium Act provides that the holders of first mortgages on the units have lien priority over the condominium. This means that when an owner stops paying and defaults, the apartment will be sold and the bank gets paid  first (principal interest, default interest, and fees, plus collection expenses). Since foreclosures in New York can take four to five years, the condominium will not be receiving common charges and assessments for this apartment – even if it's occupied – for quite some time, because of Section 339-z.

Before Bankers Trust vs Pal was decided, we were able to convince judges that in order to maintain the asset so that it could be sold at foreclosure and raise the maximum amount of money for all of the defaulting unit-owners, creditors, and the condominium, the board needed a way to collect its common charges. We argued that it was in everyone's best interest for the court to allow the condominium to collect use and occupancy charges from an occupant, or have the apartment rented if it was vacant and collect the use and occupancy charges from the new tenant.

Bankers Trust vs Pal involved a Park Avenue condominium in which a unit-owner leased his apartment for a substantial amount of money and did not pay $50,000 in common charges. After Bankers Trust began the lien foreclosure, the apartment was sold, but only for enough to repay the bank. The condominium received none of the common charges that had accrued over the years.

The condominium sued and lost in state Supreme Court. And so the condominium decided to take it up on appeal and they went to the First Department, which is Manhattan and the Bronx, and they lost again. They tried a third time and lost at the Court of Appeals level.

When they lost it Supreme Court, we – as their attorneys – tried to talk them out of appealing to the Appellate Division. When they lost at the First Department we tried to convince them not to go to the Court of Appeals because we could still bring an alternative case with a more sympathetic board in Brooklyn or Queens. But they refused. They went to the Court of Appeals, and it ruled against them. This is now the law in New York.

It's one thing if a single unit-owner defaults in a 300-unit building. But what we could see is a repeat of what happened about a decade and a half ago. In a bad enough recession, dozens of unit-owners defaulted and the banks separately foreclosed on the units, and the condominium is not getting 20, 30, 40 percent of its common charges while these foreclosures proceed.
Strangely, in situations like this, the lenders do not have their attorneys rush to foreclose as quickly as possible. So that slows the process down tremendously. There's nothing that the condominium board can do during the foreclosure, with one exception. And that can be and will be a huge problem.

What has to happen is that 339-z needs to be amended, and all of the condominium unit-owners who are reading this should immediately contact their assembly members and your state senators and have that done.

Other states have similar provisions, but they give the condominium boards either the ability to collect something towards the expense of operating the building or a six-month lien priority. But those are states where foreclosure can occur, and they have a power of sale built into their laws. The condominium can be foreclosed upon in a couple of months. In New York, we have an extremely complex practice to foreclose a mortgage which requires 13 separate motions. A contested foreclosure can last perhaps five years.

Now, if you’re on a board and you have one or more defaulting unit-owners, what you don't want to do is try to go into the foreclosure action and fight the lender. Because you will just generate tens of thousands of dollars of legal fees to slow  the foreclosure down and and not get satisfactory results.

The alternative course of action is to separately begin an action to have a receiver appointed to keep the apartment occupied – and for the receiver to pay use and occupancy charges that are not part of the foreclosure. The lenders can usually be convinced that this is really in their best interest, and because you were not involved in the original foreclosure action, there's less of a problem with Section 339-z because of the nature of the appointment of a receiver. And since the receiver is a court officer, the receiver can get the occupant to pay something toward operating expenses. This doesn't always work, but is far better than trying to fight the foreclosure.