Homeowners' Association Collections - Bankrupt Owner

I have advised several homeowners' associations recently who are being told by an owner that the owner's obligation to pay assessments has been discharged in bankruptcy.  The HOAs are worried about fulfilling their duty to the association's membership to collect revenues without running afoul of a bankruptcy discharge.

The most common form of bankruptcy an owner will file is a Chapter 7, which typically culminates in the owner receiving a "discharge" or release of pre-filing unsecured debts.  There are intricacies to the bankruptcy process that are outside the scope of this post, but assuming the owner still owns the property that is the subject of the assessments after filing bankruptcy, the bankruptcy will not discharge assessments coming due after the date of filing bankruptcy.  This means the HOA may still collect from the owner those assessments made after the date of the owner's bankruptcy filing.  The HOA will want to work with legal counsel to determine the timing of collection and the amount that can be collected to avoid violating bankruptcy laws.

Some owners will go into bankruptcy and, despite still holding legal title to the property in the HOA, will "walk away" from the property.  In most HOAs the fact an owner has abandoned the property will not absolve the owner of his or her obligation to pay assessments.  Likewise, it will not affect that HOA's lien for assessments.  As with all such matters, a careful review of the covenants of the HOA is the first step in pursuing a collection.

The lien on the property is usually not affected by bankruptcy, but that does not mean enforcement of the lien is the most effective means of collecting past-due assessments.  The lien will usually be subordinate to a first mortgage, so the possibility of collection through foreclosure of the lien is curtailed.  The lien is still useful to have and a notice should be recorded, as it will help ensure payment of the past-due assessments in the event of a sale.

Often the best alternative for collection is a suit directly against the owner, leaving the lien and the property out of it.  Although the owner may not have a lot of assets after the bankruptcy, the owner will also not have a lot of unsecured creditors competing for the owner's income, because they will have lost their rights in bankruptcy.  In any event, a judgment awarded after bankruptcy can survive for years and will not be subject to discharge in a future bankruptcy, because debtors are precluded from filing serial bankruptcies under existing law.

With a thoughtful approach and good legal advice, an HOA has good alternatives for collecting past-due assessments from owners who have gone through bankruptcy.  In a time when more and more people are defaulting on obligations, it is a board's duty to be aware of and to pursue the available means of collection.

Beware: Adverse Possession Risk Lingers After Sale of Property

So you are selling a property and a neighbor may have an adverse possession claim.  After closing, that claim is the buyer's problem, right?

Wrong.

The Washington Supreme Court recently reminded property owners of that conclusion in its decision in Edmonson v. Popchoi, 172 Wn.2d 272 (2011).

In Washington, the most common form of deed - the deed that is required by most purchase and sale agreement forms - is the "statutory warranty deed," defined in RCW 64.04.030.  Among the statutory warranties flowing from that form of deed is the warranty that the grantor (seller) will "defend the title" to the the property "against all persons who may lawfully claim the same."  Since an adverse possessor is a lawful claimant, a seller warrants against adverse possession claims.  Because the obligation to defend is based on a written contract (the deed), the obligation lasts for the duration of the six-year statute of limitations for written contracts.

Popchoi purchased property from Kiss with the intent to remove an existing structure and build a new single-family home.  Prior to completing the purchase, Popchoi had the property surveyed and the survey showed an encroachment on the property by a fence owned by Edmonson, a neighbor.  Popchoi did not disclose the encroachment to Kiss and went ahead with his purchase from Kiss.  Kiss gave Popchoi a statutory warranty deed.

When Popchoi began construction, the neighbor sued for adverse possession.  Popchoi contacted Kiss and demanded that Kiss defend the claim.  Kiss agreed, on the condition that Kiss have the sole right to control the disposition of the claim.  Kiss intended to concede the neighbor's claim and simply pay damages to Popchoi, because to do so would less expensive than defending the claim.

Popchoi rejected Kiss' offer and proceeded to defend the claim on his own.  Edmonson prevailed on a summary judgment.  Popchoi then asserted a damage claim against Kiss and the trial court ordered Kiss to pay the value of 165 square feet lost to Edmonson and $30,281.90 in attorney fees incurred by Popchoi in the defense of the claim.   The attorney fees award was almost three times the value of the land.  Kiss appealed the attorney fee award, which was affirmed by the Court of Appeals.

The Supreme Court affirmed the award of attorney fees, holding that the statutory warranty deed imposes upon the grantor a duty to undertake a good faith defense of the claim.  The Court held that Kiss breached that duty by conditioning his offer to defend on the ability to immediately concede the claim and pay damages.  Put another way, Kiss had to litigate the claim.

Importantly, the Court rejected the argument that the buyer waived the deed warranties as to the adverse possession claim by closing with knowledge of the adverse possession issue.  Even a buyer with knowledge of a potential claim can rely on the deed warranties.

In summary, the case teaches:

• That the deed warranties include a warranty that buyer will not have to suffer or defend an adverse possession claim for the six years following closing;
• That the duty to defend title means just that - the seller must actually defend the claim, or pay the costs of a defense, in addition to compensating for any lost property.

Further, sellers should not rely on the title insurance policy they purchase for the buyer at closing.  Standard title policies do not cover issues of adverse possession that are not a matter of record.  Extended title policies are available with such coverage, but may be prohibitively expensive and need to be reviewed by counsel to assure the coverage is adequate.

Sellers need not live in fear, however.  With the help of effective legal counsel, a seller can identify known risks and expressly disclaim and allocate those risks, either in the deed or in a properly-drafted addendum to a purchase and sale agreement.  This process should be part of nearly all real estate transactions and is well worth it, because it is the only effective way of managing a seller's risk after closing.

- Ryan D. White

Planning for the Coming Shortage: Conversion Condominiums

As of the end of 2011, approximately 3,010 apartment units in 17 projects were under construction in Seattle, according to the Downtown Seattle Association.  Zero condominium projects were reported to be under construction at that time.  Simultaneously, even bearish sources like the popular blog Seattle Bubble are reporting near-record-low inventories of homes on the market.

While there are myriad reasons to believe the housing market is not yet in a true recovery, there are indications that a recovery is on the way.  The statistics above suggest that when a recovery does occur we may quickly see a strong seller's market for condominiums, while simultaneously experiencing a glut in the multifamily rental market.  While those statistics relate to King County, there is no reason to expect the trend is much different in other urban areas in Western Washington.  In such a scenario, conversion condominiums may be the answer.The Washington Condominium Act (RCW 64.34) allows for conversion of existing buildings (of all kinds, not just multifamily residential), but places special restrictions on conversions, especially with regard to residential properties.  For instance, there are special notice obligations the owner owes to any existing tenants in the property, which are set forth in RCW 64.34.440.  Notices must be given at least 120 days in advance.  Existing residential tenants also have a right of first refusal on the unit they occupy.  A declarant may also be required to pay relocation assistance.

Further, owners often make improvements to units prior to offering them for sale, because purchasers typically have higher finish expectations than renters.  However, owners who have made improvements to a condominium prior to sale will be subject to the implied warranties of quality set forth in the Act, as to any such improvements.  Accordingly, an owner intending to proceed with a conversion ought to be careful in choosing and contracting with contractors to ensure those contractors are providing a sufficient quality of work and making warranties consistent with the owner's warranties to the purchasers.

Approached without care the conversion process can offer substantial pitfalls.  However, if the future dearth of condominium units suggested by some statistics comes to pass, the process will also offer a great opportunity for profit.

- Ryan D. White

Priority of Condo Association Liens

The six months of condominium association assessments immediately preceding foreclosure of the association's lien have priority over the lien of an owner's lender (RCW 64.34.364), an advantage recently affirmed by the Washington Court of Appeals in Summerhill Village Homeowners Association v. Roughley.

Summerhill involved a condominium in Issaquah.  When the owner fell behind on her assessments, the association filed a foreclosure action, served the lender and the owner and recorded a lis pendens against the property.  The owner and the lender failed to respond and the association was granted a default judgment.  The association then proceeded with a foreclosure sale.  Following the sale, the lender's successor moved to intervene in the association's action and asked the trial court to void the sale, which the court declined to do.  The court ruled that the lender was not entitled to redeem the property and had lost its mortgage in the sale.  The lender appealed the decision, but the Court of Appeals affirmed the trial court.

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Today even good buildings face delinquencies.

The decision is noteworthy in that it affirmed both the association's lien priority over a mortgagee and that such a lender may not redeem the property (i.e. buy it back by paying off the new owner).  It highlights the robust rights of newer condominium associations to recover unpaid assessments, which rights are increasingly important in this post-bubble world.

Associations should note that the super priority lien is only available to those condominiums formed after July 1, 1990 (i.e. "New Act" condominiums) or those condominiums formed prior to that date that have amended their declarations and opted in to the new priority scheme.  Accordingly, an association should carefully consider amending its declaration to take advantage of the super priority available under the Condominium Act.

Lien foreclosure is not a universal solution, however.  The limited six-month reach of the lien priority and the lack of interested buyers at a foreclosure sale can undermine the association's effort to recover by way of a foreclosure.  Accordingly, associations should consult with counsel and carefully consider their options before pursuing any kind of collection.

- Ryan D. White

Successfully Negotiating Commercial Loans

Intelligent borrowing is a critical element of becoming a successful real estate investor.  Whether the investment property is a multifamily development, such as an apartment building, or a commercial office building, having the right loan can make the difference between a project that generates a robust stream of income for its owner and one that risks becoming a liability for the borrower and, potentially, the lender.

What some owners do not realize is that commercial loans and the tens or hundreds of pages of documents that comprise the loan agreements are not take-it-or-leave-it transactions.  Tailoring an agreement to suit the needs of the particular borrower, bank and property will benefit all parties, because it helps to prevent default and conflict, which can destabilize the building, scare off tenants and threaten the profits of both lender and owner.

With that in mind, below are some of the most commonly negotiated categories of loan terms, in my experience, in no particular order:

• Grace period and notice requirements before a default may be declared;
• Borrower warranties and disclosures regarding the condition of the property (these should reflect actual known conditions, rather than simply warranting an absolute absence of defects);
• Borrower warranties regarding the financial condition of borrower (failure to tailor these warranties may result in additional non-recourse liability for the borrower);
• Applicable law, jurisdiction and venue for any disputes;
• Ongoing financial reporting requirements, which can have a tremendous effect on the cost of the loan to the borrower;
• Prepayment penalties and what constitutes "prepayment";
• The initial and renewal terms of the loan, including conditions for extending the maturity date;
• How rents are handled and by whom;
• Due-on-sale provisions, including defining what constitutes a prohibited sale;
• Debt service coverage ratio ("DSCR") requirements;
• What constitutes an event of default;
• Allocation of expenses related to closing and servicing the loan.

This is not an exhaustive list, but is intended to provide examples of areas within the loan documents that may be worthy of special attention.  Of course, once you have identified areas requiring specific attention, you will want to negotiate modifications and draft revisions in such a way that they will satisfy the needs of each side, without causing undue conflict.  A skilled attorney will be invaluable in that process.

- Ryan D. White