Managing Financially Distressed Communities In Pennsylvania Neil M. Hilkert, Esquire and Mary Ann Mulfino, CMCA Reidenbach & Associates, LLC

Managing Financially Distressed Communities

In Pennsylvania

Neil M. Hilkert, Esquire and Mary Ann Mulfino, CMCA

Reidenbach & Associates, LLC

We are in financially challenging times and no person, business or condominium association is immune from the effects of our distressed economy.

Community associations have seen an explosion of economic related issues in recent months adversely affecting the operation of their association.

Associations have unit owners failing to pay monthly assessments and increased unit foreclosure filings and budgetary issues are the main contributors to the Associations economic downfall.

Association boards can mitigate the effects of the primary financial issues in a distressed economy with the assistance and guidance of professionals – management and legal.

2MANAGING FINANCIALLY DISTRESSED COMMUNITIES IN PENNSYLVANIANeil M. Hilkert & Mary Ann Mulfino

Financially Challenging Times

• Usually when the progress in the development slows, claims against the Declarant mount from a number of parties including vendors, the municipality, lenders and unit owners.

• This creates and exacerbates financial and other stresses on the Declarant, the development, the Board and the Unit Owners.

• Frequently, the situation turns into a chain reaction causing problems in:

• collection of assessments;• increased rental of units;• financing for the purchase of a unit; • the refinancing by unit owners; and • frequently a decline in unit values.

• When the financial viability of the development and its completion is in jeopardy, available alternatives can be employed but all include a certain level of liability and risk of the Declarant and unit owners.

How the Problems Begin…


What are the Primary Causes?

Unemployment

Illness

Lack of understanding regarding obligations to Association

Developers unable to complete build-out

Decreasing equity in homes → foreclosure

Static income with increasing fees (aging communities)

THE ECONOMY


The sale of units in a condominium or planned community have slowed significantly in the past several years.

The real estate market decline has resulted in the inability of some developers to sell units to prospective homeowners that were not sold through pre-construction sales efforts, resulting in partially completed projects because of the financial challenges faced by the developer/Declarant.

When all units have not been sold, there is a negative impact on both the Declarant and the Unit Owners in the community.

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Sales Have Slowed

MANAGING FINANCIALLY DISTRESSED COMMUNITIES IN PENNSYLVANIANeil M. Hilkert & Mary Ann Mulfino

Impact of Failed or Incomplete Project

Another consideration for the Unit Owners residing in the planned community, and the degree of impact the failed or incomplete project will have depends on whether transition of control from declarant/developer to Association has occurred.

If transition has occurred, the unit’s owners through their elected Executive Board are now managing the day-to-day operations of the Association but the project may still be incomplete with units to be built, sold and amenities to be completed.

Even when transition has occurred, the unit owners face many challenges in satisfactorily completing the project as originally planned.

The best interests of the unit owners are further jeopardized when the Declarant has filed for bankruptcy protection, is being foreclosed upon by its lender or is in Receivership.


See §3302 and §5302 Adopt and amend bylaws, rules and regulations, budgets and collect

assessments Institute, defend or intervene in litigation. Enter into contracts and incur liabilities. Regulate the use, maintenance, repair, replacement and modification

of common elements. Grant easements, leases, licenses and concessions through or over

the common elements. Impose and receive any payments, fees or charges for the use, rental

or operation of the common elements. Impose charges for late payment of assessments. Impose reasonable charges for preparation and recordation of

amendments to the declaration, 3407/5407 resale certifications or statements of unpaid assessments.

Impose a capital improvement fee, but no other fees, on the resale or transfer of units.

Provide for the indemnification of its officers and executive board and maintain directors’ and officers’ liability insurance.

Assign its right to future income, including the right to receive the payments made on account of common expense assessments (except reserve funds).

Exercise all other powers that may be exercised by legal entities of the same type as the association. 7

Powers of the Association

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• The Pennsylvania Uniform Condominium Act (the “UCA”) and the Pennsylvania Uniform Planned Community Act (the “UPCA”) collectively (the “Acts”) provides that the condominium or planned community, collectively (the “Association(s)”) is created when the developer (the “Declarant”) complies with the Acts in creating and recording a declaration (the “Declaration”).

• The Act also provides that the control and management of the development transitions from Declarant to Association control when a specific number of units, typically 75%, are completed and sold to homeowners.

• If the Declarant cannot sell to prospective homeowners, the completion of the development itself and rights of the unit owners are stymied.

The Declarant

MANAGING FINANCIALLY DISTRESSED COMMUNITIES IN PENNSYLVANIANeil M. Hilkert & Mary Ann Mulfino

Special Declarant Rights

Rights reserved of the benefit of the Declarant - §3103 and §5103

• Protect the rights and property value of the Declarant

• Divide a Unit into 2 or more units.

• Maintain office(s) signs and model.

• Make the community subject to a Master Association.

• Appoint or remove an officer or a board member during the period of Declarant control.

• Use Easements through the common facilities or controlled facilities for the purpose of making improvements within the planned community.

• Special Declarant Rights are a commodity that can be sold, divided or shared.


Special Declarant Rights A Declarant has specially enumerated rights it can reserve which are

provided for in the Acts (see §3103 and §5103) called Special Declarant Rights (the “SDR”).

The SDR allows the Declarant to manage and control the Development in a manner unavailable to the owner of any single unit.

The SDR bolsters the Declarant’s ability to complete the development and to conduct a sales program whether during Declarant’s Control or after termination of Declarant Control.

The SDR can also be transferred and any successor to the Declarant could be subject to some, none or all of the SDR, depending on the agreement reached between the Declarant and the successor.

The document transferring SDR must specify which rights are being transferred, and whether any are being retained by the original declarant, or being shared.


A transferor is not relieved of its liabilities or warranties for its prior acts and, so long as it is unaffiliated with the transferee, it does not assume the risk for the transferee’s acts.

Special rules apply for units or additional real estate purchased at a foreclosure sale or via bankruptcy, and for lenders in possession.

A purchaser via bankruptcy or foreclosure may request and receive all SDR of the original declarant, or only the rights to sell and market units.

Special Declarant Rights cont’d …


Liabilities and Obligations of Successors

A successor to any SDR who is/isn’t an affiliate of Declarant is subject to all obligations and liabilities imposed on the transferor.

Until transferring, all SDRs to any person acquiring title to any unit owned by the successor or until recording an instrument permitting exercise of all those rights.

So long as a successor declarant may not exercise SDRs under the subsection he is not subject to any liability or obligation as a Declarant other than the successor’s acts or omissions.


Successor Declarant May Chose Which SDRs It Will Accept

In a case where Declarant’s construction loan mortgagee, foreclosing upon Declarant would typically include in the petition for relief the request for the deed to contain the selected SDR to be transferred.

An alternative available to the mortgagee, successor Declarant, is to simply act as custodian rather than assuming SDRs and thereby avoid liability of a Declarant.

In this scenario the mortgagee might foreclose and take over Declarant’s development and remaining units with the intent to sell them and pay down the mortgage debt while carefully avoiding liability as a Declarant pursuant to the Acts.

While certain rights might be retained by the Declarant because of the very limited rights acquired by the successor whether a mortgagee or other party, the retention of those rights by the original Declarant does not necessarily result in the obligations of the Declarant being satisfied and the needs of the development and its unit owners met. 13

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Another Scenario… Another scenario that could unfold is the Declarant deciding to terminate the

development and its Association.

If less than twenty percent (20%) of the Units have been sold, the Declarant can terminate the Association since it has the requisite number of votes to control the outcome.

Should the Declarant pursue termination the Association property would revert to a fee simple estate.

Each minority unit owner would have the right to occupy the portion of the real estate that formerly was defined as the unit purchased.

If the Declarant terminated the Association, unit owners could claim damages for the Declarant’s failure to proceed with a sales program as described in the Public Offering Statement.

Realistically speaking, a claim(s) against the Declarant could be difficult to pursue and realize any beneficial outcome.

Instead of termination the Declarant could postpone the completion of the development and sale of units.

A lengthy postponement could result in the expiration of Declarant control and association decision making and operation could be jeopardized if transition has not occurred. 14

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Auction or Fire Sale of Units The auction or fire sale of units appears as another alternative for

the Declarant or successor.

The sale of property in an auction or fire sale while possibly accomplishing the objective of the Declarant or the mortgagee in a foreclosure of raising funds while limiting or reducing costs, it can negatively impact existing Unit Owners.

These sales can result in the destruction of value of the existing units.

The distress sale can cause the homeowner to suffer an almost immediate loss of value on paper.

However, it can be argued that a market bottom for the unit(s) might be finally established by the sale with the opportunity for unit prices to stabilize.

It is also important to remember that unlike a successor to the Declarant, a purchaser usually takes none of the duties and responsibilities of the Declarant and the character of the development could be substantially changed when incomplete units are constructed with fewer features, lower cost materials and possibly a change is design.

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Receivership In light of all the possible options that could unfold in the distressed

development, perhaps the best option, other than a workout with the Declarant, would be Receivership.

In the case of Receivership, the lender has the right by statute and as provided in the mortgagee loan documents to institute a receivership proceeding following a material default of the development loan terms and conditions.

A Receivership is a court supervised proceeding which involves the hiring of a receiver to take control of the properties of the Declarant borrower.

Under this option, the lender incurs additional costs resulting from the court’s supervision, receiver’s charges, and in engaging new vendors to complete the project and sell the units.

The lender however, avoids the expense of foreclosure or a bankruptcy by the Declarant and never takes on the responsibility of a successor Declarant and therefore avoids liability as such.

Typically, the receiver has some expertise in completing the development and the sale of units thereby maintaining as much value as possible for the lender which can also inure to the benefit of unit owners.

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When the Declarant is experiencing financial difficulties that could impact the completion of the development all stakeholders need to understand the available options and the pros and cons of each.

The Declarant, successor Declarant, Declarant’s mortgagee, the Association, the individual Unit Owners all have a substantial financial interest in completing the project.

Frequently, the path to resolution is long, tedious, and usually results negatively on the value of the investment for the existing unit owners and the business success of the Declarant.

Declarant Experiencing Financial Difficulties


1. Failure to Make Building Repairs

2. Failure to Maintain Reasonable Reserves

3. Failure to Adopt Necessary Special Assessments

4. Failure to Review Association Financial Budgets

5. Failure to Promptly Collect Assessments

Common Causes of Financial Distress


Failure to Make Building Repairs

Associations tend to delay approving necessary expenditures for building maintenance and/or necessary building repairs due to the financial hardship it will impose upon unit owners in financial distress.

Failing to promptly make building repairs exposes the association to emergency expenses and increased repair costs.

The board has a fiduciary obligation to all unit owners to maintain, repair and, if necessary, replace the common elements of the building and must fulfill that obligation regardless of the condition of the economy.


Failure to Maintain Reasonable Reserves

One of the most common mistake the association make during difficult financial times is to freeze contributions to the reserve fund.

Associations do not raise assessments or adopt special assessments in order to maintain reasonable reserves.

Under Sections 3314(a), 3320(7), and 3407(a)(4-7) of the Pennsylvania Uniform Condominium Act (the “Act”), and 5314(a), 5320(7), and 5407(a)(4-7) of the Pennsylvania Uniform Planned Community Act (the “Community Act”) the board is required to maintain reasonable reserves for the association.

Budgets should always contain a line item for reasonable contributions to a reserve fund.


Keeping the Association Budget reasonable

Seek alternate forms of income to keep the fee from increasing

Bid out necessary services aggressively and appropriately

Find vendors who will work with the Association to allow for cash flow requirements

Reduce costs without affecting value or safety (energy efficiency or alternative providers, mulch schedules, bulk purchasing, etc.)

Is the reserve under-funded with the need to perform needed capital replacements> potential for loan options.


Failure to Adopt Necessary Special Assessments

Associations are typically reluctant to adopt special assessments during financially difficult times.

It is a mistake to delay implementing special assessments for necessary building maintenance and/or repairs due to the financial burden it will impose on its unit owners.

If the association's reserves are low or non-existent, and the need for a large capital repair project exists, special assessments should be adopted, despite the financial times.

Under Sections 3307(a), 3314(c) (§5307(a) & §5314 (c)) of the Acts, the board has the authority to repair, replace or restore the common elements and to adopt special assessments, if needed.

Empathizing with unit owners in financially difficult times, will create a domino effect of financially difficult times for the association.


Failure to Review Association Financial Statements

It is necessary to review monthly financial statements to ensure the association’s funds are being handled correctly and that the association is fiscally sound.

Responsibility for the economic welfare of the association rests with the Board.

The Board should be vigilant about reviewing the association's monthly financial statements.


Collection Assessments

In assessment collections, the goal should always be to recover all costs and attorneys fees incurred by the association, as well as the assessments, interests and late fees, using the clear entitlement to such collection under the state law and most governing documents.


Failure to Promptly Collect Overdue Assessments

A common mistake made by the association during difficult financial times, is to provide unit owners extra time to pay their assessments.

Giving unit owners extra time to pay their assessments creates an association in financial distress.

When the association does not get paid in a timely manner by the unit owners, the association’s financial obligations also do not get paid in a timely manner.

Collection policies should be enacted for delinquent assessments where legal action commences 60 days after assessments are past due.


Foreclosures By Mortgagee

Sometimes a unit owner fails to pay his or her mortgage (in addition to not paying assessments) and the mortgagee will file a foreclosure action against the unit in response.

In those situations, foreclosures may take nine to twelve months before the foreclosure action is complete and the lender is required to pay assessments.

It is important that an Association be diligent in collecting delinquent assessments before delinquent assessments pile up on a unit and become lost through a mortgage foreclosure.

Promptly direct your attorney to file an Appearance in the foreclosure litigation and Answer or Counterclaim in the event the unit's assessments are not current to protect the association's interests.

The board should promptly assert its rights in the foreclosure litigation as well as initiate collection of delinquent assessments to preserve their rights and protect the association's interests.


Contractual Obligation of Unit Owners

At the time of closing, when an individual purchases a condominium unit, he assents to the terms and conditions contained in the condominium/planned community documents.

The condominium/planned community documents created the arrangement.

Each unit owner is a member of the association.

The unit owners, as members of the association, elect an executive board which, among other things, is in charge of collecting the assessments, either voluntarily or by legal means.


Breach of Contract Action Against Unit Owner

Since the unit owner assents to the terms and conditions contained in the condominium documents, the association may file a breach of contract action against the unit owner.

Usually, the documents stipulate the unit owner must reimburse the association for the attorneys’ fees and costs associated with collecting unpaid assessments.

Under a breach of contract theory the association sues the unit owner personally and does not directly attack the unit owner’s interest in the unit itself.

This is a good way to obtain a Judgment against the delinquent unit owner.


Foreclosure Action Against the Unit

Under Section 3315 of the UCA (§5315 UPCA), the association has the right to foreclose on the unit owner’s lien in a mortgage foreclosure action.

Section 3315/5315 of the Acts provides that so long as the condominium association records the condominium declaration, the association has an unavoidable statutory lien for the unpaid assessments.

The purpose of the lien is to secure payment of the past due assessments.

Similar to the attorneys’ fee provision contained in the condominium documents, Section 3315 (§5315) specifically provides the association with the right to reimbursement for attorneys’ fees and costs incurred in the foreclosure action.


Foreclosure Case Example

In Gateway Towers Condominium Association v. Krohn, (Super. Ct. 2004), after failing to pay the monthly condominium fees assessed to the unit owner’s unit for several months, the association filed a mortgage foreclosure complaint under Section 3315/5315 of the Acts.

The unit owner did not dispute that he failed to pay the assessments and he did not contest the amount of the assessments therefore, the trial court granted the association’s Motion for Summary Judgment and the unit owner filed an appeal to the Pennsylvania Superior Court.

As part of his appeal, the unit owner argued the parties had contractually agreed that arrearages in assessments could only be resolved by a lawsuit of assumpsit (contract action), which by implication, precluded commencement of the mortgage foreclosure proceedings.


Foreclosure Case Example cont…

The Superior Court continued to note that nothing in the language of the condominium documents restricted the form of relief the association could take to recover unpaid assessments.

The Superior Court ultimately concluded the provision of the condominium documents allowing the association to bring a breach of contract action to recover unpaid assessments did not preclude the association from commencing a mortgage foreclosure proceeding.

In other words, although the association has the right to proceed against the unit owner through a breach of contract action, the association lawfully could also exercise its statutory right to foreclose on the lien provided by the Acts.


When to Write Off Bad Debt?

FHA statutory requirements→15% delinquent over 60 days.

Bankruptcy was discharged or foreclosure action completed and no personal assets.

Work with your auditor and attorney on the decision to write-off and make sure your Board makes a formal resolution to adopt.

Ask the question – can you sell your Association’s debt to a third party for a lump sum (portion of the debt balance).


UCA§ 3315 (UPCA§5315) Lien for Assessments Defined

The association has a lien on a unit for any assessment levied against that unit or fines imposed against its unit owner from the time the assessment or fine becomes due.

The association's lien may be foreclosed in like manner as a mortgage on real estate.

A judicial or other sale of the unit in execution of a common element lien or any other lien shall not affect the lien of a mortgage thereon,

except the mortgage for which the sale is being held, if the mortgage is or shall be prior to all other liens upon the same property except those liens identified in 42 Pa.C.S. § 8152(a) (relating to judicial sale as affecting lien of mortgage) and liens for condominium assessments created under this section.

Unless the declaration otherwise provides, fees, charges, late charges, fines and interest charged and reasonable costs and expenses of the association, including legal fees, incurred in connection with collection of any sums due the association by the unit owner or enforcement of the provisions of the declaration, bylaws, rules or regulations against the unit owner are enforceable as assessments under this section.

If an assessment is payable in installments and one or more installments is not paid when due, the entire outstanding balance of the assessment becomes effective as a lien from the due date of the delinquent installment.


PRIORITY OF LIEN

(A) GENERAL RULE - A lien under this section is prior to all other liens and encumbrances on a unit except:

i. Liens and encumbrances recorded before the recordation of the declaration.

ii. (a) Mortgages and deeds of trust on the unit securing first mortgage holders and recorded before the due date of the assessment, if the assessment is not payable in installments, or the due date of the unpaid installment, if the assessment is payable in installments.

Judgments obtained for obligations secured by mortgages or deeds of trust under clause (A).

iii. Liens for real estate taxes and other governmental assessments or charges against the unit.


(2) LIMITED NONDIVESTITURE - The association's lien for assessments shall be divested by a judicial sale of the unit:

i. As to unpaid common expense assessments made under sections 3314(b)/5314(b) (relating to assessments for common expenses) that come due during the six months immediately preceding the date of a judicial sale of a unit in an action to enforce collection of a lien against a unit.

ii. As to unpaid common expense assessments made under sections 3314(b)/5314(b) other than the six months assessment referred to in subparagraph (i), in the full amount of these unpaid assessments, whether or not the proceeds of the judicial sale are adequate to pay these assessments.

iii. To the extent the proceeds of the sale are sufficient to pay some or all of these additional assessments, after satisfaction in full of the costs of the judicial sale, and the liens and encumbrances of the types described in paragraph (1) and the unpaid common expense assessments that come due during the six-month period described in subparagraph (i), they shall be paid before any remaining proceeds may be paid to any other claimant, including the prior owner of the unit.

PRIORITY OF LIEN


Monetary ExemptionThe lien is not subject to the provisions of 42 Pa.C.S. § 8123 (relating to general monetary exemption).

(C) NOTICE AND PERFECTION OF LIEN - Subject to the provisions of subsection (b), recording of the declaration constitutes record notice and perfection of the lien.

(D) LIMITATION OF ACTIONS - A lien for unpaid assessments is extinguished unless proceedings to enforce the lien are instituted within three years after the assessments become payable.

(E) OTHER REMEDIES PRESERVED - Nothing in this section shall be construed to prohibit actions or suits to recover sums for which subsection (a) creates a lien or to prohibit an association from taking a deed in lieu of foreclosure.

(F) COSTS AND ATTORNEY'S FEES - A judgment or decree in any action or suit brought under this section shall include costs and reasonable attorney's fees for the prevailing party.


(G) STATEMENT OF UNPAID ASSESSMENTS - The association shall furnish to a unit owner upon written request a recordable statement setting forth the amount of unpaid assessments currently levied against his unit and any credits of surplus in favor of his unit pursuant to section 3313 (relating to surplus funds). The statement shall be furnished within ten business days after receipt of the request and is binding on the association, the executive board and every unit owner.

(H) APPLICATION OF PAYMENTS - Unless the declaration otherwise provides, any payment received by an association in connection with the lien under this section shall be applied first to any interest accrued by the association, then to any late fee, then to any costs and reasonable attorney fees incurred by the association in collection or enforcement and then to the delinquent assessment. The foregoing shall be applicable, notwithstanding any restrictive endorsement, designation or instructions placed on or accompanying a payment.

Monetary Exemption


Recap of What Managers Can Do During Financially

Distressed Times

Educate the Board to adopt a consistently enforced collection policy.

Educate the community about their obligations and the result of non-payment.

Pursue all delinquencies as soon as they occur and in keeping with the adopted policy and the Fair Debt Act requirements.

Work with owners on payment plans wherever possible – in writing with a consequence for failure to perform.

Work with legal counsel on collection cases to determine collectability (asset searches, rent garnishments, chattel sales, freezing accounts).

Protect the Association’s right to collect – if not now, then in the future.


Understand bankruptcy law and options. When can you file for relief?

If the unit is vacant – can you pursue a rent receivership?

Foreclosure – make certain to get the statutory 6 months. Can you ask for more?

When should the Association foreclose? Stop the bleeding and at what cost.

Does the Association offer an amnesty program? Delinquent homeowners pay the delinquent fees in a specified amount of time and late fees/legal costs are waived.

Know your options for collection when the Unit Owner is in Bankruptcy.

Cont’d Recap of What Managers Can Do During Financially

Distressed Times


Documents

Managing Financially Distressed Communities In Pennsylvania Neil M. Hilkert, Esquire and Mary Ann Mulfino, CMCA Reidenbach & Associates, LLC