When HOAs are Bankrupt or in Foreclosure Text Size:

Recently, more and more property owners are being forced into bankruptcy because of mounting debts and high mortgage payments. Also, property foreclosures are at an all-time high. And, it's not just individual owners who are taking the hit.

Homeowners' associations (HOAs), and the real estate projects they're created for, like a condominium complex or subdivision, can fall into bankruptcy and foreclosure as well. If you're a member of an HOA, you need to know some of things that can happen when HOAs are bankrupt or in foreclosure.

"Distress"

A real estate project is considered to be "in distress" if there's been a default or non-payment on the project's financing, such as a mortgage, and:

• The lender either forecloses the mortgage, or takes advantage of some other remedy or enforcement mechanism that the mortgage gives to it, like "accelerating" the debt and making the whole balance due immediately, or
• The creditor and debtor agree to a "workout" that settles the default

Generally, the lender will enforce the loan or agree to a workout within 60 to 90 days after the borrower's default.

Who's the Property Owner-Borrower?

Typically, a developer will take out a mortgage that will enable it to buy the land for the project, create an HOA, build homes or condos, and then sell them as they're completed. Often, the developer is part of and controls the HOA. In some instances, the developer will transfer ownership of the project, primarily the "common areas" that the HOA has the responsibility to maintain, to the HOA after the project is complete.

There are, of course, other possibilities. Nonetheless, in most instances, there is a mortgage on HOA property, other than the personal mortgages that individual condo or home owners might have taken out to purchase their homes.

Bankruptcy

There are three primary types of bankruptcies:

• Chapter 7, where the debtor's assets are "liquidated" or sold and the money is used to pay creditors
• Chapter 11, which allows a business to "reorganize" its debts and pay them over time while continuing its business operations
• Chapter 13, where an individual borrower comes up with a plan to pay off creditors over a period of time, usually between three to five years

Regardless of which bankruptcy the HOA or developer files, the court can order that the land be sold, and the creditor will have lien against the money made. The buyer will typically be bound by the project's declaration of covenants, conditions and restrictions (CC& Rs) to continue the project as an HOA project.

In addition, in any bankruptcy, the debtor can reject or keep unexpired leases and other kinds of contracts. Often, there are many leases and agreements that are vital to the success of the project. For example, unit owners might have the right to use adjoining property where a recreational facility or parking garage is located because the developer executed a long-term lease for that land. If that lease is rejected in the bankruptcy, the unit owners will lose access to those amenities.

Similarly, it's possible that the CC&Rs could be rejected on the ground that they're a contract. So, if a developer-controlled HOA files for bankruptcy and rejects the CC&Rs, it could result in each unit owner's loss of the right to use the common areas and facilities owned by the HOA, and possibly permit those areas and facilities to be used for some other purpose, like some commercial use.

With respect to HOAs, the bankruptcy laws in this area are uncertain. So, if you're connected with a developer or HOA that has filed for bankruptcy consider contacting a bankruptcy or real estate attorney as soon as possible, to find out what your rights are and how to protect them.

Foreclosure

Like any property owner with a mortgage, a developer or HOA can be subject to foreclosure, which is when the bank or mortgage company takes the property that secures the loan and then sells it. In some states, the creditor can use non-judicial foreclosure, which, generally, allows it sell the property at auction without a court order. In most states, the lender must go through the judicial foreclosure, which requires the bank to give the HOA/developer a chance to pay the default. If it's not paid, the bank has to get a court order allowing it to sell the property.

Generally, a foreclosure can be stopped immediately by paying what's owed to the lender. There are some defenses to a foreclosure action, too, such as:

• Lack of good faith by the lender or "predatory lending," such as lending the developer more money than it can repay
• The lender failed to honor its commitment to provide funds to the HOA/developer
• The lender's excessive late charges and default interest amount to an invalid, unenforceable penalty

The foreclosure laws vary by state, so look at the laws in your area carefully if you're in a foreclosure.

Workouts

A "workout" may be as simple as the lender's agreement to reinstate the loan upon the developer's payment of all prior arrears, or it may involve the more drastic step of the developer's deeding the entire project to the lender in exchange for the lender's agreement not to foreclose. Some common workouts include:

• Extension of the loan's due date
• Forbearance, or suspension, of interest in exchange for additional collateral from the HOA/developer
• Interest rate reduction
• The lender takes some equity ownership in the property in exchange for some of the debt

Generally, lenders would rather agree to a workout than have to go through the process of starting to foreclose and then defending its rights to the property when the HOA/developer files for bankruptcy. So, if you're in a tight position, you shouldn't hesitate to ask your lender for a workout.

Questions for Your Attorney

• If the developer of our condominium complex goes into foreclosure, can we, the HOA, bid on the property? Can we make a special assessment to raise purchase money?
• Can a lender use non-judicial foreclosure in this state?
• The developer of our condominium complex just filed for bankruptcy. Apparently, he wasn't paying some of the complex's bills, such as sewer fees and garbage collection. The HOA said that it will have to discontinue these services unless we agree to a special assessment. Do we have any other option? Can't we make the developer pay?

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