Second Legal Alert

You probably don’t need me to tell you that these are difficult times. And community associations are not immune from the financial storms that are rattling the windows of consumers, businesses and government offices from one end of the economy to the other.

Managing association finances -- never an easy task in the best of times – becomes even more challenging and possibly overwhelming as homeowners, struggling with financial problems of their own, fall behind on their common area fees and, in increasing numbers, lose their homes to foreclosure.

Association boards responsible for governing their communities must find ways to keep budgets balanced, maintain essential services and protect property values, even as the normal revenue stream from common area fees is disrupted. When budgets are already tight, even a small decline in anticipated revues can have a large impact.

The financial pressures boards are confronting may be more severe than most board members have seen in their tenures, and possibly in their lifetimes. But the strategies for dealing with them are no different than the strategies used by any household facing hard times: Find ways to reduce expenditures, increase revenues, or both.

Economic Basics Apply

Of course, those tasks are more challenging for boards dealing with dozens and possibly hundreds of households, but the principles are the same. The first step for a board, as for a household, is to take a good, hard, realistic look at the association’s finances. The review should focus on delinquent payments, because that is where problems are likely to arise. The more effectively associations control delinquencies, the more likely they are to avoid severe financial problems. You can be hopeful that conditions may improve and owners who have fallen behind will be able to catch up. But hope is not a strategy. It is certainly no substitute for an effective and consistently applied collections policy, which offers the best hope of keeping the association’s finances on a relatively even keel.

Communities in states that have a “super lien” provision in their condominium laws (Massachusetts and Rhode Island are two of them) can expect to recover at least six months of unpaid condominium fees either from delinquent owners or from lenders that foreclose on them. The Massachusetts statute includes attorney’s fees and the legal costs related to the collection effort under its super lien umbrella, increasing the amount communities can count on recovering. Associations in Rhode Island can recover up to $2,500.00 in legal fees and $7,500 in costs.

This gives boards a powerful collection weapon; they can foreclose on a delinquent owner and force the sale of the unit, knowing they will collect the amount protected by the super lien before the mortgage lender enforces its lien and collects the amount due under the mortgage. But the statutory protection is helpful only if communities keep delinquent payments within the six-month super lien window; let the delinquency ride for nine months, and the association may have to write off three months of fees.

To protect association revenues, we usually recommend that they turn over delinquent accounts to their attorney for collection after 60 days; in the current environment, some communities are initiating collection actions after 45 days, to be certain that delinquent payments remain within the super lien limit. The important point for boards is to stay on top of the association’s delinquencies, and make sure you apply payments to a delinquent owner’s account to the oldest charges first, because those will be first to fall out of the super lien basket.

A Time to Negotiate

Associations without the super lien backstop have a more difficult collection task and are more likely to face severe financial problems in an economic downturn, as communities in New Hampshire (which has no super lien statute) can attest. Initiating a foreclosure action against delinquent owners doesn’t always help, because if the lender forecloses on the unit, the association collects only if funds remain after the mortgage is satisfied, which is never assured in good times, but highly unlikely today. For these communities, negotiating repayment plans with delinquent owners is the best strategy. The hope of collecting even a small portion of the money owed is a much better prospect than the likelihood of collecting nothing at all after a foreclosure.

Communities with super lien protection might also want to be more receptive to repayment negotiations with owners than many of them tend to be. The housing rescue plan President Obama announced recently encourages all lenders (and may require some of them) to restructure the loans of struggling homeowners to help them avoid foreclosure. If lenders are restructuring loans for owners, the courts may expect community associations to follow suit. As a result, boards may find some judges less willing to approve association –initiated foreclosure sales in the future than they have been in the past. If lenders are bending, boards may find it more difficult to take a hard line. Strategically, they may have to demonstrate that they have at least tried to negotiate a repayment plan with owners before moving to foreclose on them.

Loan modification discussions may or may not prevent foreclosures for individual owners, but they will almost certainly delay the foreclosure process. Associations with super liens will still be able to enforce them (unless courts in large numbers begin to resist), but the collection process will almost certainly take much longer. This suggests the first entry on our list of suggested strategies for community associations:

	Anticipate cash flow problems. The certainty that the association will eventually collect all the money it is owed won’t help pay its bills today. Boards should budget for these shortfalls. Look at the association’s historical delinquency rate and double it in your revenue calculations. That’s probably a conservative estimate; as we have seen delinquencies more than triple in the past 18 months. Also double the amount of time you usually expect to collect delinquent payments from financial institutions. Banks aren’t rushing to foreclose, because once they own the units, they are required to pay their share of the common area expenses. TO delay that reckoning, some banks are actually forcing associations to initiate foreclosures and then t sue the banks to collect the delinquent payments that banks in super lien states are required to pay.
	Be proactive. Denial is not a river in Egypt and in the sand is not where the board’s head should be. Face the association’s problems squarely and immediately; don’t wait until you’re down to the last dollar in your operating account before you begin discussing how you’re going to pay the association’s bills. You don’t have to wait until the next annual meeting to recast the budget; if it’s clear the numbers aren’t working, rethink the budget now.
	Develop a strategy for filling the revenue gap the association faces. On the revenue side, your primary options include:

	Increasing common area fees – never popular, but possibly necessary.
	Levying a special assessment – another means of compensating for delinquent payments, but bear in mind that the super lien covers only common fees; it does not include special assessments.
	Obtaining a bank loan. The super lien provides sufficient security for lenders, who will use common area fees as collateral for the loan. Associations in states lacking the super lien may have more trouble obtaining bank financing.

On the expense side, look for reasonable ways to cut costs. Set spending priorities. Consider delaying capital expenditures you were planning to undertake this year. You can’t forego essential services – snow removal and heating oil deliveries – but you may be able to renegotiate contracts with vendors. Consider reducing the lawn-mowing schedule or foregoing the planting of spring flowers. The landscaping improvements you were planning may have to wait another year. If your community hasn’t converted to energy-efficient lighting, this may be a good time to consider that move. You may want to consider opening the swimming pool later than usual this season, or perhaps, not opening it at all. These choices won’t be easy or popular, but they may be necessary

	Be creative. If ever there was a time to think outside the box, this is it. A New York condominium converted unused space in its basement to storage cubicles, which the association then rented to owners. It makes sense to look for ways to cut expenses, but don’t overlook the prospect of increasing revenues as well.
	Don’t slash and burn. You can’t avoid tough choices, but you can make sure they aren’t short-sighted. An example: Deferring essential maintenance. Repairing the roof will be expensive, but less costly than dealing with water damage in multiple units and the possibility of a mold problem resulting from it. Firing the management company also ranks high in the penny-wise, pound-foolish category. Eliminating the management fee will save a lot of money, but it will also remove the expertise and experienced hands the association probably needs to guide it through a difficult environment.
	Bankruptcy is not an option. Facing seemingly overwhelming financial problems, some associations in other parts of the country (none in this area, as far as we know) have contemplated seeking bankruptcy protection or asking a court to appoint a receiver for the community. You don’t want to go down either of those roads. For one thing, it is not clear that non-incorporated associations can file for bankruptcy. Even if that option were feasible, it wouldn’t be desirable. What prospective purchaser would knowingly purchase a unit in an association under a bankruptcy umbrella? Foreclosed units would remain unsold; financially strapped owners trying to sell their units to avoid foreclosure, increasing the likelihood that they, too, would become delinquent in their payments, exacerbating the association’s problems. Voluntary receivership – asking a court to appoint a receiver to run the community – is equally undesirable, and for similar reasons. No one wants to buy a unit in a community operating under receivership. And it’s hardly a plus for owners to relinquish control of their community to a receiver. Far better for the board, elected by owners, to decide how to allocate the community’s resources. A special assessment or dues increase ordered by the board won’t feel good; but an increase or assessment mandated by a court-appointed receiver will feel awful!
	Include owners in the decision-making process. This is probably the most important point for boards. You’re going to have to make difficult decisions; don’t make them in a vacuum. . Communicate with owners. Explain the financial pressures the community is facing and let them weigh in on the options the board is considering. Special assessment, fee increase, or bank loan? Close the pool or cut back on landscaping? If owners have agreed in advance to cut back on lawn service, they are less likely to start screaming at the board w hen the grass begins to turn brown. Savvy politicians will tell you, “Don’t waste a crisis.” This financial crisis may give boards an opportunity to solve a problem that has plagued common interest ownership communities from their inception: How to engage residents actively in the governance of the communities they own.

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