Co-op v. Condos: Cooperative Foreclosures: The Jungle of 'Non Judicial" Process
“Cooperative apartments are personal property, not real property. Accordingly, a contract for the sale of a cooperative apartment, in reality a sale of securities in a cooperative corporation, is governed by the Uniform Commercial Code. Where a cooperative tenant defaults on a security agreement which underlies a loan related to the purchase of shares in a cooperative, the remedies found in UCC article 9 are available to the lender."
If at first you feel the above quote sounds like an intimidating amount of information to comprehend at one time, you’re not alone—even the savviest real estate investors and attorneys can get lost in the jungle of Co-Op and Condo foreclosures.
Foreclosing on a co-operative apartment is a fundamentally different process than the processes employed to foreclose on a Condominium, or other forms of real property in New York State. Despite Condominiums and Co-Operatives both being Common Interest Communities—a design of people from like backgrounds, cultures and concerns to live amongst each other while sharing the shared expenses of their common demands– Condominiums and Cooperatives are no more identical twins than Arnold Schwarzenegger and Danny Devito.
Condominiums are multi-unit dwellings with privately owned residences and shared common areas. Condominiums are classified as real property, meaning that buyers own the deeds to their dwellings. The Condominium employs a Board of Managers to operate the daily operations of the condominium whose board rarely can justify interference with a condominiums owners right to buy, sell, alter, mortgage or otherwise affect its unit– subject to the limitations agreed upon by the unit owner at time of purchase. Generally, upon successful foreclosure, the mortgaging bank will be in first position to collect its indebtedness before the Board of Manager may seek to collect past due common charges.
Coops are not considered real property, but personal property. When you buy into a co-op, you become a shareholder in a corporation that owns the property. As a shareholder, you are entitled to exclusive use of a housing unit in the property. The Cooperative employs a Board of Directors to operate the daily operations of the Cooperative who reserve the right to approve or reject a potential sale of a Cooperative unit to a third party pursuant to the” Business Judgment Rule.” The business judgment rule provides that a Corporate board’s action is protected from challenge if there is a good business justification for the decision and it is in good faith and not fraudulent or an abuse of discretion.
In its simplest form, while a Cooperative Board can reject a potential buyer for no stated reason, a Condominium is under an affirmative obligation to justify why and for what reason a potential purchaser would be rejected.
As Condominiums are “real property”, actions relating to said real property are largely governed by the New York State Real Property Actions and Proceedings Law (“RPAPL”). In this instance, a Condominiums Board of Managers ability to foreclose on real property requires lengthy and expensive legal process resulting in a judicial decree awarding a Judgment of Foreclosure and Sale.
In contrast, as a Cooperative unit is considered personal property, foreclosure can be employed without resort to courts—resulting in a dramatically faster and cheaper process. The security interest in a Cooperative apartment is created under the Uniform Commercial Code (“U.C.C”). Under the U.C.C, a lender’s security interest is born upon the borrowers execution of a security agreement known as a U.C.C-1. Although not a mortgage, when properly recorded, the U.C.C-1 acts similarly, putting the world on notice that a lien exists against the unit, which secures the borrowers indebtedness. Because the security interest is born under the provisions of the U.C.C, the lender actions relating to the foreclosure of the condo are governed by U.C.C. Article 9.
Generally speaking, UCC Article 9 mandates two notices be served. First, the lender must serve the defaulting borrower with a reasonable authenticated notification of disposition ninety (90) days prior to the disposition/sale. Second, the lender must serve a notice at least ten (10) days before the actual sale. The statute also requires the lender to run a lien search on the unit in dispute between twenty (20) and thirty (30) days prior to the sending of the second notice. The substantive requirements of the respective notices be strictly complied with in addition to any additional notice requirements found in the borrower’s proprietary lease.
Moreover, contrary to the logic detailed above, the New York State legislature has codified that within three (3) business days of the ninety (90) day notice, the lender attorney must electronically file with the Department of Banking various information including but not limited to “the name, address, last known telephone number of the borrower, and the amount claimed as due and owing on the mortgage, and such other information as will enable the superintendent to ascertain the type of loan at issue.”
Generally, so long as the disposition is properly noticed, and sold in a commercially reasonable manner without a substantial discrepancy (which may indicate suspicious activity) a Court called to adjudicate the claims of a borrower who later challenges the lender or Board’s compliance with the statute, will likely uphold the sale at which time the Board of Managers is entitled to recover past due Maintenance and Legal Costs before a secondary obligor such as the lending bank may recover upon its lien.
Notably, because a lending bank generally maintains a lien secondary to that of the Board of Directors, the bank will often, as a method of protecting its security interest, pay any maintenance deficiency a borrower may have while simultaneously commencing its own unit foreclosure to avoid increased legal costs. Therefore, as a practical matter, the Board of Directors is encouraged to first correspond with the underlying lender to obtain payment of past due maintenance fees before commencing its own foreclosure.
Non Judicial Cooperative foreclosures governed under the U.C.C are much faster, easier, and less expensive than the traditional method of foreclosing upon Real property under the RPAPL—however Cooperative Boards and their respective management companies are urged to employ the attention of legal counsel to ensure the legislative protections built into the system as a safety net for the non-judicial process are strictly complied with.
After all—it’s still a jungle out there.