Condos Win: Banks Lose

Written by Posted On Tuesday, 03 April 2018 13:30

A new case in the District offers good news to condo associations struggling with condo owners delinquent on their fees: It reinforces their right to foreclose on a unit without having to wait for the bank to do so first.

HOAs have lost money they desperately need to operate whenever they wait for banks to foreclose first. Other winners in the case are buyers looking to whisk up a foreclosed condo at a huge bargain. Losers are banks that are left without the right to foreclose first and unable to get back the money they loaned.

Back in May 2014, Andrea Liu bought a unit at the Sonata, a luxury condo building in Northwest Washington, at a foreclosure auction, paying $17,000 for an apartment that was valued around $700,000. The reason Liu got such a deal on the condo was because the previous owner stopped making mortgage payments and paying condo fees on the unit. Under D.C. condo law, condo associations have what is known as a six-month "super-priority" lien. If a unit owner stops paying fees to the association, the association can foreclose and get its money before anyone else, including the bank.

In mortgage law, a mortgage lender records a first deed of trust to establish its priority lien on a property. If the owner defaults, the lender can foreclose. If the first deed of trust holder forecloses, the rights of any other lien holders are usually wiped out - except super-priority liens, which can wipe out even the first deed of trust.

Because of this, most banks, when faced with a foreclosure by a condo association in the District, will often pay the condo association what it is owed to prevent the foreclosure.

In this case, U.S. Bank, which held the mortgage on the unit that Liu bought, tried to pay off the approximately $5,200 the owner owed in condo fees to the association. But it was one day too late. The foreclosure had already taken place. U.S. Bank then filed its own foreclosure action in the D.C. Superior Court against the original condo owner and included Liu in the lawsuit. Not long after U.S. Bank filed its suit, another case came before the D.C. Court of Appeals. In Chase Plaza vs. JP Morgan Chase Bank, the court held that a condominium association can extinguish a first deed of trust by foreclosing on its six-month super-priority lien.

In the Superior Court case, Liu argued that she purchased the condo at the foreclosure sale free and clear of U.S. Bank's mortgage. The Superior Court disagreed and found in favor of U.S. Bank. Among other reasons for the decision, the court said "it would be an inequitable windfall and contrary to the parties' expectations to permit Ms. Liu to disavow the bank's mortgage . . . and would impose an enormous foreclosure deficiency on (the previous owner) if Ms. Liu's purchase is not subject to the bank's lien."

On appeal in early March, the Court of Appeals reversed the Superior Court's decision, confirming that Liu was the property owner and did not have to pay U.S. Bank anything. Perhaps the most significant reason is found in this statement from the court's opinion: It is "the general and well-settled principle of foreclosure law that liens with lower priority are extinguished if a valid foreclosure sale yields proceeds insufficient to satisfy a higher-priority lien."

And the court made it clear that the District's six-month lien is such a higher-priority lien. That is why it is commonly referred to as a "super-priority" lien.

The high court also dismissed the lower court's suggestion that it was unfair for the bank to lose more than $800,000 while Liu got a windfall. The court pointed out that "although it may seem like Ms. Liu was able to procure the property for a relatively low amount of money through the foreclosure process, any concerns about this process are properly addressed through the legislative process."

It is important to note that the U.S. Bank case only deals with condo fees prior to April 7, 2017. The law was changed after that date, permitting condo associations to choose either to foreclose on the six-month super-priority lien, which would not be subject to any existing first deed of trust; or to foreclose for more than the six-month lien, but subject to any first deed of trust.

This is an evolving legal issue. The bottom line: While banks are historically reluctant to foreclose, condominium associations cannot wait to get money owed by a delinquent owner. The bank may be able to afford the loss, but the condo is dependent on everyone paying its fair share.

The super-priority lien is not unique to the District. Some 25 states, such as Alaska, Alabama, Nevada, Florida and Illinois, have similar laws. The Maryland legislature also adopted a modified form of lien. As of 2011, Maryland condominium associations have a four-month priority, but not to exceed $1,200. While other states (including the District) include such items as late fees, legal fees and special assessments in the computation of the delinquency, in Maryland the delinquency can only be based on the actual, unpaid regular assessment. Clearly, the banks had their way in Annapolis.

Bottom line: If banks don't want to lose money, they cannot wait to foreclose. While no one wants to wish a foreclosure on anyone, if a condo owner is delinquent and cannot pay the condo fee, that is impacting everyone else in the association. Many years ago, Fannie and Freddie - the secondary market for loans - required banks in states with super-priority liens to take prompt foreclosure action so as to protect their investment and their assets.

Clearly, U.S. Bank did not heed that advice.

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Benny L Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.

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