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To foreclose or not to foreclose? That is the question for many condominium associations
by: Rob Samouce
A new appellate court case out of the other coast of Florida calls for us to revisit the issue of whether a condominium association should foreclose on a delinquent unit owner when the owner is also delinquent on his first mortgage.

In the case of Aventura Management, LLC v. Spiaggia Ocean Condominium Association, Inc., 38 Fla. L. Weekly D 190 (3rd DCA 2013) decided on Jan. 23, 2013, the appellate court found that because the association foreclosed and obtained title of the unit before the first mortgagee bank foreclosed, the subsequent purchaser at the bank foreclosure sale would not owe any of the prior delinquent assessments owed to the association on the unit from the delinquent original owner that the association foreclosed on. The court referred to Section 718.116(1)(a), Florida Statutes which provides that: “a unit owner is jointly and severally liable with the previous owner for all unpaid assessments that came due up to the time of transfer of title.”

So when the association took title to the unit in its foreclosure sale, it became liable for the delinquent assessments of the previous original owner. The association did not pay the delinquent assessments to itself. Therefore, when the subsequent purchaser took title at the bank foreclosure, it had a joint and several claims against the association for the assessments the association did not pay to itself. So the “previous owner” to the subsequent purchaser at the bank foreclosure sale was the association and not the original delinquent owner.

Since the association did not collect the assessments from its previous delinquent original owner, the subsequent purchaser at the bank foreclosure sale did not owe anything to its previous owner of title; the association.

The association, being an intervening owner between the original delinquent owner and the subsequent purchaser at the bank foreclosure, severed any liability of the subsequent bank foreclosure purchase owing any of the original delinquent owner’s delinquent assessments to the association.

This new ruling is pretty close to what the greater majority of Florida law firms already believed the law is so the ruling is not that surprising. However, it was not unusual for many first mortgagees in their foreclosures to pay the association their safe harbor amount of at least the last 12 months of assessments or 1 percent of the original mortgage debt, whichever is less and if the mortgagee failed to name the association in its foreclosure, the full amount of what was due, regardless of whether the association had taken title or not.

Now, where the association has already foreclosed on its delinquent owner and has taken title to the unit, the first mortgagee or purchaser at the first mortgagee’s foreclosure sale, where the association has previously purchased the unit at its own foreclosure sale, may now refuse to make any payment to the association.

In deciding whether to foreclose on an association’s delinquent assessments before the bank does, the board will still have to make many of the same case by case decision that the board had to make before the ruling in the Aventura case.

The first question the board has to address is whether the board believes that it will recoup sufficient amounts through the rental of the unit to offset the past due assessments owed, as well as the costs and attorney’s fees incurred in the foreclosure, and if not, will that amount at least offset the loss of the 12 months of assessments or 1 percent of the mortgage, whichever is less?

Next the board will need to consider whether the first mortgage holder has started its foreclosure and estimate how long its foreclosure might last.

The final consideration is whether or not the unit’s equity is close enough that a short sale might be possible to pay the past due assessments, costs and attorney’s fees. In addition, the board may still desire to use the foreclosure process to encourage a unit owner to pay but may decide to hold off moving forward with obtaining title to the unit.

The final reason that boards might decide to foreclose still remains. There will still be times when the board is willing to foreclose on an owner just to get that owner out of the community. That will still hold true in spite of the Aventura decision.

Although it would appear that the Aventura case may be harmful to associations in Florida, it really is what most attorneys thought was the state of the law. If the association takes title to a unit through its own foreclosure, it may not receive any additional funds from a subsequent purchaser at the first mortgagee’s subsequent foreclosure sale.

There has been some chatter from a few attorneys in Florida, who regularly practice in this area, that the best way to avoid the Aventura decision and try to get all the assessments (if the association wants to go ahead and foreclose its lien before the first mortgagee forecloses) is for the association to purchase the unit in a wholly owned limited liability corporation (LLC). However, there are many important issues that should be considered before an association decides to go the LLC route in search of assessments.

The first of these issues is that Chapter 718, Florida Statutes does not provide any authority for a condominium association to set up and establish an LLC. Since the statutes do not provide such authority, at a minimum the Declaration, Articles of Incorporation or Bylaws would have to grant such power to the condominium association. As the governing documents do not usually provide for such authority, a membership approved amendment to the documents granting such authority would be required.

The question that also has to be asked would be whether or not all of the legal work and all of the costs of setting up this LLC would be a proper common expense of the association. Again, it appears that at the bare minimum that an additional amendment would be required to justify such expenses.

There are also some additional tax questions that need to be answered by the association’s CPA regarding how to handle the books and records of the single owner LLC. Although your CPA might find that a single owner LLC usually does not have to file a separate tax return, if the LLC is considered a “disregarded” entity, the LLC would have to run its own parallel set of complete books to comply with Generally Accepted Accounting Principles (GAAP) and this would add a material burden to the association’s accounting and bookkeeping functions in order to comply with GAAP, and presumably additional costs.

Another potential issue with operating a single member LLC is the potential for piercing the corporate veil of the LLC. There have been changes in the Florida statutes over the last couple of years regarding a creditor’s ability to go after the assets of a single member LLC. There are also potential issues regarding the undercapitalization of the LLC and the fact that the LLC will be the entity that “sells” the unit to the buyer after the foreclosure sale and the intimate nature of the decisions that are being made by the association’s board of directors, which will be the same board of directors that will be demanding payment of the past due assessments from this new buyer. Obviously since that entity will be jointly and severally liable for the assessments due on the property, that entity will not be able to hold but one unit for its life. That will be a very expensive method of trying to avoid a loss of some assessments.

If there is a mixing of the association’s funds and the LLC’s funds, then the alleged subsequent purchaser debtor would have a much easier time at the piercing of the LLC’s veil to get to the association’s assets. At that point the association is right back to where it would be under the Aventura decision.

Then we come to the potential costs of the operation of the LLC. As a separate entity, the LLC would need separate directors and officers’ insurance, separate liability insurance and separate fidelity bonding. The association’s insurance could not cover the LLC or it would be another good reason to pierce the corporate veil between the two entities.

In addition to separate insurance, to avoid veil piercing and avoid violation of the co-mingling statute, the LLC would require separate bank accounts which would incur monthly banking fees, require monthly reconciliation and would require separate accounting by the CPA.

On top of the additional CPA fees, which will make the accountants happy, most likely there will need to be additional management fees going to the management company under a separate agreement. Once again, if the management company were to handle the operation of the LLC (record keeping, bookkeeping, rentals, record keeping and letter writing on behalf of the landlord, etc.), under the association’s contract with the management company, this would simply act to be an additional commingling item that could be considered by the court in piercing the corporate veil.

Next we get into the potential problems that the association might have in the LLC’s purchase of the unit at the association’s foreclosure sale. Once the LLC takes title, it is responsible for all past due assessments on the unit. In addition, that liability will include any assessments that come due while the LLC is the owner. If a buyer purchases the property at the first mortgagee’s foreclosure sale, then that purchaser, along with the LLC, is jointly and severally responsible for all assessments that were due up until that point.

The association, even without the potential piercing issues, may then be liable for a breach of fiduciary duty to the new owner (the buyer from the LLC) for the association’s failure to bring suit against its own LLC for the LLC’s failure to pay those assessments. Obviously, the board cannot show favoritism to its own wholly owned LLC. Once again, there would appear to be many more issues than the expense of setting up the LLC would be worth.

The joint and several liability of the LLC would almost seem to force the association into creating a new LLC with each and every unit that the association is going to foreclose. That in and of itself would seem to require costs of creation, attorney’s fees, corporate fees, insurance costs, management costs and all the other costs that may not justify the creation of an LLC. The overall expense of the LLC for each foreclosure may not be justified by the return, not to mention the potential litigation that might be involved. All of these costs surely might benefit the law firm that is recommending them much more than they may benefit the association.

As can be seen from some of these examples, the cost of trying to avoid the Aventura decision may be much more expensive than the cost of compliance and the liability risks associated with the LLC scheme are great. Rather than going down this risky and expensive LLC path, the association should be fully informed when making its decision on proceeding on a case-by-case basis with whether to complete “its own” foreclosure before the bank does.

No matter what anyone thinks about the Aventura case, its impact on Florida law will probably be short lived. Last year a bill was introduced in the Legislature, which never got out of committee that would have clarified this section of the statute. That bill would have provided that the purchaser from the first mortgagee would not have owed these amounts, thus supporting the majority decision. The draftsman of the original statute is the drafter of this revised provision and he never intended for there to be a carry-over of the old assessments obligation to the new purchaser at the foreclosure sale. We might see that provision again in a bill this year in the Legislature and the Aventura decision might help that bill to get through committee this year. We will have to wait and see, but if such legislation does not pass this session, any LLC creations may really have been a waste of time and money as such entities would stand no better than the association.
Rob Samouce, a principal attorney in the Naples law firm of Samouce, Murrell, & Gal, P.A., concentrates his practice in the areas of community associations including condominium, cooperative and homeowners' associations, real estate transactions, closings and related mortgage law, general business law, estate planning, construction defect litigation and general civil litigation. This column is not based on specific legal advice to anyone and is based on principles subject to change from time to time. Those persons interested in specific legal advice on topics discussed in this column should consult competent legal counsel.