HOA Financial Matters: What's Receivership, and When Do Condo and Homeowner Associations Need It?
Though it's still rare in community associations, receivership has become more common in today's economy. With any luck, your HOA will never experience receivership. But some unlucky condo or homeowners associations will. So here are some basics on receivership, along with information about how it's arising in associations today.
Receivership—A Simple Concept
A receiver is a person or company appointed by a government entity, court, or other party to take over the day-to-day operation of an entity to do such things as pay bills, collect income, and schedule necessary repairs.
"A receiver stands in the shoes of the person or entity he's replacing," explains Mark Makower, a partner at Dickinson Wright PLLC, who specializes in association law in Bloomfield Hills, Mich. "In an association, the receiver would be functioning as the board of directors."
State laws for receiverships vary. Your state may have no provision for receivership in the statutes governing condo or homeowners associations, but there may be a general statute on receivership.
"In Florida, a receiver can be appointed to conduct the affairs of the association for condos and homeowners associations when the board can't muster a quorum, such as when it can't get three people to serve in a five-person board," says Bob Tankel, principal at Robert L. Tankel PA in Dunedin, Fla., a law firm that advises associations. "Any owner can make a demand and have a meeting to either elect or appoint a board, and after a certain number of days, the owner has a right to ask a court to appoint a receiver."
Michigan has a statute governing condos but no statute for subdivisions, says Makower. "Under our condo statute, receivers can be appointed to take control of units when owners are delinquent in assessments," he explains. "Then we have the general Revised Judicature Act, which allows appointment of receivers where it would be prudent or equitable to do so. You can get a receiver appointed if you can convince the judge it's proper. In Michigan, we almost never have receivership for associations, if at all. But banks use it a lot when they foreclose on condo and subdivision developments to operate the property while they're waiting for the development to be completed."
Michigan is a state hard-hit economically, and many of its associations are in severe distress. That doesn't, however, mean receivers will become more common. Instead, Makower expects insolvent associations to file for bankruptcy. "I have a few association clients on the verge of considering what they need to do because of the default in assessments, with delinquencies exceeding 60--65 percent," he explains. "Those associations can't continue to hit up the people who will pay or have paid, and they're really facing the point of no return. I expect sometime in the very near future we'll see our first few Chapter 11 reorganization bankruptcies largely to provide associations the time and lack of interference to restore their income base. That means they'll put a large assessment on the table because it's what's required, and they'll give people time to default, for banks to inject funds, or for units to be sold at much lower prices. A receivership doesn't cure those problems."
Receivers Grow in Florida
James Donnelly, president and CEO of Castle Group, a property management company in Plantation, Fla., that manages 55,000 association units, has run into receivers at properties his company manages. He says a growing occurrence in Florida is the appointment of a receiver to operate on behalf of an entire association to collect rent from delinquent owners.
"It's a relatively new development here, but several courts in Florida have approved receiverships for whole associations that allow the association to collect rents on investor-owned units that are paid to the receiver," he explains. "It's not that the receiver has taken over management of the entire association. But an investor may own a property where the monthly association maintenance fee is $300, and he's collecting monthly rent of $1,500. The investor takes the money and doesn't pay the mortgage or the association because the bank isn't going after him. And the association doesn't have a provision in its governing documents that allows it to demand that rents be paid to the association. That created an inequity because these investors were receiving rents but weren't paying their mortgage or association fees. One really smart lawyer figured out that the association could petition to have a receiver appointed to collect rent from those delinquent owners. As soon as that lawyer did it, others followed."
Receivership Grows in Arizona
Brian Lincks has seen receivers appointed three times recently in his work as vice president of City Property Management Co. in Phoenix, which oversees 260 associations. In each case, the developer defaulted in the middle of the development process, and the property became bank-owned. In two of the cases, the bank later failed and the development either fell into the hands of a new bank that purchased the failed bank, or it fell under the control of the Federal Deposit Insurance Corporation, which operates failed banks until they can be resold. In each case, Lincks had to fight to get the assessments paid, and he wasn't always successful.
In one case involving a town home development with 300 units in which only three units had been closed, the developer failed, and the bank took over. The bank then appointed a receiver to operate the development while it was being completed but argued that it wasn't required to pay assessments on the finished but unsold units because it didn't control the property—the receiver did. After a long battle, Lincks and a team of attorneys convinced the bank that while it had appointed a receiver to manage the property's day-to-day operations, the bank had always owned the property and must pay up. It did.
"When a developer has defaulted and the bank would be responsible for taking care of the obligations to the association, appointing a receiver is an angle to stall that process," says Lincks. "Sometimes receivers say they're working between the bank and the association until the bank officially takes control of the property. In other words, receivers are appointed in an effort to say that the lending institution that took the property isn't totally in control, and that's a deviation that allows them to say they don't need to pay assessments yet."
That wasn't the case with two other properties. In those cases, the developer's failure led to a bank takeover. But when those lenders also later failed, the FDIC took over those banks' assets and appointed receivers to operate the developments. The FDIC has so far successfully argued that it never owned the properties and refuses to pay the assessments.
The bottom line in Lincks' experience so far? "If the FDIC appoints receivers, there's no payment to the associations. That's a never-never land," he says. "But if the bank takes the asset and appoints the receiver, the bank has to pay the assessments."
All of the wrangling over who must pay assessments when a receiver is appointed can be especially painful for associations. In one of Lincks' developments, there were 210 total units, 72 were built, and, of those, 15 were still owned by the developer. The clubhouse, swimming pool, security gates were finished, but one last condo building and several small swimming pools hadn't been completed.
"We kept all those amenities open to attract a new developer to purchase the project," explains Lincks. "On top of that, to sell some of the units, the developer had given buyers an incentive of two years assessments, but those buyers didn't get that money in escrow. The most any owner got out of the developer was six months. The assessments were hovering at $200 a month, and they've gone up to $310 to cover expenses. In the end, we've been able to put money in reserves with what we'd call 'loose change' after other operating costs. We'll have almost $50,000 where there should have been $250,000 in reserves. The association is slowly limping along."
When a Receiver Can Resolve Disputes
It's common for attorneys to tell association members that if they can't get enough members to serve on the board, receivership may follow. "I threaten it in situations where the association can't elect a board because nobody will step forward to serve," says Makower. "I use it to combat apathy, saying, 'If nobody will serve, it'll be necessary to ask the court to appoint a receiver to do so.' Then they'll step up."
But receivers can also be necessary when warring factions can't agree on how an association should be run. "We've got a case where that's an issue now," says Matthew A. Drewes, a partner at Thomsen & Nybeck PA in Edina, Minn., who represents associations. "It's rare, but it may come about here. This particular case involves an inability of the association to agree on which faction of the membership is in control. It's a fairly small association, and some members have questions about the propriety of the election of certain board members."
Another problem is the association's financial well-being. "There's also an issue with the appropriate use of funds and their relative scarcity," says Drewes. "In addition, some decisions have to be made concerning indemnification of officers based on past decisions and ongoing litigation. Certain people have requested indemnification, and others within the association dispute their right to indemnification. Either the board's authority to direct those decisions isn't being recognized, or we have an issue where board members are uncomfortable making that decision. The parties may need to seek the appointment of someone to take charge of making those executive decisions at least for a period of time.
"It really is a Catch-22," adds Drewes. "We've got either a fight on who ought to be in control and/or a real grudge match about where certain limited resources should be allocated."
Though a receivership may be the best way to resolve the impasses at that association, Drewes isn't happy about it. "Asking to appoint a receiver to have someone make executive decisions in the stead of those who were elected to make them is probably not the best use of a receivership," he says. "More often it's something that should be considered where there's a question of allocation of finite financial resources or the association is in financial jeopardy because of the mismanagement or alleged mismanagement of the association."
Money Down the Drain?
The problem with receivers is that somebody needs to pay them, and they don't come cheap. "Courts appoint whomever they believe will be able to do the job," says Makower. "Generally they'll ask for recommendations from counsel, but what I'm seeing a lot on the bank end is that courts aren't appointing property management firms or people with that type of experience. They're appointing business reorganization firms or people who traditionally serve as receivers for troubled companies. You're paying a higher rate and getting less expertise. They don't know too much about what they're taking over. Everything is done through consultants and independent contractors, and they might even hire a property manager. So you pay market rates, you have increased reporting requirements because it's done through the court, and by the time you're done with all these requirements, you're raising your operating expenses exponentially."
Receivership is a "very painful and expensive process," says Tankel. "If a client came to me and said, 'I want a receiver appointed for a board,' I'd say, 'Why don't you spend the money you'd spend on me to conduct a political campaign to fill the board?' The receiver will do only what the court allows it to do and charge $150-$300 per hour while not necessarily having the best interest of the community at heart. It would be a tremendous burden and expense."