Dealing with Lenders of a Defaulting Co-op Shareholder

By: Jay Hollander
Date: 1998

Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.

The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances.

Article

Ironically, despite a healthy economy and a real estate market increasingly perceived to be in full recovery as a result of spiraling rental costs, shareholder maintenance defaults in Coops continues to be a lingering problem.

As a result, Coop Boards' relationships with the lenders of these defaulting shareholders continues to require attention since it is often the most likely way Coops will receive outstanding maintenance arrears and additional rent such as the Corporation's legal fees.

The key to a Coop board's successful navigation of this issue starts with the insistence on a properly drawn recognition agreement, insuring that the Corporation has a first "lien" on the shares of the defaulting shareholder.

In basic terms, this Agreement protects the Coop in two ways: First, it insures that, in any foreclosure of the stock and lease by the lender, the Coop will be paid out of the proceeds before any other commercial or personal creditor. Second, and equally importantly, the typical recognition agreement provides that, following the default in maintenance by the shareholder, any lender which wishes to protect its position and its interest in its collateral, will have to "cure" the shareholder's default within a fixed period of time, or else the Coop will be free to cancel the stock and lease and sell or rent the apartment to someone else.

The upshot of this is that coops have an additional weapon or club to make sure that there is never a shortfall in maintenance for too long a time. Although it is not always instinctively remembered by boards or their managing agents, most coop recognition agreements provide for additional be sent to lenders under recognition agreements, mostly for the protection of the lender. The purpose of this extra notice, which is separate from any notice which is sent to the defaulting shareholder, is to afford the lender one last chance to protect its collateral (the stock and proprietary lease) before the coop cancels the stock and proprietary lease.

On the other hand, there are benefits to the coop board as well. Generally, loan agreements which cooperators sign with their lenders provide that any default by the cooperator/borrower in their obligations to the Coop under their proprietary lease, also constitute defaults under their loan agreement. As a result, shareholders late on their maintenance risk having their loans called if they don't promptly cure maintenance defaults.

Sometimes, the opposite occurs. Some cooperators who stop paying their maintenance have also already stopped paying their lenders on their share loans. Banks, being the large institutions that they are, however, may not have yet commenced any default proceedings against the cooperator. Boards who send recognition agreement notices provide a wake up call to these lenders and accelerate the process when they, the board will get their maintenance payments, either from the shareholder or the lender.

A diligent Board will monitor shareholder arrears and, despite short terms costs, quickly pursue those cooperators who do not prioritize their maintenance obligations through timely payment each month.

The benefits of this approach are at least two fold: First and foremost, it operates to reduce the chances of arrears accumulating to an unacceptable level. This is especially true when one considers the inevitable delays which Housing Court adds to the process, despite the recent introduction of a designated Coop/Condo part.

The second benefit of the approach is that overall collections improve once news gets out to all cooperators that the Board is serious about maintenance collections. This one-two punch of improving shareholder specific collections while simultaneously creating a climate in which all cooperators come to appreciate the need to prioritize their maintenance obligations to the Cooperative, is a powerful argument for cooperatives to implement such a policy.

Together with increasing its attention to communications with the lenders of defaulting shareholders, boards would do well to review their late fee policy to see what monies can be raised through late fees. While such fees are not enforceable if viewed as being punitive, coops are entitled to recoup reasonable amounts to recoup their expenses incurred in reasonable collection efforts maintained against defaulting shareholders. Such expenses would include, legal fees for preparation of preliminary notices and court papers, as well as court appearances.

Here, too, the presence of a lender is a boon to coops because these items of expense are normally characterized as "additional maintenance" in the coop's proprietary lease, and, accordingly, must be cured be cured by a lender together with all other items of outstanding maintenance.

How, exactly, do the sums get paid to the Coop by the lender? Generally, one of two ways. Some lenders will pay as they go, even while they commence proceedings to foreclose on their loan to the defaulting shareholder. Others will advise the coop that they are foreclosing and advise the coop that it will be paid at the foreclosure sale. While this last option does involve somewhat of a wait for the coop, depending upon the coop's overall health, it might be preferable to incurring further expense chasing a defaulting shareholder in the meantime.

After any foreclosure, a typical lender will continue to pay until such time as it has procured a bona fide individual to whom to sell the apartment, thus, giving the coop a new and presumably more financially responsible, shareholder.

But what happens if the Lender neither pays nor forecloses? This might be the case where, for example, the balance on the loan is more than the market value of the apartment.

In such cases, provided the coop gives the lender any appropriate notice called for under the recognition agreement, virtually all proprietary leases allow coops to foreclose on shares themselves.

Alternatively, the coop could evict the shareholder from possession of the unit and sublet the apartment for the shareholder's account, applying any collected funds first to defray current maintenance obligations and then, in reduction of past due arrears.

Either way, the presence of a lender does not unduly hamper the abilities of a Coop to deal with defaulting shareholders. On the other hand, when properly understood by a wise board of directors, the presence of a shareholder lender can give a coop a highly valuable additional resource to collect maintenance when the obligated shareholder defaults.

Copyright © Jay Hollander, 1998. All Rights Reserved.