Fractured Condominiums in Florida: How Do We Pick Up the Pieces?

As lenders are faced with the decision of whether to foreclose on distressed Florida condominiums and investors evaluate the benefits and risks of purchasing such properties, there are a number of considerations which are unique to the condominium form of ownership and the regulatory requirements that govern condominiums. This alert provides a brief overview of the primary areas of concern that lenders and investors must consider when taking title to condominium projects in Florida.¹

Successor Developer Considerations

An investor or lender seeking to purchase units (or take back units in a foreclosure or deed in lieu of foreclosure) in distressed condominiums confronts a variety of questions when trying to determine how to structure the transaction in such a way as to maximize the benefits to the investor or lender. On June 1, 2010, Governor Charlie Crist signed Senate Bill 1196, a portion of which is entitled the Distressed Condominium Relief Act (the “Distressed Condo Act”), which is to be added to Chapter 718, the Condominium Act, as Part VII. The new law will take effect on July 1, 2010.

The new law creates two new categories of owners: bulk assignees and bulk buyers. Neither of these new categories of owners are considered developers and neither have warranty liabilities as to work that was done by a previous party. There are pros and cons to falling within each category, depending on the specific facts of the transaction which must be analyzed on a case-by-case basis. Among the issues to consider are:

• creation of a separate sole purpose entity to take title to shield parent entities from liability and evaluation of applicable “piercing corporate veil” law
• analysis of potential filing requirements with the Florida Division of Condominiums, Timeshares and Mobile Homes (there is no registration requirement for commercial condominiums)
• analysis of whether turnover of control of the association will be triggered by the transaction and how many seats on the board of directors will the investor or lender be able to control after turnover occurs
• analysis of whether there is an assessment guarantee still in effect and whether the investor or lender wishes to continue that guarantee
• analysis of potential warranty liability for any work to be completed by the bulk assignee or bulk buyer
• analysis of how bankruptcy courts may alter state law with respect to bulk assignee and bulk buyer issues

Disputes and Litigation Regarding Purchase and Sale Agreements

Individual unit purchasers attempting to cancel their real estate purchase contracts and receive their deposits back have spawned a flood of lawsuits and judicial decisions, both state and federal. Issues that should be considered include analysis of potential claims and rescission rights under the Florida Condominium Act, Florida securities law, Interstate Land Sales Full Disclosure Act and federal securities laws. The types of claims that are being brought by purchasers include the following:

• Florida Condominium Act Claims. Pursuant to the requirements of the Florida Condominium Act (the “Condo Act”), developers are required to distribute to purchasers any changes or modifications to the approved condominium documents within 10 days after the amendment is approved by the Division of Florida Land Sales Condominiums and Mobile Homes (the “Division”). (See Section 718.502(3) and Rule 61B-17.006(2), Florida Administrative Code). In accordance with the Condo Act, each purchaser has 15 days from the date of the purchaser’s receipt of the revised documents to review the amendment. Section 718.503(1)(a) provides that each purchaser has a 15-day right of rescission after receiving amended documents if the revisions are “material and adverse” to the purchaser. According to case law interpreting this standard, a change is considered “material” if a “reasonable buyer under the purchase agreement [would] find the change to be so significant that it would alter the buyer’s decision to enter into the contract.”² “An adverse change is contrary to one’s interests or welfare; unfavorable.”³ The burden is on the “rescinding party to prove that the change [is] both material and adverse ... .”⁴ The courts have also stated that the test is whether a reasonable buyer under the purchase agreement would find the change to be so significant that it would alter the buyer’s decision to enter into the contract. Other types of claims under the Condo Act being seen include false advertising claims under Section 718.507.
• Interstate Land Sales Full Disclosure Act Claims. All condominium projects in Florida must either be registered with U.S. Department of Housing and Urban Development (HUD) pursuant to the requirements under the Interstate Land Sales Full Disclosure Act (ILSA) or satisfy the requirements of one of the exemptions from registration under ILSA. There are a significant number of exemptions under ILSA, with the most common ones that condominium developers rely upon being the Improved Lot exemption, which generally requires the condominium unit to be delivered within two years from the date the purchaser executes the purchase and sale agreement, and the Fewer Than 100 Lot/Unit exemption, which exempts condominium projects from registration if the project has fewer than 100 condominium units.
• Other Types of Rescission Claims. There are currently many rescission claims based upon (i) common law claims for fraud, misrepresentation and breach of contract; (ii) alleged violations of the Deceptive and Unfair Trade Practices Act; (iii) alleged violations of out-of-state registration requirements (as to owners who reside outside of Florida); and (iv) alleged violations of state and federal securities laws.

Appointment of a Receiver

The foreclosing lender or prospective purchaser must interface with the receiver, if a receiver has been appointed, to facilitate a smooth transition from the original developer to the receiver with respect to the operation of the property and the condominium association. The Florida Condominium Act provides that the appointment of a receiver for the developer triggers turnover of control of the condominium association to the non-developer owners within the association unless the receiver is discharged within 30 days after such appointment or a court determines within 30 days after appointment of the receiver that transfer of control would be detrimental to the association or its members. This is certainly something worth considering prior to the appointment of a receiver as the lender or investor most likely will want to control the board of directors for as long as it can.

Another aspect of receivership is to consider whether the receivership is “passive” or “active.” In a passive receivership, the receiver was put in place to keep the lights on and to prevent further deterioration of the collateral. In these cases, the lenders are typically just trying to hold the project together so that it can complete a loan sale or transfer title after the foreclosure sale. An active receivership generally involves a receiver who is enhancing the value of the project such as one where incomplete units are finished and a marketing program is initiated. Sometimes lenders do not want to take title, so they obtain a court appointed receiver to finish construction and implement a sales program in addition to maintaining the condition of the project and get to foreclosure as quick as possible.

Collection of Assessments

A new section has been added to Chapter 718, which governs condominium associations, and Chapter 720, which governs homeowners associations, that gives associations a new tool in their fight to collect assessments from delinquent unit owners. This new law states that if a unit is occupied by a tenant and the owner is delinquent in paying any monetary obligation due to the association, the association may demand in writing that the tenant pay all future rents and other monetary obligations related to the home directly to the association. The association must provide written notice to the owner of the association’s demand on the tenant. The tenant must comply with such demand until the association releases the tenant or the tenant ceases to occupy the home. If the tenant fails to direct the required payment to the association, the association has the power to issue notices under Section 83.56 and may sue for eviction under Chapter 83 as if the association were a landlord under Part II of Chapter 83.⁵

Operating the Association and Condominium Regime

Since condominium regimes are creatures of state law, there are many technical requirements that must be satisfied in connection with the structuring and operation of a condominium regime and condominium association. Existing condominium documentation must be carefully reviewed to identify developer rights and obligations, developer guarantee and deficit funding status, whether budgets have been properly adopted and whether reserves have been properly collected or waived. Other matters that should be reviewed include the following:

• analysis of construction obligations (phasing, construction/building permits, demolition requirements for improvements not completed within certain timeframes)
• analysis of condominium documents to identify developer rights and obligations and potential areas where the condominium documents need to be amended to correct errors, account for changed facts or to face realities of the current market
• hold board of director elections and meetings and annual member meetings
• analysis and structuring of association budgets; holding budget meetings
• audit of the association records to provide the new owner with a full understanding of the status of the association’s finances, including identifying delinquencies and structuring a plan for correcting non-compliances to get the association to a point of financial stability
• whether turnover is triggered

Termination of a Condominium Regime

A viable alternative to becoming a bulk assignee or a bulk buyer is the elimination or termination of the existing condominium regime. Elimination of the condominium regime typically decreases ad valorem taxes and enhances marketability of a bulk property sale. This option must be implemented in strict accordance with state law and the requirements of the declaration of condominium for the project. When electing a strategy to implement, the lender should consider (i) all condominium termination issues, including creating a plan of termination, creating a buy-out and repurchase plan for interests of minority owners, conducting condominium association meetings regarding termination and operating the condominium regime as a tenancy-in-common post turnover, and (ii) due diligence on potential zoning issues regarding change in use, including confirming whether non-condominium use is acceptable in the applicable zoning category.

¹ All references to sections and chapters in this article refer to the Florida Statutes.

² D & T Props., Inc. v. Marina Grande Assoc., LLC, 985 So. 2d 43, 49 (Fla. 4th DCA 2008)

³ In re Suncoast Towers East Associates, 241 B.R. 476, 480 (S.D.Fla. 1999).

⁴ Id.

⁵ The association is not otherwise considered a landlord under Chapter 83 and specifically has no duties under Section 83.51.