the CFM Distinction

Thursday, August 5, 2010

Is the lifeblood of the association bleeding out?

The association lives on assessments. Many CID’s are facing major financial difficulties due to the failure of a high percentage of members to pay their monthly obligation. Late fees are assessed, interest calculated, and notices of delinquency mailed. At some point the account is sent to a collection firm or attorney to begin the process of preparing an assessment lien.

All of these actions are based on the CC&R’s, Delinquency Control Policy and California Civil Code. The management team should implement the policy of the board in the timely application of each step of collection of the assessment.

Now, under Civil Code section 1367.1 (c) (2), any lien recorded on or after January 1, 2006 requires a decision by the board of directors. “The board shall approve the decision by a majority vote of the board members in an open meeting. The board shall record the vote in the minutes of the meeting.”

After the recording of the lien, what happens? Following the recording of the lien, it may be enforced by any manner permitted by law. This may include Judicial Foreclosure or Non-Judicial Foreclosure.

Many boards are reluctant to take this next step. This reluctance is due to both misinformation and prudence. There are pros and cons to foreclosure which must be considered by the board before taking this action.




Ultimately, the goal of the board is to have the owner pay what is owed to the association. If the notices and lien have not caused the owner to do something about their debt to the association, will the threat of foreclosure? If the owner is facing financial ruin including the inability to make their mortgage payments, they probably will not be moved by a threat of foreclosure by the board.


The association is always in second place to the first deed of trust. Depending on the date of the filing of the assessment lien, the association could be in third or fourth position behind a second loan or line of credit. All of this information goes into the decision process when contemplating the next step on behalf of the association.

If the first deed of trust holder has filed an NOD (Notice of Default), the company providing collection services for the association may be reluctant or unwilling to proceed with an action on behalf of the association.

This has become a major problem for associations at this time. The lenders are taking their foreclosure off the calendar, meaning that they are delaying their action, and the association is left with a non-paying unit or lot and unable to proceed themselves.

Why do the lenders fail to continue their foreclosure action? Their borrower is not paying the mortgage and you would think they want to get them out of the property and find a paying customer. If they foreclose without a buyer ready and available, the bank becomes responsible for the assessments, taxes and insurance. If the property is in a project with a high number of delinquent accounts, there may not be a market for the unit at this time.

Another issue is that the lender does not want to recognize the loss on their books. If they foreclose, they are taking back the unit/lot in lieu of their mortgage and very often must sell the property for much less than the book value of the loan.

One opinion on this issue comes from a loan broker I spoke to in Marin. He feels that the lenders were caught flat footed by the mortgage meltdown and do not have the trained personnel to deal with the volume of foreclosures. According to this source, who by the way is my step-son and mortgage broker, the lenders are buried under an avalanche of defaults. Their foreclosure department has neither the time nor training to proceed in an expeditious manner.

So why can’t the association foreclose its lien, rent out the unit, and use the rental income to cover the assessments, taxes and insurance until the bank gets off its duff and takes action? Great idea, but illegal. California Civil Code section 890 (a) (1) “Rent Skimming” means using revenue received from the rental of a unit or home at any time during the first year period after acquiring that property without first applying the revenue to the payments due on all mortgages and deeds of trust encumbering that property.

In this case, the association is left with three options:

1) Do nothing! Wait for the bank to foreclose its loan.
In this case, the association may have recourse to get a money judgment against the prior owner and garnish their wages or file the judgment in any county where the owner has assets.
2) Foreclose the association’s lien, wait one year, and then rent the unit or home out and use that money to pay assessments, taxes and insurance.
3) Foreclose the association’s lien, contact the lender, and try to make a
deal with the lender to avoid “Rent Skimming”. Get them to agree that
the association will rent out the unit, maintain it, pay the insurance and
taxes and apply what is remaining to the assessments, and any thing
left over goes to the lender. This agreement should be immortalized in
writing with the help of the association’s attorney.

Another thought is that if there is a second deed of trust or line of credit which was taken out after the association’s lien was filed, they are in jeopardy from both the first deed of trust holder and the association. If the association files an NOD, that may force the holder of the second to come forward.

If the association decides to move ahead with their foreclosure, consideration as to the type of foreclosure must be taken. The association may use judicial or non-judicial foreclosure. There are pros and cons to both methods as follows:



Non-Judicial Foreclosure

Pros

1) Cheap, quick and relatively easy.

Cons

1) If there are no bidders on the court house steps and the owner does not step forward to “save” the property from foreclosure, the association will become the owner of the property.
2) The association can’t rent the property for one year from taking title unless they want to turn over the rents to the lender, or try to negotiate sharing rents with the lender.
3) The association has pursued a remedy and cannot seek a money judgment against the prior owner due to the one action rule.

Judicial Foreclosure

Pros

1) A judge and court are involved in the process and give protection to the association’s action. This is very important when there is a question of title or a high equity balance in the property.
2) There is a possibility of not only selling the unit or lot, but getting a judgment against the owner if the proceeds are insufficient to cover the amount owed to the association. This is especially true if the unit was owned by an investor who has other properties and assets.

Cons

1) Expensive, slow, and requires legal counsel.
2) After getting a judgment from the court, you still have to either sell the unit or lot, or try to collect from the debtor.
3) There is a redemption period of up to one year following the sale during which the prior owner can pay what is owed and redeem their unit/lot. This can put quite a damper on any potential purchaser of the unit or lot.

Let’s assume that the association filed their assessment lien, waited out the time and the lender foreclosed. This action by lender has now wiped out the association’s lien as it applies to the property, but has no effect on the personal debt owed by the prior owner.

The association should determine if the owner is worth pursuing in small claims or other civil courts. Are they investors who have other assets to be attached? Do they have wages to be garnished? If this was the sole residence of this owner, very likely they have just lost their one major asset and have nothing to go after. On the other hand, if they were investors and own property in other areas, the association may well want to seek a money judgment in either Small Claims Court or Municipal Court and file that judgment in any county where that individual or company owns assets.

Remember the limitation for small claims action. The association can only seek to recover two claims per calendar year of $2500 or more not to exceed $5000 each.

If the accounts receivable exceeds $5000, the board must consider the cost related to hiring an attorney and paying court costs if they want to seek a judgment in municipal court.

Remember the old adage, “He who screams loudest, gets his way”? Don’t let this be the description for your collection policy. Many boards are being harassed by delinquent owners to “take them out of collection”. The board needs to prepare a defense made up of their fiduciary duty to protect the assets of the association and their duty to treat all owners on a fair and equitable basis.

Once the account is in collection, the board should refer the owner to that agency when they have questions or demands. If the owner requests a “Meet and Confer”, the board must agree. That doesn’t mean that the assigned board member must sit through three hours of weeping, wailing and cajoling.

Set a board policy for all Meet and Confer sessions.
1) They are to be held within _____ days of the receipt of the written
request for the hearing.
2) They are to be no more than 30 minutes.
3) The owner will be allowed 15 minutes to present their issues.
4) The board will take 5 minutes to question or clarify any issues necessary.
5) The owner will then have 10 minutes of rebuttal or closing argument time.


After all avenues of collection have been utilized, and a decision of the board has been reached that no further action should be taken in the attempt to collect the past due amounts, a motion of the board should be made to “write off’ the bad debt. This is a bookkeeping process which removes the balance from the books and records of the association as an active balance of accounts receivable.

This action does not mean that in the future, if this party were to win the State lottery, the association can’t seek collection via their judgment if they did not foreclose their lien.

The amount written off is charged to a Bad Debt Expense or against the Allowance for Bad Debt on the balance sheet.

At each year end, the CPA for the association should analyze the accounts receivable and create an Allowance for Bad Debt which is a contra-account on the balance sheet. This account is the estimate of how much of the total accounts receivable may not be collected.

Another way that this account is created is during the budget process and accounting year end actions. During the budget process, the accounts receivable should be analyzed to create assumptions as to the probability of assessments being paid by the membership in the next fiscal or calendar year. If the association has been experiencing a 10% delinquency they should create a line item in the budget for expected delinquencies in the next year.

The net effect of this line item is that it increases the assessments to all owners to cover those who are failing to pay their fair share. This may seem unfair to all the owners who do pay on time each year, but you must remember that this is a non-profit association and the budget comes down to a zero each year. That means that if 10% of the membership fails to pay their assessments, 10% of the expenses can’t be paid.

Bad debt expense is not the same as Allowance for Bad Debt. Bad Debt Expense is related to the assessments and other charges billed in that year only. At the end of the year, if you have not written off the balances from accounts receivable, but still have a probability of not collecting those amounts, you should debit the Bad Debt Expense and credit the Allowance for Bad Debt to maintain that probability.

Work with your association manager, collection agency, and CPA to make sure all of these issues are properly recorded, and that all delinquencies are pursued with the intent to collect what is owed to the association in a timely manner. We can only hope the tide will change in the next few years so we can have a new ‘hot topic’ to discuss in the HOA industry. Until then, stay the course and adhere to your policies!

1 comment:

  1. Thank you for the post. Another problem in foreclosed properties problem is that the large number of cases that feature sketchy documentation presented by a lender to prove ownership. Added to this are the multiple transfers characterizing many mortgage transactions, each draped with a bewildering assortment of documentation. These are some simple information. Thank you.



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