Articles

The Perils to Associations of Owning Homes that they have Foreclosed Upon

 By Bradley J. Epstein, Angius & Terry LLP

             Community associations have the power to foreclose upon homes in order to collect delinquent assessments, and association boards have the authority to wield that power on behalf of their associations.  However, during this current economic downturn, oftentimes, there are circumstances that provide that it is in the associations’ best interests for boards to refrain from wielding that power.  This is especially true since, most likely, the associations will become the owners of the homes through their foreclosures.  Under such circumstances, it may be in the associations’ best interests to take other actions besides foreclosure, such as lawsuits, in order to attempt to collect delinquent assessments.  This article discusses the circumstances when association boards may want to refrain from foreclosing upon, and thereby becoming owners of, homes in order to collect delinquent assessments, and the factors that association boards should consider when deciding, as an alternative to foreclosing, whether to file lawsuits to attempt to collect the delinquent assessments.

Associations have the power to foreclose upon homes when homeowners fail to pay assessments.

             State law and associations’ governing documents give community associations the power to foreclose upon homes in order to collect delinquent assessments, without the associations having to file lawsuits.  This power is almost identical to the power that a home lender has to foreclose upon homes when a homeowner fails to pay their mortgage.  In general, an association can foreclose upon a home within about six months after the homeowner fails to pay their assessments, and in such a foreclosure, the association need not file a lawsuit.  In particular, the steps that an association must take to perform the foreclosure are as follows when a homeowner fails to pay their assessments: (1) send the homeowner a letter stating that the association intends to file an assessment lien; (2) thirty days thereafter, file with the county recorder an assessment lien; (3) thirty days thereafter, file with the county recorder a notice of default; (4) ninety days thereafter, file a notice of sale; and (5) six weeks thereafter, sell the home at a foreclosure sale.  At the foreclosure sale, either a bidder at the sale becomes the owner, or if there are no bidders at the sale, then the association becomes the owner of the home.  

 Unlike before the current economic recession, association boards must now decide whether to foreclose upon and become owners of homes. 

            Before the current economic recession, it was extremely rare for associations to foreclose on homes in order to collect delinquent assessments.  This was because home values were increasing, which resulted in homes being worth more than the homeowners owed to their lenders.  Accordingly, during that time, it was relatively easy for homeowners to take steps to obtain funding to pay delinquent assessments, and it made economic sense for homeowners to retain their homes with equity, rather than allow their associations to foreclose on the homes for delinquent assessments.

            Over the last five years, however, the economic conditions that have included a large drop in home values, in turn, have resulted in a large increase in the number of homeowners who have failed to pay their assessments.  Not only have a large number of homeowners failed to pay their assessments because they are unable to afford the payments, but a large number of homeowners have failed to pay their assessments because they have decided that they no longer want to own a home that is worth significantly less than the amount that they owe to their lender for the home.

            Typically, when a homeowner decides to no longer own a home that is worth significantly less than the amount that they owe on the home, the homeowner will not only fail to pay their assessments, but, they will also fail to pay their mortgage.  If a lender timely forecloses upon a home when a homeowner fails to pay their mortgage, then it is usually more economical for an association to wait the six months for the lender to foreclose, rather than proceeding with foreclosure to collect the delinquent assessments.  This is because lenders’ mortgages have a higher “lien priority” than assessment liens, and therefore, if a lender forecloses on its mortgage, then the association’s assessment lien will be extinguished.  If the reverse were true that an assessment lien had a higher lien priority than a mortgage, then no lender would give a mortgage on a home, because in that scenario, an association foreclosing on an assessment lien of a few thousand dollars would extinguish a mortgage that could be hundreds of thousands of dollars or more.

             Furthermore, if a lender timely forecloses, then either the lender or a bidder at the lender’s foreclosure sale will become the new assessment-paying homeowner.  In the case of a lender’s timely foreclosure, usually, the amount of assessments owed by the foreclosed-upon homeowner would be relatively minimal.

            However, over the last five years, most lenders have failed to timely foreclose.  This is because lenders have lacked an economic incentive to foreclose.  If they foreclose on a home, then they will have another home in an overwhelmingly large portfolio of homes that they have foreclosed upon, and they will have the additional obligations for the home, such as paying assessments, eviction of the foreclosed-upon homeowner, renovating the home for sale, and selling the home.

            Further, unfortunately, since over the last several years, almost every home that an association would sell at a foreclosure sale is worth significantly less than the homeowner owes on its mortgage, then, over the last several years, there are usually no bidders at the foreclosure sales.  Associations therefore become the owners of the foreclosed-upon homes, without having recouped any of the association’s losses from the delinquent assessments.

Associations who foreclose on and thereby become owners of  foreclosed-upon homes have liability risks as a result of their ownership of the homes.

             Boards of associations that become owners of foreclosed-upon homes understandably want to recoup their associations’ losses that have resulted from the delinquent assessments.  At first blush, an association foreclosing on and then renting out a home seems like a viable solution to recouping those losses.  However, associations may encounter several liability risks when renting out a foreclosed-upon home, which may outweigh any potential recoupment of losses that have resulted from delinquent assessments.

            First, if an association fails to pay the lender on the mortgage of the home that it foreclosed upon, then the lender can foreclose on the home, and extinguish the association’s ownership of the home.  Homes foreclosed upon by associations will almost always have mortgages.  This is because if a home lacks a mortgage, then it is unlikely that the homeowner would have let the home be foreclosed upon by the association, since the value of the home would have been more than the amount that the homeowner owed on the home. 

            In such cases, associations are not parties to the homeowners’ mortgages.  Therefore, the associations lack contractual obligations to pay the lenders on the mortgages.  However, if no one pays the mortgage, then the lenders can foreclose on the homes, and if the lenders foreclose on the homes, then they will extinguish the associations’ ownership of the homes.

            Second, if an association rents out a foreclosed-upon home, and fails to pay the mortgage, then the association and its board risk criminal prosecution and civil lawsuits for “rent skimming.”  State law defines rent skimming as obtaining possession of a home with mortgage, renting out the home, keeping the rents, and not paying the mortgage. Arguably, the lender of the mortgage on the home and/or the tenant can sue an association and its board for rent skimming, and if successful, can obtain a court award equivalent to the rent received, punitive damages, and attorney’s fees incurred.  Arguably, associations and their boards can be criminally prosecuted if they engage in multiple acts of rent skimming, and if convicted, can be fined up to $10,000 and jailed for up to a year.

            Third, if an association fails to get liability insurance on a home that it foreclosed upon, and a person gets physically injured at the home, then there is a substantial possibility that the association would lack insurance coverage in the event of a lawsuit by the injured person.  Arguably, it is not necessary for an association to obtain property insurance on the foreclosed-upon home if it lacks any equity.  Rather, the lender can obtain that insurance, since it is only one with any equity in the home.

            Fourth, if the foreclosed-upon homeowner remains in the home after the association had foreclosed upon the home, then the association would need to evict the homeowner if the homeowner failed to agree to pay rent to the association.  In that case, the association’s board would incur the time, stress, and expense of an eviction lawsuit.  The association would have to hire an eviction attorney, who may have to prepare for, and go to trial against the homeowner.

            Fifth, if the foreclosed-upon homeowner agreed to pay rent to the association, then the association’s board would incur the time, stress, and expense of being a landlord.  The association would most likely need to hire a rental property manager to deal with the myriad of potential rental issues.

            Sixth, typically, if the foreclosed-upon homeowner had failed to pay the assessments and the mortgage, then the homeowner had also failed to pay the county property taxes and utilities.  Accordingly, the county and the utility companies may file liens that they could eventually foreclose upon.  Typically, counties and utility companies foreclose upon homes only after more than five years pass after they file liens.

            Seventh, the foreclosed-upon homeowner may have failed to properly maintain the home, both inside and out, and may have intentionally damaged the home.  The Association could then be confronted with thousands of dollars to repair the home. 

            Eighth, associations who foreclose upon and become owners of homes will no doubt incur the typical costs of home ownership, such as utilities, garbage, sewer, pest control, landscape maintenance, etc.

            Ninth, State law places the following additional burden on associations after they have taken all of the steps to foreclose upon a home.  Associations must wait an additional ninety days after they have foreclosed upon a home before they actually become the owner of the home.  In particular, State law provides that associations’ foreclosure sales are subject to a right by the foreclosed-upon homeowner to, within ninety days of the foreclosure sale, pay all delinquent assessments and collection costs and retain ownership of the home.

          Rather than foreclosing on the homes, Associations have the alternative of suing homeowners who have failed to pay assessments.

                        State law and CC&Rs authorize associations to sue homeowners for delinquent assessments.  Small claims court lawsuits are typically much quicker and more cost-effective than superior court lawsuits.  State law provides that associations may sue in small claims court for up to $5,000 per case, up to two times in a year, and thereafter, up to $2,500 per case during that year.  Also, pursuant to State law, an association may sue a homeowner for delinquent assessments as long as the association has not foreclosed upon the home.

            Association boards should consider several factors when deciding whether to sue a homeowner who has failed to pay their assessments.  First, in order to successfully sue a homeowner, the association must locate the homeowner and personally deliver the lawsuit papers to the homeowner.  State law provides, in general, that unless the association personally delivers the lawsuit papers to the homeowner, the association will not be able to obtain a judgment against them.  Consequently, if the homeowner no longer lives at the home, and the association board does not know the location of the homeowner, then the association must incur the expense of trying to find the homeowner, such as through a private investigator. 

            The second factor that boards should consider when deciding whether to sue a homeowner who has failed to pay their assessments is that State law provides that either a board member or the association manager must attend the small claims court trial.  Accordingly, associations have the expense and inconvenience in a lawsuit of that attendance at trial. 

            An alternative to a small claims court lawsuit is combining all of the delinquent homeowners as defendants in one superior court lawsuit.  This alternative has the advantage of avoiding the limitation referenced above that associations may sue in small claims court for only up to $5,000 per case, up to two times in a year, and thereafter, only up to $2,500 per case during that year.

            The third factor that boards should consider when deciding whether to sue a homeowner who has failed to pay their assessments is whether the homeowner is financially able to pay a judgment.  Unfortunately, the following are currently substantial possibilities: (1) the homeowner lacks income sufficient to pay the judgment; (2) the homeowner lacks assets sufficient to pay the judgment; and/or (3) the homeowner will file bankruptcy and not have to pay the judgment. 

            In spite of these possibilities, fortunately, it is not uncommon are homeowners to pay or agree to a payment plan for delinquent assessments when an association sues them.  Some homeowners want to meet their obligation to pay assessments and will pay when sued.  These homeowners commonly incorrectly believe that since a lender had foreclosed on their home, then they were not obligated for the assessments that they had failed to pay during their ownership.  Furthermore, associations that successfully obtain judgments in their lawsuits against homeowners can file their judgments, as liens, against any homes that the homeowner may thereafter purchase elsewhere.

            Also, as a measure of attempting to ensure collection of assessments, associations should always file liens for the delinquent assessments, regardless of whether they file a lawsuit, rather than foreclosing.  Filing a lien is especially important to protect an association’s rights in the event that the delinquent homeowners files bankruptcy.

            Accordingly, association boards may want to refrain from foreclosing upon and thereby becoming owners of homes in order to collect delinquent assessments, and boards should consider, as an alternative to foreclosing, filing lawsuits to attempt to collect the delinquent assessments.