What if your developer is broke?

Over the years, I have addressed numerous issues dealing with condominium and homeowners association developers, such as warranty defects, conveyance of common areas, turnover of the association to owner control, etc. Although, this topic did come up from time to time, there is of course a new spin on it; developer insolvency.

Historically, when the developer went belly up, the board of directors was faced with the prospect of no recourse for defective construction or unpaid assessments from the developer-owned units.

Now, developer problem 2.0 for 2009 and beyond is, how to run an association when only 25 percent of the units have been sold, the remainder of the property is in foreclosure, and services still have to be provided. The questions emanating from this issue, right now, could be a special practice area in and of itself.

I will attempt to address the most common issues we are dealing with now, although I would suggest to my readers that if this does not include your unique situation, send me an e-mail at jshifrin@ksnlaw.com. Unfortunately, many of these problems are not addressed by statute, but do require a legal remedy.

Small association when only one or two units have been sold

From the late 1990s until recently, anyone who could "fog a mirror" could qualify for a low-interest loan to buy anything with the description of "real estate." When all of this came crashing down in last few years, many individuals who purchased a six-flat, for example, and converted it to condominiums, were only able to sell some of the units. But when the financing dried up, they walked away, leaving the lender with the unsold units, and the problem of dealing with an association they had to run and a property to maintain to protect the collateral.

I am confident that no one in lending underwriting ever considered this issue when they gave someone with no credit, no cash and no experience the capital necessary to buy the property initially. There are several routes to pursue, assuming the developer is broke and standing in the unemployment line with everyone else.

First, the unit owners who are "stuck" (can't sell, poured their life savings into the purchase, etc.) can try and crisis manage the buildings themselves; perform their own services as much as possible (single-family owners do it) like taking out the garbage, changing light bulbs, cutting the grass, etc., until things turn around or the bank is able to sell off its inventory.

The most important expense is the insurance and as long as that is paid, everything else is discretionary. (For those of you who live in established communities and want to cut association expenses in general, don't get any ideas here!)

Second, the owners could negotiate with the bank to take the remainder of the property off its hands. What it is or will cost the lender to maintain their investment may be worth more to just unloading it. The owners could "de-convert" the property, own it as tenants in common and rent out the remaining units as an investment property for themselves. The bank, depending on who it is, might even finance a buyout at a low rate of interest.

Third, depending upon personal circumstances; walk away. If you do not have that much invested, and consider your investment is basically worthless until a dramatic swing in the market, you are just throwing good money after bad.

Fourth, depending upon the initial cost of the unit and if the building is filled with investment units owned by the bank or scavenger purchases (this is really more for the high-end projects), pool your funds, hire a lawyer to file an Action in Declaratory Judgment and Partition to severe the units and dissolve the condominium association. Now this is no longer your problem to provide services to these other units, particularly if they are not paying assessments.

This raises a general question for almost all situations where there is a large number of dwelling unit foreclosures. Some lenders are holding back on paying the current assessments until the unit is sold. This creates a major cash crunch for many properties, because they still have to provide services and pay the bills for all units. Emergency circumstances may dictate drastic measures. If the banks' units are being rented, the tenants can be evicted if the assessments are not paid. Also, I have never advocated cutting off utilities to delinquent owners; after repeated notice and lack of cooperation, in my opinion, a lender/owner could be viewed as acting in "bad faith," but it is unlikely that a court would view an association in desperate straits to have no remedy. Perhaps, the insurance companies would cooperate and only insure the common elements and those units that are paying assessments. There is no lender that would not then have to pay up assessments knowing their collateral were in jeopardy of fire or other catastrophe.

Larger properties with a large percentage of owner occupied units, but an insolvent developer and unfinished amenities

This is actually a far more complex situation because an association may have to be involved with attorneys for one or more lenders, a court-appointed receiver, local government, a surety bond company that insured completion of public improvements, and possibly one or two court proceedings (bankruptcies have to be filed in Federal court, although most foreclosures are filed in state court; they would still have to be separate proceedings, regardless).

How will the unfinished portions of the property be completed, who will pay for it, who honors existing dwelling and common area warranties, who is paying the taxes and insurance, and a long list of other issues. This is a situation where the community must really pull together and have a board in place that can, hopefully, work in near-consensus mode with an experienced property manager and attorney. New associations typically deal with all types of issues when they first turn over. Some are important and some may seem trivial. Other than the most important issues, they must be set aside because it is a question of priorities and time-allocation prevails. Local government must become a partner in the completion of all public improvements (streets, sewers, gutters, drainage, etc.). Since the bond is required by the village, it is up to the village to pressure the bonding company or withdraw bank funds, where appropriate, to get the roads completed.

The receiver and the developer's lender have exposure if they have acted in the capacity of a successor developer. Certainly, for the protection of their collateral, they must be a working partner with the board to get the property up to speed.

The developer is gone, or refuses to elect a board consisting of owners

The Illinois Condominium Property Act (765 ILCS 605 et. seq.) requires the developer to turn over control of the association "not later than 60 days after the conveyance - of 75 percent of the units, or 3 years after the recording of the declaration, whichever is earlier" (Section 18.2). This also applies to master and other types of homeowners associations (765 ILC 605/18.5 (f) (2). In the event the developer refuses, after sending the appropriate notice, interested members of the association can band together, get a petition signed and force the turnover with or without the developer's cooperation. Certain issues will have to be addressed, such as the books and records, and bank deposits, but as I have advocated repeatedly over the years, the owners are always better off deciding their own destiny and making the decisions about spending their own money.

These are just a few of the problem areas we are seeing and until new developers who are properly capitalized can step up and fill the gap in the marketplace, association members who have been left with unfinished properties will have to learn how to solve these problems without developer assistance or cooperation.

• Jordan Shifrin is an attorney with Kovitz Shifrin Nesbit in Buffalo Grove. Send questions for the column to him at jshifrin@ksnlaw.com. This column is not a substitute for consultation with legal counsel. Past columns can be read at www.ksnlaw.net.