Priority Lien Can Shield Homeowner Associations from Foreclosure Losses

Published on: March 20, 2008

Foreclosures are setting new records nationally and locally, and common interest ownership communities are feeling the impact. As foreclosures and mortgage delinquency rates have increased, so have association accounts payable as more owners fall behind in the payment of their common area fees.

There was a time when a foreclosure wave like the one we are witnessing today (2 percent of all mortgages were in foreclosure in the fourth quarter of last year) would have meant financial strain, at best, for most homeowner associations and financial disaster for some confronting the revenue shortfall created when one or more owners fail to pay their share of common expenses. But thanks to the 1992 “Super Lien” statute, Massachusetts community associations have a means of protecting themselves from foreclosure-related losses.

As the term suggests, the “super lien, also known as a “priority lien,” takes precedence over the claims of all other creditors, including the holder of the first mortgage, ensuring that the association will be able to recover at least six months of unpaid common fees plus the legal expenses related to the collection of those delinquent payments. Absent this potent legal weapon, associations would be able to collect unpaid fees following a foreclosure only after the mortgage had been repaid.

Equity Questions

That wasn’t a serious concern a few years ago, when property values were rising and the housing market was strong. But declining values combined with low- and no-down payment mortgages and multiple cash-out refinancings have left many owners with mortgage balances that exceed the value of their homes. In these situations, the priority lien can be a financial lifesaver for common interest ownership communities, especially for smaller communities with few owners to shoulder the burden if others fail to pay their fees.

Like any tool, however, the priority lien is effective only if wielded properly. For association boards, that means responding quickly when owners fall behind in their payments – good advice in general, but absolutely essential in the current environment, when collections delayed could mean collections denied. Remember, the super lien covers only six months of back payments, so timely filing is crucial; file the lien in the ninth month and the association may have to write off the first three months of unpaid fees.

Board members understandably want to treat struggling owners gently, but the statutory window doesn’t provide much wiggle room. However sympathetic boards may be to the plight of owners facing foreclosure, they can’t give these owners “just a little more time” to catch up without jeopardizing the financial interests of all the other owners in the community. Boards should initiate the collection process early, usually no more than two months after an owner has become delinquent. They also should take care to post applicable charges to owners’ accounts as they are incurred and apply any payments delinquent owners make to their oldest balances first (because balances older than six months won’t be covered by the priority lien).

There are other reasons for beginning the process sooner rather than later. First, sometimes simply sending a collection notice—with a reminder that the association has the authority to file a lien and to collect attorney’s fees — is enough to encourage delinquent owners to catch up, if they can. Also, it makes sense to begin chasing owners when they are only two or three months behind and still have a chance of catching up, before the delinquency has become, or seems to have become, insurmountable.

Boards that move quickly to deal with delinquent owners also have the flexibility of offering a repayment plan. If you strike a deal after two months and the owner fails to make the agreed-on payment the following month, the association can begin the formal collection process at that point without jeopardizing its position. If the board waits until the five-month mark, it will have no choice but to demand full payment and file suit against the owner immediately to perfect the association’s priority lien.

Many condominium documents allow the board to demand payment in full of the fees owed for the year if an owner falls behind, but this strategy makes little sense. An owner who can’t pay one or two months of fees is unlikely to be able to write a check for the entire year. Even more problematic, the acceleration process could complicate the perfection of the priority lien, without providing any tangible benefit for the association.

No Rush to Pay

The super lien statute requires associations to notify lender s when an owner becomes delinquent in the payment of common fees. Lenders have often responded to those notices in the past by contacting the borrower and demanding payment or by paying the delinquent amount themselves – including interest, late fees, and special assessments, which aren’t covered by the priority lien – in order to prevent the lien or (if the lien has been filed) to eliminate it and clear the title. That is no longer the case.

Mortgage lenders, overwhelmed themselves with rising delinquencies and foreclosures, now will typically pay only the feels covered by the priority lien, and they aren’t rushing to do that. They are far more likely to let the association file its lien, let the property go through the foreclosure process, and then force associations to file suit against the lender in order to collect the amount due under the priority lien. This doesn’t affect the outcome – boards that have taken the proper steps can be confident that they will eventually collect the money owed, but the process is likely to take a lot longer than it has in the past. To the extent possible, boards should anticipate that possibility and build a cushion into their budget to prevent cash flow problems during the collection process. If the current year’s budget does not contain an adequate cushion, boards may have to close the revenue gap by increasing common fees, imposing a special assessment, or obtaining an association loan. When considering those options, it is worth remembering that the priority lien covers only monthly common area fees.

Protecting the Community

In addition to the obvious financial challenges foreclosures create, they also produce vacant units and with them, another set of complicated problems for home owner associations. For example, the lack of heat in cold weather could produce frozen pipes, with resulting damage not only to the vacant unit but to adjacent units and to the common areas. A slow leak creates the threat of water damage in other units and mold, which could affect the entire community. The owner and/or the lender of record are responsible for securing the vacant property, but if they don’t respond, boards should do whatever is necessary to protect the community, including paying the utility bill to keep the unit heated in the winter, and using the board’s authority to make emergency repairs to prevent a problem in the unit from spreading. Although the association may not be able to recover those costs, it is almost certain that paying those bills will cost the association far less than the repairs to multiple units damaged by frozen pipes or the insurance premium increase resulting from filing a water damage claim.

While foreclosures can produce multiple problems for community associations, some boards see them as opportunities to increase association revenues – by buying the units and re-selling them or renting them for a period.  This isn’t a strategy I usually recommend.    Purchasing a foreclosed unit might make sense for an association that plans to offer on-site residence as part of the compensation to a maintenance employee, but barring that, purchasing a unit offers few advantages and many risks.  For one, the association may not be able to sell the unit as quickly as it anticipates or for as much as it hopes to gain, making it more a drain than an asset.  And renting has headaches of its own – finding good tenants, dealing with bad ones, and covering the management costs during periods when the unit is vacant.  Community associations are non-profit entities.  In a foreclosure situation, the board’s goal is not to create investment opportunities (or incur investment risks), but to recover as much of the unpaid common fees and related collection costs as possible.  Fortunately, the super lien provides an effective means of doing that.  Associations have no compelling reason to get into an ownership or rental situation and it’s not in their interest to do so.