Delinquent homeowners can affect a community in a variety of negative ways. Obviously, the association needs homeowner dues to be paid, preferably on time, in order to operate. However, there are many residual, undesirable consequences of having too many delinquent ac- counts. A community with an abundance of homeowners in arrears could be declined for a capital improvement loan when needed, therefore preventing the community from performing necessary major repairs or replacements. The Federal Housing Administration (FHA) also looks at the number of delinquent homeowners in a community in its approval process and will not approve communities with past-due accounts over a certain percentage. If an association can’t obtain FHA approval, which allows potential purchasers to obtain FHA mortgages for homes in the community, owners will have a smaller pool of available buyers. Cleaning up past-due accounts in an expeditious manner will not only benefit the association itself but also all the home- owners who have a stake in the community. How, then, should this be done?
According to attorney Daniel B. Greenstein, the first step in the process of collecting delinquent dues from a unit owner, generally, is a letter from the association. This is a formal notice demanding that the unit owner pay his or her outstanding assessments, which are detailed within the document. This notice also warns of impending legal action if the debt is not paid by the specified deadline. Depending on the situation, the association’s letter may have a variety of other contents. Association counsel may thereafter send such a notice.
There are usually two options an association can pursue, he said, if the demand letter was unsuccessful in recovering the assessments owed. Generally, those two options are filing for a money judgment lawsuit or a foreclosure of the lien against the delinquent unit.
Some states give associations the option of evicting delinquent owners prior to going through the foreclosure process. However, this option is not allowed in Minnesota. In some states, the association also has to re- cord a lien before it can foreclose on it. “Under the statutes in Minnesota governing most associations, a paper lien is not required to be filed; rather, any association with a delinquent account has an automatic statutory lien against the delinquent unit. There are two ways that a Minnesota association can collect delinquent sums due it. The first is to bring a suit for a personal money judgment against the record owner. Once a judgment is obtained, the association is entitled to attempt to execute on the person’s assets, such as wages and bank accounts. If the delinquent party (judgment debtor) has no non-exempt assets, such as wages or savings, it is extremely difficult to collect from that judgment debtor,” Greenstein explained.
A second method of collecting on delinquent accounts is to initiate a foreclosure. Most association lien foreclosures are performed by advertisement; this means that there is no court involvement, he noted. The lien foreclosure process takes about eight months to complete and requires the association to spend money on costs and expenses. “All of these costs and expenses are recoverable from the delinquent owner if he or she redeems the unit from the sheriff’s sale by paying the association the total sums due,” Greenstein said.
He continued, “The foreclosure process looks like this: after many required notices are sent to the delinquent owner, the sheriff of the county where the property is located actually auctions off the unit to the highest bidder. The association with the lien can bid its full lien amount without posting any payments to the sheriff. If successful, the association takes title to the unit subject to the owner’s six month redemption period and any first mortgage or tax lien on the property. The association does not need to make payments on the mortgage or tax lien but must satisfy them upon selling the property.” After the foreclosure process, the purchaser of the property will become responsible for those.
When should an association pursue collecting delinquent assessments? It depends on the association, and perhaps even the state, Greenstein said, but most pursue collections after three payments have been missed or after $500 has accrued, whichever comes first. This is an effort to make sure that fees do not immediately overshadow the assessments to be collected. Additionally, it is often easier for an owner to catch up and pay a lower balance quickly, which is important for getting back on track and staying current on upcoming assessments. “We often recommend starting the process much sooner,” said Greenstein. “The reason is that our first step must be a thirty-day demand letter that complies with the Fair Debt Collections Practices Act. So, it is important to keep in mind that there will initially be another thirty-day period in which the delinquent owner can pay their account balance.”
Can associations embarrass their residents by publicly disclosing their delinquencies? Associations cannot make it a point to embarrass residents on purpose in order to motivate them to pay overdue assessments, Greenstein said. Doing so in order to punish a delinquent owner could constitute a breach of fiduciary duty. However, some associations can disclose to residents the breakdown of an assessment, including specific amounts owed by specific owners, because homeowners have the right to know everything that goes into calculating assessments. Some states even require associations to do that regardless. “In Minnesota, most attorneys recommend that associations not disclose which homeowners are delinquent; rather, delinquencies may be discussed at closed meetings,” he ex- plained. Moreover, when disclosing balances, it is crucial for associations to be confident in their accuracy, as stating incorrect amounts may make them liable of defamation.
As for keeping records throughout a collections process, associations should already have previously adopted policies regarding the collections process and what records need to be kept. It should also make sure that all accounting is correct.
How can an association determine if an account is likely to be collectible? One way to determine this is to look at the equity of the house and the balance on the mortgage. If the house is worth more than the mortgage, it’s most likely collectible. “In Minnesota, we cannot obtain a current mortgage balance from public records; however, we can see when the mortgage loan was given and the original amount. Often, this gives us clues as to the current amount owed to the lender,” Greenstein explained.
On the other hand, if the house is worth less than the balance of the mortgage, the house is empty, or the owner is missing and/or judgement- proof, then there is not much likelihood of the account being collectible, at least from the owner. The association could then use the empty unit to try to generate revenue by renting it out, which is a common solution.
Depending on the state, there may be two options for foreclosure: foreclosure by advertisement and judicial foreclosure. As mentioned above, foreclosure by advertisement is a way of serving a foreclosure if the owner proves hard to find, moreover, it is a quick and efficient process without court involvement.
“A judicial foreclosure, sometimes called a foreclosure by action, re- quires the court to approve each step of the process and typically takes much longer than a foreclosure by action,” Greenstein said. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure complaint is served, there is a period of time during which the owner can file an answer. If the owner does not respond in time, the association can proceed with the foreclosure process. A sheriff’s sale is then scheduled and held, with the buyer from that sale becoming the unit’s new owner. “In both types of foreclosure, advertisement and action, the delinquent owner has a six month period to redeem the property by paying off the balance due,” he noted.
Debt collectors have a variety of obligations in regard to communication with debtors. But most debt collection laws, such as the United States Fair Debt Collections Practice Act (FDCPA), are only applicable to third- party collectors and not the party to whom the debt is owed, such as an association. According to Greenstein, any rules on communication are to be followed by the association’s attorney, who should be the association’s main form of contact with the debtor. The association’s attorney should be kept informed of anything relating to that unit, to make sure everyone is on the same page. This includes informing the attorney every time a payment is made.
With regard to associations themselves, communications should be undertaken in the best way possible to help ensure the recovery of money owed and to get owners to pay assessments moving forward. “However, once the association’s attorney is involved, all communication should go through the legal counsel,” Greenstein, advised.
The Fair Debt Collection Practices Act (FDCPA) is a federal law that regulates the collections practices of third-party debt collectors in order to protect debtors. If the FDCPA is applicable with regard to a given debt, then there are a variety of controls on the debt collector pursuing that debt. “Associations are not governed by the statute, as the association itself is not a third-party debt collector, because it is collecting its own debt,” Greenstein said. However, he noted, collection agencies and attorneys are third party debt collectors. Therefore, associations do not have to comply with the FDCPA when setting up payment plans or pursuing debtors.
If a delinquent owner is willing to cooperate and sign paperwork, Greenstein advised that the association should draw up a repayment plan, especially if the balance is relatively small. This is often the best way for associations to recover delinquent fees.
With regard to setting up a repayment plan, the plan should first be put in writing to protect the association. According to Greenstein, the agreement should focus on not only the amount of money owed as of the date of the agreement, but also on the amount that has not yet accrued. The length of the repayment period should be reasonable for both the owner and the association—neither too long for the association to ever recover the money, nor too short for the owner to feasibly repay the debt while staying current.
The plan should hold the owner accountable for staying current on future assessments, while still repaying delinquent ones. If the owner fails to stay current on future assessments, the agreement should allow the association to take action and take a judgment on the balance due. “This is typically done by having the owner sign a confession of judgment at the same time as the settlement agreement,” Greenstein said. This gives the association a way to address the debt if the owner doesn’t follow through with the agreement.
Payment plans may vary by owner, but the association should remain mindful that they should not vary by much. Plans should be drawn ac- cording to an owner’s ability to pay, and deviations should not be so great as to make the association liable of discrimination. Associations also have the option of outlining repayment plans in their governing documents, he said, “But such plans customarily are in the rules so that the future directors can make changes to the repayment plans as times change.”
Are new owners responsible for paying assessments owed on fore- closed properties? “Technically, a new owner is not personally liable for the debts which came due before the new owner took title. However, the association will still have a lien against the new owner’s unit for unpaid assessments. If not paid, the association can foreclose the lien. This means it is critical for every new owner to receive a ‘dues current’ letter from the association before closing,” Greenstein explained. “This is necessary to ensure that a new owner is not stuck with a lien from the previous owners’ failure to pay all sums due to the association.”
In some instances, small claims court may be a viable option when pursuing delinquent fees. It could be a smart and affordable option for an association because using an attorney is often not necessary.
When an owner fails to pay assessments, the association can bring them to small claims court and file a standard breach of contract case. This is because the declaration of the association is considered a form of contract, and the owners are expected to pay the assessments as described therein, Greenstein explained. However, going about it in this way does not necessarily ensure that the association will recover anything. “A conciliation court referee has the discretion to compromise the amount and give the owner a discount. Any decision made in small claims court can be appealed by either party to district court, where the process starts over,” he said.
To “execute” an asset means to take or seize it. An execution is the physical act of enforcing a judgment, and garnishments and levies are types of executions. Typically, common language provides that a garnishment is a wage execution, while a levy is a bank account execution.
A wage garnishment is when the owner’s employer withholds a certain portion of the owner’s nonexempt wages (wages above the poverty line). According to Greenstein, before the association can request a garnishment it must first obtain a judgment against the owner. “A wage garnishment and a bank levy should be handled by your legal counsel,” he advised.
If an owner fails to pay assessments, the association will have a lien. “In all Minnesota associations formed since 1994, every association has an automatic lien by statute against any owner that is delinquent in his or her account with the association. It is automatic. In older associations, a paper lien may have to be drafted and recorded against the delinquent owner’s unit. Check with your legal counsel on which process will apply to your association,” Greenstein explained.
According to Greenstein, the point in the debt collection process at which a lien is actually recorded depends on the association and its governing documents. It is recommended that associations do not hesitate to record a lien as it is a way of protecting the association in the event of an owner’s bankruptcy or attempt to sell or refinance their property. Some associations may issue their demand letter to the delinquent owner prior to filing a lien, while other associations may file the lien first. As stated earlier, some states also require associations to record a lien prior to going through the foreclosure process.
It is not advisable to pursue delinquent owners who decide to walk away from their properties. Instead, Greenstein said, it is typically more worthwhile for an association to foreclose its lien and take ownership of the unit. This will allow the association to sell the unit or to rent it out to recover money. It is very unlikely that an association would recover payment if they personally sued an owner who has abandoned their unit. When an owner “walks away from” their property, they are essentially giving the property to the bank in exchange for not owing the remaining mortgage.
If the association tries to pursue a delinquent owner who has abandoned their property, it can only really pursue that owner’s personal as- sets, as the property is no longer theirs. Pursuing the owner’s personal assets would require a money judgment from the court. “But it is highly unlikely the recovery will work. If a person walks away from their home, they are normally in dire straights financially,” Greenstein said.
The association’s options for pursuing personal assets after receiving a money judgment would be to execute a garnishment or levy. However, Greenstein noted that seeking recovery of debt through personal assets is never a sure thing. For example, if the owner declares bankruptcy, and depending on the kind of bankruptcy, the association may never recover that money directly from the owner.
Once an owner files for bankruptcy, all creditors must cease collections against the owner, including the association. This is required by the bankruptcy code. There are usually two types of bankruptcy seen in a situation like this: Chapter Seven bankruptcy and Chapter Thirteen bankruptcy.
A Chapter Seven bankruptcy entails a liquidation of the owner’s assets. In this situation, once an owner is discharged from bankruptcy court, the association can no longer collect from the owner personally, though it is still entitled to collect on its lien. The association is still entitled to collect future assessments if they are not paid as well.
A Chapter Thirteen bankruptcy involves a creating a repayment plan for the owner in which they must pay the bankruptcy trustee a monthly amount to be distributed to the creditors, including the association. This plan is usually completed between three to five years. In this situation, the association should recover at least most of the money owed, if not all.
A judicial foreclosure is a foreclosure via the court system. It involves recording a lien and filing a foreclosure complaint in a civil lawsuit. “Minnesota does not require a judicial foreclosure but allows foreclosures by advertisement,” Greenstein noted. Some states require that all foreclosures be judicial ones. A judicial foreclosure must be performed by the court, and a court must enter judgement and authorize the home’s sale. Once the foreclosure sale goes through in a judicial foreclosure, it is final.
Minnesota allows for foreclosure by advertisement in which the fore- closure notice is published publicly in some manner, including a foreclosure notice on the front door of the property. According to Greenstein, “Foreclosure by advertisement is faster and less expensive than a judicial foreclosure, and it is most often used when foreclosing an association’s lien in Minnesota.”
“In both a judicial foreclosure and a foreclosure by advertisement, the owner will have six months following the sale to redeem the unit. A redemption occurs when the owner pays the association in full, including its foreclosure costs and legal fees, and retires the entire balance of sums due on his or her account with the association,” he said.
f the unit’s lender comes in once the association has already started the foreclosure, can the association discontinue it? The association can discontinue the foreclosure process at any time, Greenstein said, “But there is a risk in doing so.” There is no guarantee, or law, that requires the lender to finish their foreclosure process. “They may stop the process for any number of reasons and should that happen, the association will have to start its foreclosure process over from the beginning,” he said.
Should an association move forward with its own foreclosure once the lender begins their foreclosure process? “Typically, no. If a first mortgage holder is foreclosing, it most often makes sense to let the lender finish its foreclosure and not start the process. This saves the association the money needed to pursue a foreclosure. In most cases, if the owner does not redeem the unit from his or her lender, the lender will be required to pay the association six months’ of assessments at the end of the six month redemption period,” Greenstein explained.
When must a lender pay delinquent assessments? In Minnesota, a purchaser via a sheriff’s sale is not required to pay any assessments that accrued prior to that sale. “But the lender must pay the association six months’ worth of assessments at the end of the redemption period if the lender becomes the property owner,” he repeated.
When is the bank held responsible for the property? The bank be- comes responsible for a property once the sheriff’s deed has been issued to it during a foreclosure or if it receives a deed-in-lieu of foreclosure, which is when the owner is allowed to walk away from their property and ownership in exchange for not being held responsible for the remaining mortgage. Once the bank receives a deed for the property in its name, it must send a copy to the association. “In Minnesota, the lender is not responsible for past assessments, except that it must pay the association six months’ of assessments when the redemption period expires,” Greenstein said. It does, however, become responsible for paying that property’s future assessments until it is sold. If the bank becomes delinquent on the assessments, the association is then allowed to pursue collections from the bank.
The bank may also be held responsible for not maintaining whatever that unit is responsible for, such as certain repairs and perhaps mowing the lawn, he noted. If the governing documents state that the units are individually responsible for such things, the association may hold the bank responsible and may also pursue it in court for unaddressed maintenance issues. Alternatively, the association may have the ability to maintain parts of the unit on the owner’s behalf and may bill the owner or bank for that upkeep.
What are the pros and cons of foreclosing on a delinquent owner with the intent to rent out the unit to recoup association fees? In general, Greenstein said, there are no negative consequences to renting out an empty unit that is under the association’s control. Doing so allows the association to both recover debt and potentially secure upcoming assessments from that unit, while ensuring that the unit stays fit for habitation.
According to Greenstein, in most cases short sales are not in the association’s best interest. Short sales occur with properties that have little to no equity. While a short sale may ensure paid assessments from a new owner going forward, it will also usually result in the association not recouping those delinquent assessments. Associations are better off going through the foreclosure process and renting out that unit in the meantime to recover at least some money. A short sale is acceptable, however, if it results in a full recovery of debt for the association, even if the lender is at a loss.
After the association has foreclosed its lien for assessments, it becomes the owner of the unit and subject to any first mortgage of record. This means the association owns the unit and has the right of use and pos- session of the unit in any manner it sees fit. “Often, it takes a mortgage company anywhere from nine months to a year or longer to initiate a foreclosure. Due to this, after the association takes title to a unit, there is a window for the association to generate rental income from the property,” Greenstein said.
The association then has the right to rent out a property to generate monthly rental income and can apply that rental income to the delinquent amount it is owed due to the previous owner’s nonpayment of assessments. “If the association intends on doing this, there are several things which should be kept in mind. First, tenants are protected and will have the right to possession of the unit if a valid lease is entered into with the association. The lease must contain language that informs the tenant the unit is subject to a first mortgage but the tenants are adequately protected be- cause Minnesota law requires any mortgage company to honor an existing lease that is in place or provide at minimum 90 days’ notice for the tenant to vacate,” Greenstein explained. In most circumstances, a one-year lease will expire well before the mortgage company forecloses and takes title. This is because it usually takes over six months for a mortgage to foreclose and sell the property at sheriff’s sale; after the sale, the mortgage company does not take title to the property until the expiration of the redemption period, which is an additional six months.
“Even if there happened to be several months left on the lease when the mortgage company takes title, the mortgage company will then con- tact the tenant, direct them to make rent payments to them, rather than to the association, and either honor the lease until the remainder of the term or provide a 90 days’ notice to vacate, which will likely extend beyond the lease term anyway,” he said. In some circumstances, the bank will even offer the tenant “cash for keys” which is a lump sum payment to the tenant in exchange for them agreeing to vacate the property prior to the expiration of the lease term.
Another consideration is the condition of the unit. Minnesota law re- quires that anyone renting a property ensure the unit is “habitable.” “This means the unit must have heat, be free from pests and not having any conditions which could adversely affect the health, safety or welfare of any occupants. Therefore, the unit should be inspected prior to renting to make sure it is in adequate condition. If significant money must be spent to put the unit in rentable shape, you may want to rethink your plan,” Greenstein advised. The association can provide language in the lease to avoid being responsible for appliances or fixtures.
Finally, the association should consider the rental value of similar property in the area. “Typically, an association that is going to rent a fore- closed property will charge less for rent than the fair market rental value of similar property in the area. This is because the property is subject to a first mortgage, and the association generally will not warrant appliances or make any repairs which are not necessary to maintain the property in habitable conditions,” Greenstein explained. The association should con- sider what it could rent for and discuss what costs may be involved in cleaning the unit and preparing it to be rented.
Once a unit is rented, the income can be applied to the previous owner’s delinquent balance. “Make sure to apply monies received to the oldest debt first,” he said. In many cases, the rental income will exceed the amount which was owed on the unit prior to the assessment lien fore- closure. “If or when the first mortgage steps in and forecloses there is still a delinquent amount owed, the association can collect the previous six months of assessments from the bank when it takes title. This is true whether the unit is rented or not,” Greenstein said.
If an association decides to rent out an empty, delinquent unit in order to recover unpaid fees, it will then find itself in the position of being a landlord. An association’s best practice when it comes to its landlord du- ties is to follow the law. Many states have detailed laws governing the ob- ligations of landlords, so associations should become familiar with those laws and follow them. Regardless, Greenstein advised that it is best for associations to hire a professional to ensure compliance with all relevant laws.
“As foreclosures have increased since 2008, many investors look for association foreclosure sales and offer to pay the association in full on such account and take over the association’s position by way of assignment. In other words, in exchange for payment in full of a delinquent account, the association assigns its lien rights to a third party. The third party looks to negotiate with the owner’s lender to buy out the mortgage and own the unit, usually for resale. This has many benefits for the association,” Greenstein explained.
If repairs must be made to the unit, then the third party is responsible for making them, as they are responsible at that point for making sure the unit remains habitable, much like a traditional landlord. “If a renter is found for the unit, the third party must deal with the renter. During this time period, the third party is responsible for all assessments due the association, just like any other owner,” he said.
As for security deposits, associations typically have to follow the same regulations that other landlords must follow. In most states, landlords are required to give the tenant a receipt as proof that the security deposit is in a secure bank account, separate from the landlord’s personal assets. They may also be required to pay interest on the security deposit. Not follow- ing the proper procedures for handling a tenant’s security deposit could subject the association to damages and attorney’s fees for that tenant. Given this, it’s best to have leases reviewed by the association’s attorney.
If a lender comes in when the association is renting a unit, can it argue that there are no delinquent assessments that it must pay? That is possible if everything that has accrued after the sheriff’s sale has been paid, or if the association is obligated to apply the rental income to current assessments first, Greenstein said. However, it may be the case that the rental income was put towards repairs, past assessments and other costs, and there was no income left to put toward current and future assessments. Depending on the priority of the different costs associated with the unit, as outlined by the governing documents and state laws, the bank may still be responsible for current and upcoming assessments, even if there is rental income coming in.
To sum up the collections options available to associations, it generally comes down to foreclosure or a money judgment.
A foreclosure is an in rem proceeding, which is an action that focuses simply on the property and does not seek any personal judgment against the homeowner. A foreclosure judgment does not allow asset execution, Greenstein noted. It is only used to take possession of the delinquent property. The process begins by recording a lien, though a foreclosure may not necessarily follow from a lien. However, there is no foreclosure without a lien.
A money judgment, on the other hand, allows the creditor to take an individual’s non-exempt personal assets, including money. “However, as a general rule, if the owner is not working it may be difficult to find any non-exempt assets from which the association can get paid,” he said.