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Lessons in Fiduciary Duty

Posted on Author By David W. Merritt, Esquire

In an October 21, 2016, published decision titled In Majorca Isles Master Ass’n, Inc., 560 B.R. 824 (Bankr. S.D. Fla.) (“Majorca Isles”), the United States Bankruptcy Court awarded a Florida Master Association with an incredible $16.3 million judgment against a developer and its appointed trustees, in what the Court described as a “modern day story of David and Goliath.”  Setting aside the transition aspects of the case, the decision provides an excellent guide for boards and property managers – particularly those involved with master associations – facing issues of poor record keeping and conflicts of interest.

In Majorca Isles, developer D.R. Horton appointed trustees to sit on both a master association (the “Master”) and its five subsidiary associations (the “Subsidiaries”).  The Master was responsible for shared property and services, including swimming pools, clubhouses, parking areas, landscaping, gate facilities, security guards, and cable television.  The various governing documents of the Master and the Subsidiaries condominium associations provided:

  1. Each unit owner was personally obligated to pay assessments to the Master;
  2. The Master was empowered to impose, liens, late charges, and attorney’s fees on delinquent unit, and to bring foreclosure and money judgment actions against the individual owners;
  3. The Master was required to maintain complete and accurate records as to assessments paid by each individual owner;
  4. The Master could choose to delegate its assessment collections to the Subsidiaries, in which case the subsidiary associations were to pay the master assessments in full prior to the Subsidiaries’ expenses.

Despite these requirements, beginning in March 2006, the Master collected assessments from unit owners without creating any financial records of the assessments.  Then, in October 2007, the trustees determined to collect the Master’s assessments by “bulk billing” the Subsidiaries.  As a result of the bulk billing, the Master continued to create no financial records for individual owners.

As the great recession set in, revenue dropped and nearly half of the Master’s unit owners became delinquent.  The trustees, sitting on both the Master and Subsidiary boards, decided to cut funding to the Master in favor of the Subsidiaries, removing amenities like security personnel, home alarm monitoring, and cable television.  Facing growing delinquencies, the Master sought the assistance of a collections law firm in September 2009.  The firm, after reviewing the governing documents, advised the trustees: (1) the Subsidiaries were prohibited from paying their own expenses prior to fully funding the Master; (2) collections were made impossible by the lack of financial records; and (3) owners would likely be able to successfully defend against any collections actions due to the trustee’s non-conformance to the governing documents.  The trustees wrote off their attorney’s advice as “just a legal opinion”, and quietly abandoned attempts to recover the unpaid assessments.

Control of the master board turned over to the unit owners in January 2011.  Lacking records necessary to collect delinquencies, and unable to pay its expenses, the Master became immediately insolvent and filed Chapter 11 Bankruptcy, bringing it under the jurisdiction of the Bankruptcy Court and to the attention of Barry Mukamal, a bankruptcy trustee.  Mukamal, in what the Court described as an “extraordinary” service to the Master, recreated seven years of assessments records “from scratch,” and successfully pursued the developer and its trustees for a $16.3 million judgment.

Importantly, the Court found the individual trustees breached their fiduciary duties to the Master.  In doing so, the trustees managed to satisfy almost every major method for undermining the business judgment rule protecting fiduciaries: (1) acting despite a direct conflict of interest; (2) acting contrary to specific terms of the governing documents establishing their authority; and (3) disregarding the specific advice of qualified professionals such as legal counsel.  The Court concluded the trustees were personally liable to the Association for over $3.8 million for, among other things:

  1. $750,000 in delinquent assessments made uncollectable by the failure to institute a collection program, the failure to collect from the Subsidiaries, and the disregard of advice from outside counsel;
  2. $200,000 to recreate the Master’s financial records due to the failure to create or maintain adequate records; and
  3. $867,066 for unilaterally removing security services and cable television amenities, thereby favoring the Subsidiaries and the developer.

Majorca Isles must be read in the larger context of the trustees’ roles as employees of the developer, as among other things, the trustees were therefore not protected by any indemnification clause in the governing documents.  While the egregious conduct in the case would likely fall outside of a traditional indemnification clause, it is also likely the Court would have been more sympathetic to elected volunteer trustees.  Additionally, the Court’s decision, applying Florida statutes and common-law, can only serve as persuasive precedent in New Jersey.

Nevertheless, the decision drives home that trustees and property managers owing a fiduciary duty to a condominium or homeowners association can be sued for failing to create accurate and complete financial records, failing to establish a meaningful collections program, and failing to provide advertised amenities.  In particular, trustees and property managers should strongly consider abstaining from decisions where any of the following apply: (1) a direct conflict of interest splits fiduciary duties between a master and subsidiary association, or between an association and some third party; (2) the action, course of conduct, or lack of action contradicts the governing documents; or (3) the decision contradicts the advice of the qualified professionals such as engineers and legal counsel.

Units In Collections With No Mortgage

Posted on Author By Marlena Diaz-Cobo, Esquire

What happens when a unit is in collections and then upon a title search, we determine there is no mortgage on the property?

This is a common situation when the property was bought a long time ago, and the debtor recently fell on hard times or the debtor is a relative that inherited the unit from the deceased owner. Although the mortgage is paid, the debtor cannot pay their monthly maintenance fees.

The Association will most likely proceed with its collection efforts whether it be through a foreclosure against the debtor’s property or through a money judgment action against the debtor personally. A foreclosure’s end goal is to get to a sheriff sale, and likewise if there are no assets to collect on an outstanding money judgment, the end goal would also be a sheriff sale.

So, we are at the sheriff sale stage now, and there is no mortgage on the property! Before we actually go to the sheriff sale, we would advise the Association of all that needs to be taken into consideration to make an informed decision.

First, we would obtain a full title search to determine all docketed judgments, liens, and any tax sale certificates. If there are various judgments and liens on the property, and the Association is not interested in obtaining clear title, then the Association could bid at the sheriff sale the current amount owed. If a third-party purchaser successfully bids on the property, then the Association will be made completely whole. However, if no one bids, and the unit reverts to the Association, the Association can rent the unit until the holder of that lien or docketed judgment forecloses on the property. This can take a very long time, especially if the lien holder has not instituted any foreclosure action yet.

If there are docketed judgments and liens on the property, and the Association is interested in obtaining clear title, any judgment that is docketed, and any outstanding lien would have to be satisfied in order for the Association to gain clear title. If the unit is worth substantially more than the amount of the liens, or docketed judgments, satisfying those liens/judgments might be a good option for the Association since the Association can possibly become the outright owner, and will be able to sell the unit at the fair market value, reaping a substantial sum!

A cost/benefit analysis would have to be undertaken to determine whether it is in the Association’s best interest to gain clear title. Whether the Association is interested in obtaining clear title or not, the Association can potentially reap a lot of money by taking a unit without a mortgage to sheriff sale. The Association can either be made whole by being paid by a third-party purchaser or the Association can rent the unit pending the lien holder’s foreclosure action. If the Association becomes the outright owner, the Association can sell the unit at fair market value and reap the entire amount the unit is worth.

What’s The Buzz On Drones

Posted on Author By Francis J. McGovern, Jr., Esquire

Eric Koehler, Vice President of Falcon Drone Services and Fran McGovern from McGovern Legal Services along with Access Property Management presented the benefits of using drones in community associations on Wednesday April 12. The demonstration was open to both board members and property managers in the Hills Communities. All were excited to see how the new technology worked. The presentation provided a demonstration of the drone in use. All participants were encouraged to provide comments and questions.

Highlights of Drone Technology

Eric Koehler explained that drones are amazing pieces of technology. They allow community associations the ability to survey their communities in a cost effective way. A drone makes it easier to survey roofing projects, check gutters, and examine roads among other things. The technology of the drone allows for a more effective and efficient way of viewing the community. This technology allows the property manager, contractors, and board members to review the video on their own time.

Privacy is Important

A privacy oriented homeowner may have questions about drone usage. The community association treats the footage collected like any other site inspection or photograph that is taken while on site. All information collected would not be distributed or made public. Fran McGovern explained the legal aspect of using drones, expressing that it is important that homeowners are notified prior to the usage of drones, just as they would be during any other project. Continual updates from the community manager will provide homeowners with the times and dates of all activity.

Community associations are also very interested in keeping their interests safe and secure. The association must be sure that it maintains the rights to all data that is collected when using the drone. In addition, the association will ensure that the drone operator retains the proper insurance to indemnify and hold the association harmless like any other vendor.

The popularity of drones is increasing. As the technology advances, community associations can grow along side of it by adopting smart usage policies and encouraging a safer, more cost effective way to survey their community.

Transition – Evaluate, Communicate, Negotiate, Litigate

Posted on Author By Francis J. McGovern, Jr., Esquire

Transition is the due diligence process required by the board members’ fiduciary duty. In sum, the homeowner-elected board members must determine if the sponsor did what it was supposed to do and, if not, take action to get the deficiencies corrected.

Upon assuming board control homeowner-elected board members must:

  1. evaluate the association’s physical and financial condition
  2. communicate the findings to the members and the sponsor
  3. negotiate for repairs, money or a combination of repairs and money.

Evaluate.

Due diligence begins with evaluating the association’s physical and financial conditions. These evaluations must be undertaken promptly. Delay may result in losing some or all claims due to expiration of warranties, statutes of limitation and/or the statute of repose.

Engineers, architects, accountants and other experts are enlisted by the board and the association’s attorney to ferret out deficiencies and “connect the dots”. “Connecting the dots” requires experts to:

  1. Identify the duty – statutes, architectural drawings and specifications, building codes, industry standards, manufacturer’s specifications, etc.
  2. Specify how the duty was breached – for example, required building wrap was not installed
  3. Specify the damage – for example, moisture got behind the siding and was not shed down and out; instead the moisture damaged the substrate and structural members
  4. Specify how the breach caused the damage – for example, if the required building wrap had been properly installed, water that got behind the siding would have been shed down and out of the building envelope without damage to the substrate and structural members. Instead, the water was absorbed by the substrate and structural members resulting in rot and mold growth.

After “connecting the dots”, the association’s experts should carefully determine how much it will cost the association to fix the various physical and financial defects. This “cost to cure” report provides the board with a basis for prioritizing the deficiencies and evaluating how much the association should spend on attempting to compel the sponsor and others to remedy particular deficiencies. Without reputable experts solidly connecting the dots and determining the cost to cure, the association has little prospect of transition success. Assuming the experts connect the dots and accurately estimate the cost to cure, the board, its experts and counsel must finally evaluate the probability of recovery.

Is there an individual or entity that has the resources to cure the deficiencies or pay the association so that it may cure the deficiencies. Is it the sponsor? Is it the sub-contractors? Is it one or more insurance companies? Typically transition is resolved with contributions by all of these but, if there is little or no prospect of recovery, the association should carefully consider other options such as self-funding repairs, obtaining a bank loan to fund repairs or phasing repairs over time while using “Band-Aid” fixes in the meantime.

Communicate.

Many boards are reluctant to communicate expert findings to the membership. This is a mistake. Everyone hopes that the transition process will be smooth and amicable. However, transition can be long, contentious and expensive. If the membership does not support the board, management, its attorneys and experts, half of the battle is already lost. The board must share as much information as possible with the membership during the transition process so that the members know what it going on, know why various items have not yet been fixed and know why it is important for the association to spend the time and money to see the transition process through to resolution.

Negotiate.

Once the board has a comfort level with the experts’ findings and recommendations, the board and counsel will negotiate with the sponsor, developer, sub-contractors and others. In most cases this negotiation results in an amicable transition agreement whereby the sponsor and other responsible entities make repairs and/or pay the association so that it may make the repairs. In exchange, the association gives the responsible entities a release and hopefully everyone lives happily ever after.

But…should we litigate? If there is no amicable resolution, should the association litigate? This is a big decision and the “cost to cure” and “viability of recovery” evaluations become that much more important. There are many times where a litigated transition is necessary. The board should not shrink from turning to the courts on behalf of itself and its members. But, before doing so, a cost-benefit analysis must be carefully considered.

If the cost to cure and probability of recovery outweigh anticipated expert fees, attorney fees and other expenses, litigation likely makes sense but if the board finds that it is more economical, certain and timely to merely fix the deficiencies itself, it may do so and sign no release. In any case, transition releases should not be signed in exchange for nominal or no consideration. In sum transition is due diligence involving attorneys, experts, managers, board members and association members to cost-effectively resolve physical and financial deficiencies.

Associations’ Right To Sell Units

Posted on Author By Francis J. McGovern, Jr., Esquire

Along with associations’ ability to sell units by foreclosing on liens, they can also sell units to satisfy money judgments – if they can prove the owner has no other personal assets.  A New Jersey court rule and statute both permit a judgment creditor to levy upon a debtor’s real property if the creditor cannot find assets to satisfy the judgment elsewhere.  In other words, if the association sends an information subpoena to the debtor, performs asset searches and sends the Sheriff to the debtor’s property to inventory personal property, and there are no assets found that can satisfy the judgment, the court rules and statute allow the association to levy the debtor’s real property and sell it at Sheriff’s sale. At Sheriff’s sale, either a third party will purchase the property or ownership will revert back to the association and the association can rent the property.

This process was recently confirmed by the Appellate Division.  On behalf of an association, this firm filed a motion to permit sale since no personal assets could be found.  The motion judge denied the motion because there was an outstanding mortgage on the property and the judge felt that it would not be fair for the association to sell or rent the property and collect its judgment while the mortgagee was foreclosing.  This firm appealed the motion judge’s decision and argued the matter before the Appellate Division.  The Appellate Division reversed the motion judge’s decision in the unpublished opinion, Birch Glen Condominium Association, Inc. v. Boahene.  We successfully argued that the outstanding mortgage on the property is irrelevant to the association’s motion.  The Appellate Division agreed with this firm’s position that the motion judge erred by failing to base his decision on whether the association had taken adequate steps to try to satisfy the judgment out of personal property.  The case was remanded back to the motion judge with instructions that the judge determine whether the association made reasonable efforts to located the defendants’ assets to satisfy its judgment.

Developer Guilty of Consumer Fraud

Posted on Author By Francis J. McGovern, Jr., Esquire

In Etelson v. Shore Club Urban Renewal LLC, a Hudson County jury found that the developer, the LeFrak Organization, Inc., Newport Associates Development Company and James LeFrak violated the Consumer Fraud Act and Planned Real Estate Development Full Disclosure Act (“PREDFA”) in their advertising and marketing of a luxury high rise riverfront condominium in Jersey City (Shore Complex, North and South Towers). The jury found that the developer and its marketing materials misled purchasers of condominium units by advertising breathtaking and panoramic views of the water and Manhattan skyline when the developer knew those views would be blocked in the near future.

The jury relied upon several key facts in order to find the Developer liable for consumer fraud.  The developer’s marketing materials included a painting of the Shore Complex showing a smaller 11- 12 story building to be constructed across the street and northeast, between the Shore Complex and the Hudson River.  The developer’s sales brochure and website did not show any buildings located between the shore Complex and the Hudson River. There were some drawings that showed a smaller building to be constructed in the future.  In addition, to the Developer’s marketing materials, the developer’s sales staff told potential purchasers that a smaller building (12-15 story) might be constructed on the nearby parcel. All the while the Developer was constructing a larger building that would block the view of the river and the Manhattan skyline.

The unit owners testified that they purchased these units for the views of the river and the Manhattan skyline. The unit owners also testified that they would not have purchased the units if they were informed that a taller building was going to be constructed across the street blocking their views.

The jury awarded the unit owners $1,253,420 in damages representing the reduction in value of their units without the views. Because the jury found that the developer violated the Consumer Fraud Act, the plaintiffs were awarded treble damages, plus their costs and attorneys fees for a total damage award of $4,817,638.12.  The developer appealed and the Appellate Division affirmed the jury verdict and found that it was supported by the evidence.

The evidence at trial showed that while actively marketing the Shore Complex, the developer had submitted plans to the City planning board seeking approval for a 31 story rental apartment building tower to be constructed which would block the Shore Complex unit owners’ views of the river and the Manhattan skyline. The developer did not change its marketing material and did not disclose this to potential purchasers. Instead the developer continued to market the units by advertising spectacular views knowing that they would not last for long.

The jury found that the developer had misrepresented the views and failed to disclose their plan to develop the taller 31 story tower that would block the views. None of the developer’s sales agents told prospective purchasers that a taller building would be constructed between the Shore Complex and the Hudson River.  The Developer’s sales staff was not told about the plans to construct a 31 story tower.  They assured potential purchasers that the building to be constructed in the future would not block views for anyone residing on the 15th floor or higher.  Interestingly, the Developer’s sales staff testified that if they had known of plans to construct a 31 story tower between the Shore Complex and the river, they would have disclosed this to potential purchasers.

At trial, the developer argued that it did not mislead the purchasers because there were disclaimers on the marketing material and in the Public Offering Statement. The Appellate Court noted that these disclaimers were not dispositive on the issue of misrepresentation and indicated that the developer would still be liable if the jury found that there were misrepresentations or omissions that induced a purchaser to buy a unit.

This case is significant to Associations who are in the process of transition, the transfer of control from the developer to the Association and the identification and resolution of construction defects and financial defects.  The court affirmed that a developer can be liable to individuals for consumer fraud in the marketing and advertising of the condominium. The court also noted the significance of marketing materials, advertisements and conversations that were not part of the sales contract or the POS.

Golf Carts & Low Speed Vehicles

Posted on Author By Francis J. McGovern, Jr., Esquire

Do they really mean “golf carts” or are they talking about “low speed vehicles” a/k/a “neighborhood electric vehicles”.  Golf carts in the strict sense are “off road vehicles”, that being said, LSVs and NEVs are not.  LSVs and NEVs are typically limited to 25 or 30 miles per hour and are subject to National Highway Traffic Safety Administration regulations as well as to certain Federal Motor Vehicle Safety Standards.  We represent many active adult communities and although we have not had to prepare such a resolution yet (some just allow golf carts), we encourage our age restricted communities to seriously consider golf cart/LSV/NEV resolutions.  Not only are these vehicles, if properly regulated, convenient, as residents “age in place” there is a strong probability that such vehicles will permit residents enhanced mobility and/or be required as “reasonable accommodations” for certain handicapped people – we have already seen such cases come out of Florida courts

Protecting Against Slip & Fall Claims

Posted on Author By The Association Lawyers

It happens every winter. The Association is hit with yet another bad snowstorm. The snow removal crew arrives early and is attempting to clear the snow faster than it falls. Meanwhile a resident has decided to take his daily constitutional around the Association. The resident slips at the end of his driveway on a patch of ice and breaks his wrist during the fall. He sues the Association and is awarded significant damages. In addition to a snow assessment to cover the unpredicted snowfall, owners can now expect increased insurance premiums due to the slip-and-fall lawsuit.

This situation occurs frequently within associations.  However, an association can protect itself from this expense by passing a Tort Immunity Amendment. A Tort Immunity Amendment helps insulate an association from liability in a lawsuit filed by one of its members for a personal injury, such as a slip-and-fall claim.  Without this amendment in place, if an owner slips and falls on the association’s common property, the association often times is held liable for damages. This expense is then passed on to all owners through increased insurance premiums.

With a Tort Immunity Amendment in place, an owner’s ability to be successful in a lawsuit against the association is limited. It is important to note that this amendment does not grant the association complete immunity to act without the potential for liability.  The association may still be held responsible for any willful, wanton or grossly negligent act or failure to act.

With the winter months quickly approaching, it is imperative to review your association’s governing documents to ensure that the association and its members are protected against personal injury claims that frequently arise during this season and the resulting expenses. If an association does not yet have tort immunity, it can adopt an amendment to its bylaws providing for such immunity. By statue, at least 2/3 of the membership must vote to approve such an amendment.

Easing The Burden Of Vacant Units

Posted on Author By The Association Lawyers

In these tough economic times, it seems no association is immune to the burden of vacant units. While failure to pay assessments is the most obvious problem, vacant units can introduce a host of other problems from squatters to burst pipes. While there is no quick fix or magic formula to correct the scourge of vacant units, there are steps that every association can take to ease and even eliminate the financial and maintenance burden vacant units can create.

If the association is willing to rent units, often the best option is to contact the owner of a vacant unit to see if they would consider signing a quitclaim deed or a rental agreement. A quitclaim deed transfers ownership of the unit to the association, subject to any mortgage or other liens on the property. A quitclaim deed offers two enormous benefits. First, the association can rent the unit and begin recouping the arrears that have been accumulating. Second, the association can monitor and control the unit and ensure that it does not become a health and safety hazard in the community. A rental agreement provides the association with the authority to rent the unit on behalf of the landlord and collect the rents. It offers many of the same benefits as a quitclaim deed, but without the permanency of actually transferring ownership. In either case, the association should ensure that the unit is in rentable condition – or can be made rentable for a reasonable cost – prior to entering into any agreements.

In New Jersey, a mortgagee who takes possession of a unit is responsible for pay ongoing assessments throughout its possession. If a mortgagee has taken possession of a unit, the association can pursue the mortgagee directly for unpaid assessments. It is a fact sensitive inquiry as to when a mortgagee has taken possession. Whenever it appears that a mortgagee has become involved with a unit, it is best to contact the association’s attorney to determine what options the association may have.

Beyond collections, vacant units also can create nuisances and even health and safety hazards. N.J.S.A. 46:10B-51 requires foreclosing mortgagees to maintain vacant and abandoned properties. While the mortgagee does not have to keep a property in pristine condition, it is responsible to ensure that the property does not become a nuisance or violate any state or local code. If a vacant unit is in disrepair, the association can demand that the mortgagee make the necessary repairs and, if it fails to do so, notify code enforcement who should then force the mortgagee to make necessary repairs and perform necessary maintenance.

Lastly, with the temperature continuing to drop, associations may be forced to take some maintenance and repairs into their own hands. If a vacant property has not been winterized by the mortgagee, every association with attached units should hire a plumber to winterize any vacant units. Pursuant to the Condominium Act, N.J.S.A. 46:8B-15(b), an association has the right to enter a unit during reasonable houses “to perform emergency repairs necessary to prevent damage to common elements or to any other unit or units.” Therefore, the association may step in to winterize properties in order to prevent the extensive damage that can be caused by a burst pipe. The association can also bill back the costs of the repairs to the unit owner. While this may seem like an added cost to the association, the cost of winterization is minimal compared to the costs of repairing the area surrounding a burst pipe, not to mention the inconvenience to the surrounding units. This same logic can be applied to other unit owner responsibilities, like a broken window or door. Keeping vacant units secure is the best way to protect the entire association and to prevent much greater costs down the road.

While vacant units are never welcome, they can be controlled and even become income generating assets if the association is proactive.

Winterize Vacant Units

Posted on Author By Michael Polulak, Esquire

It’s that time of year again… when extreme cold can cause pipes to burst in vacant units.  In light of this, it is important that managers gain access into known vacant units to winterize them.  This avoids unnecessary insurance claims and premium increases caused by ruptured water lines.

The Condominium Act provides authority for condominium associations to gain access into a unit for the purposes of protecting the common elements and adjoining units.  The statute, N.J.S.A. § 46:8B-15(b), also permits the condominium association to charge any costs incurred in gaining access and winterizing the unit back to the unit owner.  However, prior to gaining access into the unit, the Association should provide reasonable notice to the unit owner and advise that the unit owner that they will be liable for any costs incurred in gaining access and winterizing the unit.

Further, N.J.S.A. § 45:22A-44(b) authorizes homeowner and townhome association boards to exercise its powers in a way that protects the health, safety and general welfare of the residents of the community.  In addition, each association’s governing documents typically provide additional authority permitting the Association to gain access into units in the event of an emergency.  Between the authority granted  in the association’s governing documents and N.J.S.A. § 45:22A-44(b),  homeowner and townhome associations generally have sufficient authority to gain access into vacant units upon reasonable notice to the owner to winterize them for the purpose of protecting adjoining units and common elements.

So, if there is any indication that a particular unit is vacant and not winterized, then we advise that management or our office send a notice to the owner advising that the Association will gain access to the unit to determine whether it is vacant and whether it has been winterized.  If vacant and not winterized, then the association will winterize the unit and charge the unit owner back any costs incurred.

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