How One Late Payment Can Sink Your Building's Budget

Every board will have to deal with residents in arrears at some point. But in this conversation, Marc Schneider, managing partner and CEO at the law firm Schneider Buchel, reveals why waiting even 45 days to pursue collections can devastate your building's finances. Schneider explains how communities with 20% arrears can still survive, the legal loopholes that give co-ops massive advantages over condos, and why your governing documents might be costing you thousands in uncollected legal fees. Whether you're dealing with habitual late payers or facing your first major arrears crisis, this episode delivers the insider knowledge you need to protect your community's financial health and stop subsidizing non-paying residents with your own money. Habitat's Emily Myers conducts the interview.

The business of running a building is demanding work that requires making endless decisions — some that can quickly lead your board into a quagmire of legal difficulties. Legal Talk interviews New York's leading co-op/condo attorneys to find solutions, and get some guidance, on these challenges. For more co-op and condo insights, sign up to receive Habitat's free newsletters or become a Habitat subscriber today!

Transcript

Emily Myers: Welcome to Legal Talk, a conversation about the governance issues facing New York's co-op and condo boards. I'm Emily Myers with Habitat, the magazine for New York City's co-op and condo board directors. And I'm joined by Marc Schneider, managing partner at Schneider Buchel. When shareholders or unit owners fall behind on payments, the remaining residents in the co-op or condo are left to carry the financial burden.

Mark, what's the first step for boards dealing with residents who are in arrears? 

Marc Schneider: The first step is to be proactive, and it's super important for boards to aggressively pursue the collection of their arrears. I know that oftentimes boards might say we could wait, the person's gonna pay, they're gonna sell their apartment, they're gonna get a job, whatever the circumstances might be.

But it's very important to understand that co-ops and condos, their governance is based upon a budget, which assumes that everybody is paying the maintenance and the common charges. So if you have even one person who's not paying their maintenance, that means that you're not collecting a hundred percent of the revenue that you might otherwise collect, which means that you need to either reduce your expenses or get that revenue from somewhere else, otherwise you're not gonna be able to pay your bill. And in that regard it's really important. We've been retained by communities where they have five, 10, we've even had communities that have 20% in arrears.

And one of the first things we tell them is, you need to go to your budget and you need to put a bad debt expense line item in there so that you make sure that you're collecting enough money to pay your bills. Because at the end of the day, the expenses are the expenses, and unless there's something in there that's discretionary, you're not gonna be able to change a lot.

I find that in most instances, most of what makes up the expenses in a budget of a condo or a co-op are fixed expenses that aren't going to change, whether they're, salaries, there's heating, you can go straight down the line of all the accounting expenses, whether it's water or gas, you name it.

You really don't have a whole lot of control over most of the expenses. So my first and most important piece of advice is don't wait. Waiting is usually the the biggest issue that co-ops and condos come into.

And the other thing you should think about is that it's a lot easier for someone who's in arrears to pay a smaller amount than it is a larger amount. 

Emily Myers: So what are some of the long-term effects of failing to act quickly then on outstanding payments? 

Marc Schneider: When you don't act quickly, you suddenly find yourself in a spot where you can't pay your bills because you don't have the revenue.

Look, if you think about anything you do anywhere you go to shop, right? At the end of the day any business that operates properly has to know that they're pretty sure their revenue is gonna come in order to pay the expenses they may have. And like I said, in co-ops and condos, most of the expenses are fixed.

You can't do much about them. So if you can't do much about them, you need to be sure that you're gonna have the amount of money that you're budgeting. And when you're budgeting, if you think that you're gonna have five people that aren't gonna pay, don't just put a budget that assumes that everyone's paying, because guess what's gonna happen?

You're not gonna have all of that money come in, and when not all that money comes in, you can't pay your bills. 

Emily Myers: So what you are talking about here is managing arrears and putting a bad debt expense line item helps to manage arrears, but what about recovering arrears? How do boards approach that?

Marc Schneider: So my advice to boards is that when you have a shareholder or a unit owner that is what I say is two months in arrears and two months. It's really not two full months because you owe the first month. On the first of the month, maybe you have a 10 or 15 day grace period. And the second month comes in again on the first day of that second month.

That's only 31 days, right? And then if you have a 10 or 15 day grace period, so about 40 to 45 days out, when someone hasn't paid two months obligations you absolutely should pursue collection. Now, when someone doesn't pay the first month. You should have a notice that goes out and in a co-op world, you have the Housing Stability Tenant Protection Act, where you've gotta send certain notices out when someone's late.

But typically a managing agent is gonna send a letter or notice or an email that says, Hey, we've noticed that your maintenance or your common charges haven't been paid. When that second month hits, and they still haven't paid it, and they haven't answered the notice, you gotta turn it over to counsel because it's effective lawyers that are going to be able to recover for you.

And when I say turn it over to counsel, it is really important that you have counsel that are aware of how to handle an arrears case. And what I mean by that is don't look for the cheapest attorneys, or what some people call are mills for collection because they're not gonna pay the attention that needs to be paid.

They're not likely gonna be paying that attention and they're not likely gonna know many of the effective strategies that are going to maximize the likelihood of you recovering the amounts that you're owed quickest, the most amount of money that can be owed. 

Emily Myers: So what are the effective strategies to get that money back?

Marc Schneider: It depends on whether you're talking about a co-op or a condo here. So let's start with co-op. For co-ops, for instance, if somebody has a what they call a co-op loan. People call it a mortgage, but it's really a co-op loan. There's a document called a recognition agreement that the lender and the shareholder and the co-op enter into when that loan is taken out, usually when there's a purchase or a refinance and that obligates the lender to pay the maintenance that's unpaid or that lender could actually lose their security interest in the stock.

They can actually get foreclosed and cut off. And the beauty of a co-op is a co-op has priority over that loan, as opposed to a condo where you're actually behind that first mortgage that exists. One of the strategies would be going to the lender under the recognition agreement and saying, if you don't pay this, we're gonna foreclose the shares.

The other thing is you send the default notice out. And after you send the default notice out, you could actually commence what's called a landlord tenant proceeding in a landlord tenant court where you can actually evict the shareholder for not paying their maintenance. So that's a strategy and you take that through.

Additionally you have a benefit in a co-op in that you can do what's called a UCC Article Nine Foreclosure. Relatively straightforward, simple. Non-judicial process, meaning you don't go through a court with it. It's a 30 day notice, and then an auctioneer publishes and they go to the steps of a courthouse and actually auction off the stock and you get paid by the successful bidder.

And by the way, if there's no successful bidder. , the co-op would get the stock and the lease back for what it's owed, so you don't actually have to write a check, and then it would enable the co-op to actually sell that stock and lease. In many instances, it enables you to generate a huge profit under those circumstances.

And there are strategies that we employ as well, because most co-ops, look, you have control over the purchasers in co-ops. You still have control when you do a foreclosure sale. There's a document called a Terms of Sale. Which is used in connection with that auction. And you could put conditions in those terms of sale.

For example, you could put in there that the purchaser must be someone that intends to occupy the unit as their their primary residence so that you don't wind up with investors who intend to sublet or rent out the unit. Especially when most co-ops, they don't want renters. So that's one of the things you would do.

And strategically, speed is the most important thing here. The faster you proceed, the faster you're gonna get your money back. In a condo, or a homeowner's association, you actually would send out a default notice. And after you send out that default notice, you could also file a lien and foreclose that lien.

Those lien foreclosures are done just like they are like a bank would foreclose a mortgage. The only difference is you don't have to give out some of the notices that the lending institutions have to give out, 'cause the condos and HOAs are not lending institutions. And within 18 to 24 months you can actually foreclose the unit.

Now, I know a lot of boards sometimes say, yeah, but the first mortgage is ahead of us. What are we gonna do? We're still gonna have the first mortgage. That's true. You would foreclose it and you would take that property back if there's no bidder, subject to that first mortgage. But that first mortgage may not even be in foreclosure, which enables you to do things like rent the unit, or if the bank is having a problem, let's say they're not paying the bank and the bank has a defect in their paper, so to speak, in their security interest, the bank may actually purchase the interest from the condominium.

I've actually had a lender purchase the condominium's position after the condominium foreclosed and then the lender doesn't have to foreclose 'cause they have good title and speed is important, right? Because what happens in the lending institution situation, the default rate of interest adds up so quickly that oftentimes the banks are underwater very quickly.

I've also had scenarios where the condo or the HOA has rented out the unit and they've actually made more than they've actually been owed. Because it might take a lender 3, 4, 5 years to finish their foreclosure. And while that's happening, you're collecting the rent on the unit.

It doesn't mean you pay the mortgage. You're not obligated to pay the mortgage when you take over the property pursuant to a foreclosure. You may sometimes have to pay the real estate tax in a condo or an HOA setting in order to avoid a tax lien from being foreclosed.

But if there's a lender with a first mortgage, the lenders are usually paying it because they don't wanna lose their interest to a tax lien foreclosure. That's something to consider. You also should know that if there's a second mortgage, meaning a subordinate mortgage on a condo or a homeowner's association, oftentimes that lender will actually pay the condominium or the homeowner's association what's owed to prevent the condo or the homeowner's association from foreclosing and cutting them off. 'cause you can cut off a second or other subordinate mortgage in that setting. So speed is really critical. The faster you move, the more the options open up for the board. 

Emily Myers: So do most situations lead to this level of litigation or. Can the arrears be recovered in a more perhaps amicable way?

Marc Schneider: So look, here's what I'll say. When that formal default notice goes out from our office, I would say that in about a third of the instances, people will pay, because they realize, oh, wait a second, I could lose my home, I could be evicted or I could be foreclosed.

And if they have the funds, they're gonna pay it. About a third of them will require the commencement of that summary proceeding or the commencement of the foreclosure action. And then about a third of them, and again, these numbers vary depending on the community, and about a third of them will wind up having to go the mat and when you do have to do the foreclosure or the eviction in many instances you don't have to complete it. Just before it gets to the end, people will pay because they don't want to fall subject to the ramifications of losing their home, essentially. And there are some other things that you should factor into, which is when you're using effective counsel that know what they're doing, we're gonna look at your governing documents, and in many instances, you're entitled to collect interest on the arrears.

And I could tell you that we've collected interest for a lot of our communities that exceed what their legal budget is for the year. I've had instances where we've collected 20, 30, 40, $50,000, even more in interest from someone that's been in arrears for three, four, or five, six years, and that interest starts to accrue and gets very large. So you wanna make sure that you're looking at the governing documents and whatever remedies that the association is entitled to, they avail themselves are. So you've got interest, you've got late fees if you're governing documents permit them, and of course the right to recover legal fees.

And there too, by the way, is an interesting conversation, which is most governing documents have the right to recover legal fees when you're in arrears. But in the condo, HOA arena, they'll oftentimes say reasonable legal fees as opposed to actual legal fees. There's a big distinction there because what the court system holds is reasonable, gives the judge the right to say what they think is reasonable. As opposed to if it's actual, they should be giving you whatever the actual fees are.

So in a lot of instances, we'll suggest to our boards that they actually seek to amend the governing documents to change that word. We've had that happen and been very successful with it. And look, it's not hard to sell a community on that amendment because the answer is if you're not getting back all the legal fees, who's paying them?

It doesn't mean that the board doesn't pay the legal fees to the law firm. They still do. It just means that your legal fee budget, which is paid by all the homeowners and shareholders is gonna have to be higher. You're gonna have to collect more money. It means all the paying people are gonna pay for the non-paying people and the work that's required to collect those monies.

Emily Myers: Sure. So that's a really comprehensive overview. And are there any red flags that indicate a resident is likely to fall into arrears? And how can boards preemptively address this? 

Marc Schneider: So look, unfortunately, it's not very common that a resident that loses their job come to you and say, look, I got a problem.

How can I work this out? Most times you're gonna, you're gonna see it when they just don't pay their maintenance. And it's important that boards and their managing agents look at the accounts receivable report, the arrears reports monthly. And look, you may have habitual late payers.

I know that in, in many communities you'll have someone that'll pay, and then they won't pay, and then all of a sudden they'll cure, and then three months later they're in arrears again. It might be instances like those where you might even avail yourself to going to do the UCC foreclosure without the route of the landlord tenant proceedings. That the person realizes, you know what, I'm not gonna play this game and every six months I'm gonna go into landlord tenant court and then I'm gonna resolve it. You want to give them a reason to have to pay. And the other thing is, charging late fees and interest when you're allowed to charge it, as well as legal fees, is another thing that will give someone an incentive to pay as opposed to them being on essentially an annuity plan where they just keep funding legal fees and interest. At some point they're gonna realize they're better off not paying others. But to answer your question about red flags you're gonna have those people that are habitual late payers, and then I think you have to deal with them a little bit even more aggressively than you might deal with others.

But if you find out that someone's lost a job or had some life event because people talk to people, that might be the thing to see if you're, if you're getting contacted by a judgment holder, sometimes you might get a subpoena that's asking you for information that's gonna be a red flag that, hey, wait, they're probably gonna be falling into a arrears with us as well.

 Boards need to raise money if you have a need for an assessment. For example, recently insurance went up significantly. And we know that inflation's been very, high over the last few years, and I've had these discussions with boards that say, we can't raise our maintenance 10%, nobody's gonna be able to afford to pay it.

And my response to that is let's look at the budget, because if there's nothing on that budget that you can cut out, you have a fiduciary duty to raise it. The other thing is, you get a board member occasionally who's not able to pay something, and you have to say to that board member, if you are conflicted, then you should recuse yourself from those discussions because again, your fiduciary duty is to the corporation or the condominium to make sure that it can pay its bills.

So it's very important that boards when you need to raise your money that if you can't cut an expense, like if your insurance went up and your broker tells you there's no alternative, we've put, gone out to market and it's not gonna get any cheaper, then what do you do? You need to raise the amount of maintenance or common charges and not be fearful of the fact that someone can't pay.

And if you think that 5% of the people aren't gonna be able to pay, then make sure that you make that assessment essentially 5% higher so that you're gonna collect enough money to pay your bills. 

Emily Myers: Wow. Marc, so much good information there. Thank you so much. Marc Schneider, managing partner at Schneider Buchel.

Thank you, Marc. Brilliant. 

Marc Schneider: You're very welcome. Pleasure being with you today.