Why Your Sponsor May Still Owe Your Building Money

Board members taking control of new condominiums need to engage an independent accountant to perform a proper financial true-up — before it's too late. Amy Jennings, a manager at WilkinGuttenplan, reveals how one Manhattan condo board discovered their sponsor owed them six figures only after the waiver period (when the sponsor markets the building by waiving common charges) ended. The building had secretly been running at a loss for at least a year. Worse, this isn't an isolated incident. Jennings explains the crucial differences in accounting that create these budgeting gaps. If your building recently transitioned from sponsor control, this episode could save your building substantial money. Habitat's Carol Ott conducts the interview.

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Transcript

Carol Ott (00:39)
Welcome to Problem Solved, a conversation about challenges facing New York Co-op and Condo board directors. I'm Carol Ott with Habitat Magazine, and I'm joined today by Amy Jennings, a manager at Wilkin Guttenplan, an accountancy firm. Amy, thank you so much for being here.

Amy Jennings (00:57)
Thank you for having me, Carol. I really appreciate it.

Carol Ott (00:59)
There are many ways sponsors market their new condominium buildings. And one of the non-sexy ways is to pay for all expenses to operate the building and waive common charges during this period. When the waiver period ends and a resident board takes over, it's a good idea to confirm that all the finances have been accounted for. Amy, you recently worked with a condominium

where you found that the finances were not in order. Can you explain what you found?

Amy Jennings (01:32)
Yes, so we were recently engaged with a new construction condominium in Manhattan. The building has less than 100 units and we were asked by its managing agent as the board recently transitioned from sponsor control to a fully residential board to submit a proposal for their upcoming audit. And when we go through the process of a request for proposal, we'll typically

request certain information just to make sure it's a good fit for us, for the client, to ascertain an appropriate fee. And that information typically includes the most recent financial statements, the governing documents, perhaps tax returns, other relevant information. so just to kind of give a little bit of background on this, the building commenced operations in late 2021.

their first initial period under which they were subject to an audit ended in 22, we were engaged for 23 audit. When we did our initial review of the 2022 financial statements during which we would expect to see that kind of, we call it true up between the sponsor activity and kind of the end of that waiver period, we anticipated to see that being properly accounted for in the 2022 financial statements. And what we ended up seeing

Was that it appeared that there were some discrepancies in how that activity was reported. So specifically when we did a quick look of those financial statements, we noticed that the building operated at a significant deficiency for the initial period.

yeah.

Carol Ott (03:03)
Can you just

explain when you say significant deficiency, does that mean the budget wasn't balanced? They were in a deficit?

Amy Jennings (03:10)
Yes. So to clarify, that means that they ran at an operating loss for the year. Basically, the revenues were not sufficient to cover the expenses of the building. And that would be reflected on their profit and loss or statement of revenues and expenses for the year.

Carol Ott (03:26)
So from what you're saying then, whatever the sponsor contributed or was covering didn't look like it was enough. Got it.

Amy Jennings (03:34)
Exactly. That's exactly

the right way putting it. So we saw that there was this significant loss on the statement of revenues and expenses, which would suggest that the sponsor funding wasn't properly offset against those corresponding expenses. And conversely, what we saw was that those contributions from the sponsor were actually recorded as a component of equity, which in our opinion was inappropriate revenue recognition.

Carol Ott (03:58)
Let me just stop you. So when you see a in a financial statement, just explain to me the revenue recognition I presume you can recognize it as cash. It can be accrued. And I don't understand what equity is.

Amy Jennings (04:00)
Yeah.

So

yeah, that's totally, totally great question. basically equity is something that, let's say there could be different components of equity. It could be your accumulated earnings from the inception of the building through today's date. You could have certain sections of equity that are restricted for certain purposes. So a common example we see in condominiums would be a working capital contribution.

Many governing documents require a working capital contribution equal to let's say two months upon initial sale. Those funds would be held within equity. So there could be different components, but that essentially will sit as a balance sheet item. Now in terms of the other question about kind of how the loss plays in or how that would kind of look if we were looking at this in

how the revenue should be recognized to offset that. So typically, and I think it makes sense if I kind of give a little background on how the accounting works under a waiver period, that might give a little bit more insight. So in most cases, as we mentioned, the sponsor has the option to delay common charges for a period during their control period. And instead, they would opt to be responsible for the operating expenses of the building. Now, depending on the individual

governing documents of the building, the expenses or other items or obligations that the sponsor is responsible for might vary. So there could be some buildings where the sponsor is responsible for other items other than just the operating expenses. What would then happen is during that control period, the waiver period, the managing agent of the building would typically prepare what we call requisition for the sponsor. So let's say we're looking at the month of February.

and they would look at all of the amounts paid during February, you all the invoices paid, and determine which amounts, if any, the sponsor is responsible for. Now, for under a traditional waiver period, all of those expenses would typically fall within that purview. Then what they would do is they would accumulate those amounts and submit that as an invoice or bill to the sponsor and say, we spent X amount that you were responsible for this month.

please cut us a check in the amount of X amount. And that's typically how that would function throughout the entire waiver period. At the end of the waiver period, there would be a true up between the amounts that the sponsor contributed. So all the amounts that they funded based on those requisitions and the expenses and other obligations for which they were responsible. In a perfect world, those amounts would be equal. Of course, that doesn't happen in reality very often.

And so what could happen, and this typically does happen, is that the excess of the expenses or obligations that the sponsor was responsible for are not sufficiently covered by the funding that they provided. And that would result in a balance due from the sponsor to the condominium. Yeah.

Carol Ott (07:03)
Let me just jump in. When you say it's not

sufficient to the funding, is it, I understand there's a way of looking at your books from an accountant's perspective, but from an actual operating perspective, I presume in this building, they were able to pay the bills. So the sponsor actually was covering the expenses of the building.

Amy Jennings (07:24)
Yes, that's correct. So they were paying the funding in this situation. And there can be a few different components that result in this kind of difference at the end of the day. So first and foremost, when the managing agent is looking at these requisitions, they're typically looking at it on what we call cash basis. So just think cash in, cash out. However, under generally accepted accounting principles and how we typically perform this true up, as we like to call it,

We perform that on an accrual basis, meaning we look at when the expenses were incurred or when the service period was provided, than when the invoice was paid. So in our example before, we're looking at February 2025 amounts paid. The managing agent would just look at amounts paid in February 2025. We would look at amounts incurred in February 2025.

And that can include amounts that we physically cut the check for in March, April, May, and beyond. And so that could result in some of those discrepancies between the funding that was requested and the actual amounts for which the sponsor was responsible.

Carol Ott (08:28)
If there wasn't a sponsor in a typical condominium, and I guess maybe co-op also, are the financials done on an accrual basis?

Amy Jennings (08:36)
Yes, typically. So in order to be in compliance with generally accepted accounting principles, typically the buildings would offer report on an equal basis of accounting. There are some exceptions. We do have some clients that report on what we call the cash basis or an income tax basis of accounting under which they're not reporting on an accrual basis. But typically speaking, we see the standard as a full basis of accounting.

Carol Ott (09:01)
So now you were presented with these documents and you saw this discrepancy. What were the steps that you took and what did you find actually?

Amy Jennings (09:05)
Yes.

Yes, so when we noticed this initially, we brought it up directly to the board that was requesting the proposal. So our initial analysis was that that true up had not been undertaken correctly, that there could have been amounts due to the condominium from the sponsor based on what we were seeing. What they asked us to do, we did get engaged to perform the 23 audit, but they also asked us to revisit the 2022 procedures over that true up.

And essentially what we did was we recalculated the balance due to or due from the sponsor as part of our audit. What that included was doing a very thorough scan of all the expenses paid from inception or the first closing of the building through the end of the waiver period, identifying that the service period fell within that waiver period of those expenses and therefore determining the sponsor's responsibility over them.

We compared that to the amounts that the sponsor actually funded based on those requisitions that the managing agent had prepared. And then we did go a step further. So we did a very detailed review of the building's governing documents. And through our reading of the governing documents, the offering plan in particular, we noticed that the sponsor was also responsible for funding reserves during the waiver period. And this is one of those things that

It's not necessarily commonplace. We do see it on a handful of buildings. But that had not been accounted for in the original accounting for the true up as well.

Carol Ott (10:37)
Those original audits were done by whose accountant? The sponsor's accountant?

Amy Jennings (10:42)
So technically speaking, what happens during the sponsor control period is that when they're required to do an audit, typically it can happen different ways. Sometimes the managing agent might have a suggestion for a CPA that they work with frequently. Other times the sponsor might have a relationship with an accountant already and they'll ask them to provide the audit services. And that is what happened in this case. the original auditor was someone who worked

with the sponsor frequently. And something that we do see here and kind of my big takeaway from all of this for any residential board members who might find themselves in this situation is that when you do come into the position of a fully residential board, it's a really good idea to kind of look at those professional service relationships with a fresh eye. Firstly, it's really important to engage an auditor or a CPA who

is both independent in appearance and fact. So if you do have an auditor who has a relationship with the sponsor, sometimes that independence might be not necessarily adhered to, right? Or it might not look independent. The other issue is that those sponsors' accountants might not have the expertise within the niche industry that is condo and co-op practice.

And therefore they might not have the knowledge or the know-how to read the governing documents with the same eye that someone who kind of lives and breathes in this world does. And so for that reason, those clauses of funding the reserves or how the true-up should be performed or the sponsors obligations could be missed. So that is kind of what we think happened in this situation.

Carol Ott (12:19)
And at the end of the day, how much money did you identify the sponsor needed to come up?

Amy Jennings (12:26)
Right, so between those two procedures of relooking and recalculating that true up for the expenses, in addition to the funding of the reserves, we were able to identify an amount in the amount of six figures that the sponsor actually still owed to the condominium. Yeah.

Carol Ott (12:45)
And

in your experience, is the sponsor going to go, yeah, here's a check?

Amy Jennings (12:50)
Not likely.

So unfortunately too, in this particular situation, the waiver period had ended at the end of 2022. We were engaged in 2024 to perform these procedures. So at that point, two years essentially had gone by. So I think in situations like this, the sponsor can certainly be caught off guard. Even the board could be caught off guard if we identify these amounts.

And for that reason, if you do find yourself in this situation, it's a good idea to get legal counsel involved as early as possible just to help with negotiating with the sponsor in terms of getting the settlement in place.

Carol Ott (13:27)
And that's what would have to happen is negotiating with the sponsor.

Amy Jennings (13:31)
Exactly. So what we see sometimes, and I don't know if this will be the case with this particular client, but we have seen with others is that this kind of exercise or amounts identified as either due to or from the sponsor for the waiver period true up can be used as a bargaining chip in other settlement procedures or proceedings with the sponsor. So

let's say the residential board has engaged an engineer to assess for construction defects. It could be that they use this as a bargaining chip, so to speak, in settling those other matters that might arise.

Carol Ott (14:04)
All right, well that is a terrific takeaway, particularly for boards who are just taking over control of their new condominiums. Thanks so much for joining me today. I've been speaking with Amy Jennings, manager at Wilkin Gutten Plan.

Amy Jennings (14:19)
Thank you so much Carol.