Facing Co-Op Bankruptcy

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Facing Co-Op Bankruptcy

The last thing co-op residents want to learn at their annual shareholders meeting is that their co-op is in risk of going out of business. But this is a reality for a lot of individuals. Co-ops are declaring bankruptcy and abandoning its “owners” every year.

What Is a Co-op?

Co-ops are housing arrangements where each tenant owns a portion of the company, which is the legal entity. These investors are given a private lease, or privilege, that allows them to occupy one of the flats or units. In reality, the owner does not really own the property; rather, they just possess shares in the company. The property is owned by the company. Owners of the shares contribute a monthly maintenance fee that is used to pay for the building’s upkeep expenditures, including taxes, insurance, cleaning, heating, water, staff wages, rubbish pickup, repairs, taxes, and the building’s principal mortgage.

Types of Default

Mortgage defaults and technical defaults are the two most well-known forms of co-op defaults.

  1. Technical errors seldom have major consequences. This type of default “consists of the failure to make repairs in violation of the mortgage agreement even though all monetary payments have been made on time,” according to Adam Leitman Bailey, Esq., a New York and New Jersey real estate attorney and the founder of the residential and commercial real estate firm Adam Leitman Bailey, P.C. in New York City. These kinds of defaults are often resolved by making arrangements for the repairs to be finished or at the very least, paid for.
  2. Because the lender is not getting payments for the building as per the original contract, mortgage defaults are substantially more dangerous. For stockholders who have faithfully paid the monthly maintenance without skipping payments, this is an unpleasant position. For cooperatives, this is often the quickest path to declaring bankruptcy. If the mortgage delinquency is not addressed, the lender issues a Notice of Default to the building’s management, and the foreclosure process starts if it does.
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Worst Case Scenario: Foreclosure

The worst scenario that may occur when a co-op files for bankruptcy is foreclosure. A foreclosure is a legal action brought by the lender to take ownership of the structure. A referee will hold an auction to sell the building, and the shareholders will revert to being rental tenants and no longer “own” their apartments, according to Stuart M. Saft, a Partner at Dewey & LeBoeuf LLP. In New York, a foreclosure can take several years, but unless the co-op has a strong defense, the shareholders will no longer “own” their apartments.

The lender has the right to foreclose on the property and evict the shareholders if a co-op declares bankruptcy as a consequence of missing mortgage payments. Because the mortgage on the building is not a personal guarantee by shareholders, Bailey continues, “The lender of the underlying mortgage cannot pursue each apartment shareholder.” The co-bank op’s will be compensated in a bankruptcy proceeding before the shareholders.

Therefore, the bank will get payment from any profits from the foreclosure sale in a bankruptcy. Even if they no longer own the apartment shares, shareholders who have personal mortgages are still liable for those payments.

The choices available to stockholders in this situation are limited. The co-op mortgagee may seek to convert a Chapter 11 (a reorganization) filing by the co-op to a Chapter 7, or liquidation, in which the building is sold right away.

If the co-op shareholders are still residing there after a bankruptcy or foreclosure, they continue to be tenants, but their proprietary lease is terminated. They may face negative income tax repercussions if they owe any mortgages on their flat but fail to make payments, according to Saft.

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If a cooperative is in danger of going into default, it might attempt to make up on payments by taking out extra loans, increasing the monthly maintenance, or adding assessments. An assessment is a brief rise in the cost of maintenance every month. This increase is intended to pay for any necessary repairs or other co-op expenditures.

Are Co-op Bankruptcies Common?

Bankruptcies involving co-ops are uncommon. Saft claims: “Since World War II, less than 10 co-ops have been foreclosed in NYC, therefore it is unlikely to happen today. However, being watchful pays off.” If all funds in the note become due as a consequence of a technical default, bankruptcy might follow, although this is improbable.

What Can Shareholders Do?

Unfortunately, if stockholders have already acquired the co-op flat, there isn’t much that can be done. They need to get assistance from an experienced attorney if they bought shares in a failing cooperative. The secret is to shop around wisely and research the co-op before making a purchase.

According to Bailey, he examines the building’s financials over the last two years to ensure the building is stable when he represents a buyer. He assesses the building’s cash reserves and compares the financial statement to any significant structural upgrades or required repairs. Buildings that are unable to pay their bills or their mortgages are a major warning sign.

Co-op apartment seekers may prevent choosing a “poor” co-op by requesting the financial information themselves. A two-year history may provide a clear picture of the building’s performance (or lack thereof). For instance, a small cash reserve can be a sign that the co-op won’t have enough money to pay for urgent repairs. In this scenario, the co-op would have to get the cash from either shareholders or the bank in the form of another loan.

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When looking for an apartment, shareholders need to ask important questions. For instance, find out whether the co-op has been paying its mortgage on time each month. Ask why if there have been any late payments. Ask whether there are any outstanding debts outside the mortgage, if any significant repairs are needed soon, and if so, how the cooperative intends to pay for them.

Saft offers these advice: “Check the most recent financial statement to see whether the accountant gave a clean audit report; get your lawyer to check to see if any liens have been filed against the structure or real estate taxes are past due. If many shareholders are not paying their upkeep, try to find out from the managing agency. Check the minutes of the co-op with your attorney to determine if there are any issues.”

The Bottom Line

The co-op board has the ability to inquire about your financial background from a possible buyer. It wants to make sure that, in addition to your own private mortgage payment, you will be able to handle the obligation of monthly maintenance. But as a buyer, you also have the right to demand financial security in the residence you choose. Make certain to inquire about every aspect. Use your rights; it’s your future.

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