The long real estate recession is over, and thank goodness for that. New developments are sprouting up everywhere in response to pent-up demand. There are even condominium developments beginning or long-stalled condominium developments resuming, and it’s time for a reminder about taking collateral in these unique projects.
A condominium is purely a creature of statute. Chapter 703 of the Wisconsin Statutes, the Wisconsin Condominium Act, defines what rights are created when a developer, called a “Declarant,” records a condominium declaration which contains the magic language, “I hereby submit this land to the condominium form of ownership.”
As soon as that declaration, and its accompanying condominium plat, are recorded in the Register of Deed’s Office in the county where the land is located, they create condominium units, which are legally existing separate boxes of air, whether anything is physically built or not. Everything inside the boundaries of the land submitted to the declaration is either a unit, or a common element. Each unit can be separately owned and mortgaged, carries a separate real estate tax bill, and is capable of being assessed a lien for that unit’s share of the expenses of owning, maintaining, and insuring the common elements.
Under the Condominium Act, the Declarant can write into the Declaration, special rights reserved only to the Declarant, and to those the Declarant authorizes to specifically receive those rights, including the Declarant’s lender. These rights are very important, and taking a security interest in those rights can make a significant financial difference to a lender, should the lender need to foreclose those rights, or put them into a receivership. Those rights can include:
- the right to expand the condominium into more land reserved as the “Expansion Land;”
- the right to create more units in the condominium;
- the right to avoid paying a full association assessment for each of the units, as long as it pays the associations’ costs above what other unit owners pay under the association budget;
- the right to reconfigure the boundaries between units by combining units and separating units;
- the right to control the condominium association until a sufficient number of the units in the condominium have been sold to unrelated third parties;
- in some limited circumstances, the power to unilaterally amend the declaration; and
- the right to declare easements over the common elements of the condominium.
The correct way for a lender to take a security interest in these Declarant rights is to take a collateral assignment of declarant’s rights, in a manner similar to an assignment of rents, which gives an immediate grant to the lender of these rights, with a limited license back to the Declarant to exercise these rights, as long as the Declarant is not in default.
The common-interest community framework is seen in almost all legal forms of real estate-related projects and ranges from condominium complexes, housing developments, vacation timeshares, and numerous mixed-use projects. The foundational document of the common-interest community is the “declaration” or the “covenants, conditions, and restrictions” (CCRs) —a document that sets forth the basic framework of the community, imposes a number of deed restrictions, easements, and servitudes, and establishes a governing association of owners geared toward handling the day-to-day and long-term planning related to the community.
These documents are drafted by the developer’s attorney and almost always provide a period of time during which the developer (known as the “declarant”) maintains significant authority over the nature and governance of the community. This is true even after lots or units within the community have been sold to third parties. The argument goes that the declarant ought to maintain a level of control (even at the expense of the interests of the lot owners) for a certain period of time while his investment is still substantially tied up in the project.
Declarant powers are valuable in the hands of the developer, allowing the developer to control additional phases of the project. These powers also have great value in the hands of a lender foreclosing on the real estate or a purchaser buying lots in a bulk sale. For instance, in the event of a developer default, a lender will foreclose on the remaining property within the community that has not been transferred to third-party buyers (such as unsold lots and common areas). Without the ability to control the board of the association and unilaterally make other decisions regarding the community, however, the bank’s collateral might quickly lose value. Because of this, lenders have increasingly come to require that a developer grant a mortgage not only on the real estate to be developed but also in the developer’s rights under the declaration. Thus, after a foreclosure the lender may not only acquire the unsold real property but also may succeed to the developer’s declarant rights to control the community.
The law in many states is unclear, however, on whether CCRs can be collateralized and, if so, how to perfect such security. Moreover, questions abound about what sort of liability might be imposed on a successor declarant. This is particularly important because there might be outstanding claims by the lot or unit owners against the original declarant relative to malfeasance, breach of obligations (such as the obligation to build recreational amenities), or warranty obligations.
This article discusses the issue of how (and if) the complex bundle of rights known as “declarant rights” under the common-interest community declaration can be collateralized. The article first gives an overview of common-interest communities and the declarations that allow for their creation and discusses the benefits and powers they confer on the developer. It then analyzes how courts have dealt with issues related to the transfer (whether voluntarily or through seizure) of declarant rights. Lastly, the article concludes with an overview of how model legislation, specifically the Uniform Common Interest Community Act, treats CCR-secured transactions.
Overview of Common- Interest Communities
Common-interest communities are everywhere. By one account, in 2014 there were over 330,000 planned communities across the United States. See Community Associations Institute, National and State Statistical Review for 2014 (2014), available at www.cairf.org/research/factbook/2014_statistical_review.pdf. The first common-interest communities came into existence around the early 1900s in the form of simple residential homeowner’s associations. See Wayne S. Hyatt, Common Interest Communities: Evolution and Reinvention, 31 J. Marshall L. Rev. 303, 318–19 (1998). Since then, the complexity of common-interest communities has grown tremendously, particularly through the increasing emergence of mixed-use developments. Moreover, the associations that govern and maintain common-interest communities have become involved in spheres beyond the mere physical or traditional boundaries of the development as they seek more and more to influence political decision making at the local level, coordinate social activities for development occupants, and even undertake the privatization of certain public or municipal services. See Stephen R. Miller, Legal Neighborhoods, 37 Harv. Envtl. L. Rev. 105, 113 (2013).
Some of these planned communities are substantial in size and scope of purpose. For instance, the Reston Town Center community in Virginia consists of three separate sub-common-interest communities: one for each of the industrial, business, and residential areas of the development. The business and the industrial centers are governed by their own association boards, while the association that governs the residential area is further divided into sub-associations that cover clusters within the larger residential development. To coordinate all these various areas, their functions, and shared expenses, a common association committee manages the entire Reston Town Center community. This managing board coordinates transportation systems and plans events and programs that support the arts and cultural aspects of the community, among other tasks. Like Reston, other common-interest communities have come to take on many of the functions of local governments by connecting the interests of various disparate parties to achieve larger, shared goals. See, e.g., Darla Guillen, Seven of the 20 Top Master-Planned Communities Are in the Houston Area, Hous. Chron. (Jan. 9, 2015), available at www.chron.com/neighborhood/homes/article/7-of-the-20-top-master-planned-communities-are-in-6004669.php.
The backbone of the common-interest community is the CCR. This document creates and sets forth the parameters of the legal regime that gives effect to common-interest communities by, among other things, ensuring that each owner is responsible for sharing in the costs of the community and that certain qualities of the community are legally maintained. For a significant period during the early part of the life of the project, it is the developer who exercises the powers under the declaration and thereby is able to control and govern the community to ensure his vision is achieved.
This power is significant because it allows the developer to make fundamental changes to the nature of the development as economic conditions shift. For instance, while the initial plan for the project might involve large residential lots, economic factors may change over time and result in smaller lots being more marketable. Moreover, the developer may decide that additional or higher assessments are necessary to meet debt service requirements on community amenities or services. The developer, by virtue of the control granted to him by the declaration, would then be able to adjust lot sizes and raise additional revenues accordingly. Mechanically, the declaration typically allows the developer to appoint the members of the community association’s governing board, add and thereby develop additional real property to the community, and even amend the declaration at will.
But the benefits that the declaration confers are not necessarily exclusive to the developer. Rather, these rights can serve as a form of collateral to guarantee that the lender, upon foreclosure of a mortgage on the real property, is able to continue to ensure that the asset maintains its quality and value until a third-party buyer can be procured. As such, many lenders have come to require that developers grant a security interest in their declaration rights to secure the debt. By doing so, the lender obtains a powerful tool that can help safeguard the property’s value if a default and subsequent foreclosure occurs and gives the lender the ability to transfer these rights to its successor.
An Anatomy of the Declaration of CCRs
Although the declaration provides a wide range of powers and advantages to a lender in the event the project must be obtained or taken over in a foreclosure sale, the way in which such a complex and multifaceted instrument like a declaration can be collateralized is not always easy or clear. Declarations comprise myriad different legal concepts and doctrines that help make the common interest regime possible. It is this intricacy that makes collateralizing these rights so difficult; in fact, because so many different types of property and contract rights are involved in the construction and functionality of declarations, one might wonder whether these rights can collectively be collateralized in one omnibus security device at all.
In thinking about the composition of a declaration of CCRs, one immediately thinks of property law because deed restrictions are so often associated with common-interest communities. Indeed, these legal institutions are what make possible the requirement that all lot or unit owners participate as members of the association and that they all pay assessments to support community obligations. The restrictions allow the association to control lot size, setback lines, the aesthetics of any renovations or additions, and even the type of mailbox. Moreover, easements in favor of the association allow its agents to unilaterally access utilities, make certain repairs, or remove nuisances. Similarly, easements in favor of the declarant give the declarant the power to maintain sales offices or model units in common areas. In light of these rights, viewing collateralization of the declaration through the lens of the law of mortgage would seem most appropriate.
One might also argue, however, that corporate and contract law provide the backbone of the declaration. Although the property law concepts discussed above are important, these rights could not be exercised without an association requiring mandatory membership by lot owners. It is the association that votes to amend the declaration, imposes and adjusts assessments, encumbers common areas, appoints and oversees architectural control committees, and sets rules and regulations for activities throughout the community. The declarant’s power over the community is less tied to the property law aspects of the regime, but rather to declarant’s ability to appoint/remove and thereby control the members of the association’s board. If this is the case, then UCC Art. 9 would seem to be the obvious contender to collateralize the declarant’s rights. In essence, the security interest is sought over governance rights, and, as such, they are akin to rights in investment property (securities) or general intangibles. The declarant’s rights seem to be a type of intangible personal right and would thus fall within the ambit of UCC Art. 9.
Viewing the document from both perspectives, it is easy to see that CCRs are not easily dropped into a single legal bucket. They contain aspects of many different areas of the law and therefore their collateralization is rendered difficult to easily achieve.
A Survey of CCR Collateralization Jurisprudence
A look at how courts at common law have viewed the transfer of rights in CCRs is instructive—indeed many cases explore and discuss the issue. In Kaanapali Hillside Homeowners’ Ass’n ex rel. Board of Directors v. Doran, 162 P.3d 1277, 1288 (Haw. 2007), the Hawaii Supreme Court recognized a transfer of declarant rights from the developer (who was acting as the original declarant) to the homeowners association board of directors. This transfer was accomplished, not through a foreclosure, but through a document entitled “Partial Assignment of Declaration of Covenants and Restrictions,” which was recorded in the conveyance land records of the county. Id. at 1281. In this document, the developer “assigned and transferred to KHHA all of Pioneer’s rights, duties, and obligations under the Declaration and First Amended Declaration as they pertained to the Subdivision property.” Id. The court recognized the validity of this transfer but did not speak to the nature of it. The facts suggest that the parties took the position (and the court seemed to agree) that a property-based approach was appropriate, because the instrument was recorded in the land records.
Similarly, in Weston Design and Development Corp. v. Rojik, No. 269181, 2005 WL 195426 (Mass. Land Ct. Jan. 28, 2005), the Massachusetts Land Court encountered the use of a deed of trust as a mechanism to collateralize CCRs, recognizing that the trustee had effectuated a partial transfer of rights under the declaration. Here again, the court appeared to approve of a property-based approach to the transfer by virtue of a foreclosure of rights in a declaration through a trustee’s sale.
Other courts have taken the opposite or at least a more opaque approach. In Lookout Mountain Paradise Hills Homeowners’ Ass’n v. Viewpoint Associates, 867 P.2d 70 (Colo. Ct. App. 1993), the court took a contract-based approach to the transfer of declarant rights. In that case the developer, Paradise Hills, Inc., executed a document titled “assignment” that alleged to assign PHI’s “right to approve building or other improvement plans on any structures located on the above described Paradise Hills Subdivisions.” Id. at 74. This was essentially a transfer by the declarant of a specific right under the declaration. Importantly, at the time that PHI executed this document, it had already transferred all of its interest in lots throughout the community to Viewpoint, Inc. Viewpoint later argued that PHI could not have transferred its rights under the declaration to the association because at the time of that transfer, PHI owned no real property in the community and thus could not still hold the power to approve architectural plans, because such a right “touched and concerned the land.” See id. at 74–75. But the court held otherwise, stating that although the obligation of lot owners to submit their plans to PHI “runs with the land,” the benefit to PHI of being able to approve or disapprove of such plans did not. Therefore, PHI could transfer those rights—much like the way a contract right is transferred—even if the transferor no longer owned any property within the community. Id. at 75. Accordingly, in this case the court held that some types of rights under a declaration are not necessarily property related—although property rights may be linked to their enforcement—and can thus be treated as personal rights (and transferable as such).
Other courts have similarly treated the developer’s rights as being personal rights. For instance, in Shields v. Welshire Development Co., 144 A.2d 759 (Del. Ch. 1958), the court held that an assignment of a developer’s right to approve plans for buildings, fences, walks, and other structures was valid. In East Sevier County Utility District v. Wachovia Bank & Trust Co., 655 S.W.2d 924 (Tenn. 1983), the court implicitly approved of the assignment of the declarant’s right to collect water and sewer line tap-on fees. In Chimney Hill Owners’ Association, Inc. v. Antignani, 392 A.2d 423 (Vt. 1978), the court assumed the validity of an assignment of a developer’s right to collect assessments. In fact, in Your Community Bank, Inc. v. Woodlawn Springs Homeowners Association, Inc., 449 S.W.3d 357 (Ky. 2014), the court specifically held that the foreclosing creditor, First Bankers Trust Company, obtained the real property by virtue of a deed in lieu of foreclosure (a real property concept) and an assignment of declarant rights by virtue of a separate agreement (a simple contract-based transfer of rights).
In essence, the courts diverge widely on how to deal with the transfer, much less the collateralization, of a declarant’s rights in a declaration. Some treat them as appurtenant to the real property itself owned by the declarant. Others, however, have taken a contract-based approach to the declarant’s rights, treating them as a related but separate right that is personal in nature, but assignable.
The Uniform Common Interest Ownership Act Approach
To some extent, the answer to the question of CCR collateralization has been addressed by the Uniform Law Commission (ULC) through the promulgation of the Uniform Common Interest Ownership Act (UCIOA), which is a successor to the Uniform Condominium Act of 1977, the Uniform Planned Community Act of 1980, and the Model Real Estate Cooperative Act of 1981. The act was first released in 1982 and revised in 1994 and 2008. UCIOA was meant to supplant the three prior acts by creating a comprehensive framework for all common-interest ownership regimes. To date, several states have adopted various versions of UCIOA; those states include Colorado, Connecticut, Delaware, Vermont, Washington, and West Virginia. Colo. Rev. Stat. Ann. § 38-33.3-316(b); Conn. Gen. Stat. Ann. § 47-258(b); Del. Code Ann. tit. 25 § 81-316(b); Vt. Stat. Ann. tit. 27A, § 3-116(b); Rev. Code Wash. Ann § 64.34.364(3); W. Va. Code § 36B-3-116(h). UCIOA provides very specific guidance on collateralizing declarant rights. Specifically, section 3-104, which deals with the transfer of declarant rights, takes a property-law-based approach. First, any transfer of declarant rights must be accomplished by the recordation of an instrument evidencing the transfer that is filed in the county records where the community is located. Further, in the case of a foreclosure on community real property owned by the declarant, the person acquiring title from the foreclosure sale, at his request, succeeds to the declarant’s rights related to that property, as well as to any rights of declarant control. This means that a lender who takes the property in a foreclosure sale will not only acquire the real estate but also any declarant rights, such as the ability to appoint the board of the association and add or remove real property to or from the development, among other things.
UCIOA also includes a rather intricate framework that attempts to balance the rights of innocent successor declarants with the rights of injured lot or unit owners who claim to have suffered a loss at the hands of the original declarant. The developer, as the original declarant, is not absolved for its own bad acts or its failure to fulfill its obligations. Rather, liability remains with the developer for those duties that arose under its time as declarant and continues even when the declarant’s powers have been placed into the hands of another. As for successor declarants, they are subject to the obligations and liabilities imposed by UCIOA or in the declaration, but importantly they are excused from any liability that might arise out of misrepresentations and warranty obligations made or incurred by the prior declarant, as well as liabilities incurred before the community was created. The successor declarant is also not liable for breaches of any fiduciary obligation by the original declarant or his appointees to the association board or for any liability incurred by the original declarant as a result of its own acts or omissions after the transfer.
Lastly, UCIOA provides a special rule for lenders that both purchase the property at a foreclosure sale and take on the mantle of the declarant for the sole purpose of holding the property and these rights for an interim time period until a willing buyer can be identified. During this interim holding period, the lender is strictly limited in its ability to exercise rights under the declaration, but, in return for these restrictions, the lender is spared from any and all liability under the declaration, except for its own bad acts. This last provision “permits a foreclosing lender to undertake such a transaction without incurring the full burden of declarant obligations and liabilities.” See UCIOA § 3-104, cmt. 7 (2008). Of course, these creditor-friendly provisions are balanced against the “need for continuing operation of the association and, to that end, permit a foreclosing lender to assume control of the association for the purpose of ensuring a smooth transition” to a subsequent buyer. Id. But, by implication, the party acquiring the rights from the lender would have responsibilities.
As noted above, the creation of many rights under a declaration is based in property law, and UCIOA’s treatment of those rights is in many ways consistent with that approach. The encumbrance of these rights in total is also consistent with property law concepts. But, if the bundle of rights is severed (that is, only certain declarant rights are transferred or if the security interest is created, not as a whole on the entirety of the project, but at a time when the declarant may own only a minority of the lots), the property law concepts appear inappropriate. This is because under these circumstances the declarant rights (which seem to be appurtenant to the real estate) necessarily now rest in a person who is no longer or perhaps never was an owner of the real estate.
The issue of the nature of CCR declarations in common-interest communities is intricately tied to the collateralization question. Theoretically they do not fit into a single legal category. Because of this, it is difficult to determine what type of security device is best to facilitate credit relationships involving common-interest communities. Although UCIOA takes a property law approach, this may not work when the owner of the immovable property imposing the common-interest community regime names someone else as the declarant. In such a situation, the declarant does not, and likely never will, own any real property within the community. Because of this, UCIOA’s framework for foreclosure and conveyance of declarant rights does not fit. A contract-based approach, however, poses challenges as well, because some of the rights that a declarant maintains are not necessarily tied to control over the association’s board (such as the ability to individually maintain model units or sales offices on, or to have personal rights of access across, common areas). These rights might seem more property based in nature and therefore militate against a contract-based methodology. A prudent lender’s counsel might be well advised to take a belt-and-suspenders approach by requiring that a declarant’s rights be not only mortgaged but also collateralized under UCC Art. 9. Without specific statutory guidance to smooth the path, effective collateralization in any single instrument might prove to be a difficult (if not impossible) proposition.