August 1, 2014
by J. Skipper Ray
Wilson & Associates, PLLC – USFN Member (Arkansas, Tennessee)
The Arkansas Supreme Court considered an issue of first impression in the case of First State Bank v. Metro District Condominiums Property Owners’ Association, Inc., 2014 Ark. 48 (Feb. 6, 2014), interpreting a section of the Arkansas Horizontal Property Act (Act). The issue being reviewed dealt with the responsibility for unpaid assessments due a property owners’ association after foreclosure of a first mortgage. The court, in interpreting A.C.A. § 18-13-116, held that the purchaser of the condominium at the foreclosure sale of the first mortgage, was personally liable for previously unpaid assessments of the Metro District Condominiums Property Owners’ Association (Metro).
First State Bank (Bank) was relying on subsection (c) of A.C.A. § 18-13-116, which provides for an exception to the Act’s requirement that when a condo unit subject to the Act is sold, unpaid assessments receive priority when distributing the funds for the purchase price. The exception in subsection (c) states that this priority does not apply to payments due under duly recorded prior mortgage instruments. The Bank asserted that this exception gave priority to its mortgage, over any lien of the association for unpaid assessments.1 Despite this language, the court relied solely on the plain language of subsection (d), which reads: “[t]he purchaser of an apartment shall be jointly and severally liable with the seller for the amounts owing by the latter under subsection (a) of this section up to the time of the conveyance ...” Thus, the court held that the purchaser of a condo via a foreclosure sale will be liable for previous assessments that the individual who was foreclosed upon did not pay.
This ruling is a departure from what has been custom in the vast majority of the state. Normally, a foreclosure sale purchaser (which is often the lender/loan servicer) is only expected to pay for dues/assessments from the foreclosure sale date forward. This is usually the situation, whether the property be part of a traditional homeowners’/property owners’ association (HOA/POA), or a condo owners’ association (COA), as in the Metro case. This is due, in large part, to most owners’ associations’ governing documents2 containing a provision that provides for the association’s lien to be subordinate to that of a prior first mortgage. The associations normally include this provision because of their awareness that many, if not most, lenders will not be willing to loan money for the purchase of a house or condo if the lender’s lien will not have priority over a lien for the dues/assessments of a property owners’ association.
In fact, Metro’s master deed contained just such a provision3, which is what makes the decision so potentially troubling for lenders and loan servicers. The question is whether the Metro ruling will only be applied to condominium owners’ associations going forward. The judicial opinion seems to clearly be confined to interpreting the Act, and the Act deals specifically with condominiums (the Act uses the term “apartments”). However, as previously mentioned, Metro’s master deed contained language that is similar to, if not exactly like, language often found in most bills of assurance and CCRs in Arkansas, which provides for priority of a first mortgage over the lien for assessments of a POA/HOA.
It does not seem beyond the realm of possibility that a traditional POA/HOA would seek to use the Metro case as the starting point for attempting to begin collecting unpaid dues/assessments, which became due prior to the foreclosure sale. Even if the state legislature were to address the issue, it would be a year or longer before a law could be enacted. If a lender is concerned with being responsible for months of unpaid dues/assessments pre-dating a foreclosure sale, it needs to be mindful on the front end of how an owners’ association’s BOA/CCR/master deed addresses priority of its lien for unpaid dues, in relation to that of a first mortgage lien.
Even if Metro will only affect condo units going forward, fallout from the decision is already being seen. At least one major title insurance underwriter has decided to no longer issue the ALTA 4.06 Endorsement in Arkansas. The 4.06 is an endorsement to a loan policy of title insurance, which provides lenders with additional coverage when the insured mortgagee’s collateral is a condominium unit. That an endorsement previously offered on nearly all condo units is no longer available will no doubt raise a red flag with originators. The likely result: at best, it will slow down the process for a buyer to obtain a loan for a condo purchase and, at worst, lead to some lenders being unwilling to make a loan on a condo unit at all.
While the COA won its battle with the Bank in this case, the next time one of its individual owners attempts to sell his or her unit, that homeowner may not be as supportive of this court ruling. In fact, if traditional POA/HOAs attempt to rely on this judicial decision as well, the seller of any residential property that is part of an owners’ association may end up being negatively affected by the holding in Metro.
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1 Although not discussed in the court’s opinion, the actual bylaws contained in Metro’s master deed provided that the unpaid assessments become a lien on the unit upon recording a Notice of Delinquent Assessment. As of the filing of the Bank’s judicial foreclosure action, Metro had not filed such a notice. It is unclear whether the Bank raised this point at trial; i.e. the lack of Metro having recorded the Notice of Delinquent Assessment in order to perfect its lien.
2 In Arkansas, these governing documents are often referred to as the association’s Bill of Assurance (BOA) for traditional homes, which is the same as what are often referred to in other jurisdictions as Covenants, Conditions, & Restrictions (CCRs), etc.; or a master deed or horizontal property regime for condominiums.
3 The pertinent language in Metro’s bylaws reads, “[t]he liens created hereunder upon any Unit shall be subject and subordinate to, and shall not affect the rights of the holder of the indebtedness secured by any recorded prior mortgage or similar encumbrance . . .” Perhaps the fact that Metro did not record a lien prior to the Bank’s foreclosure action being filed led the Bank’s counsel and the trial court to find this language inapplicable to the fact scenario involved in Metro.