How Chapter 11 Solved One Multifamily Condo Regime’s Dual Challenges of Mounting Liabilities and Unpaid Dues

With many struggling to make housing payments due to COVID-19, dues owed to multifamily condominium associations are likely to go unpaid—especially if homeowners feel deprived of the use of common areas, such as pools, gyms and playgrounds. Associations with significant reserves may be able to weather this storm, but for associations that were already struggling, the future may look less promising. Advance consideration of options and planning may help avoid a worst-case scenario and maximize value for associations and their unit owners.

In this alert, we consider the chapter 11 case of Lynnhill Condominium, an example of how to clear a logjam that arises when dues go unpaid and an association is unable to act without the unattainable 80% approval of individual unit owners. The logjam was cleared by using the bankruptcy chapter 11 process to unify widely dispersed title to condominium units and cleanse the real estate of all claims and liens.

The Death Spiral: Unpaid Condo Dues Interrupt Service Leading to Project Deterioration
Multifamily condominium regimes operate on tight budgets with fixed expenses for items such as trash removal, landscaping, insurance and maintenance of common areas. Some regimes also pay for utilities such as cable, electricity, gas and water (especially older regimes that have one master meter for each major utility for the entire property) and recoup those expenses through assessments or invoices to unit owners.

Despite inaccessibility to common areas during the COVID-19 outbreak, expenses associated with maintaining common areas have not disappeared. In some cases, associations may be contractually obligated to continue paying for certain services. Other expenses may have increased, such as those associated with cleaning and disinfecting high traffic areas and commonly touched surfaces.

Although associations have fixed expenses, dues are usually an association’s only source of revenue. Nonpayment of dues may affect an association’s ability to pay bills and provide services (including essential services for those associations responsible for paying electricity, water and gas for all units), and the failure to provide services increases the likelihood that dues will not be paid. Strategic planning may help condominium associations under financial pressure preserve value and avoid this unfortunate scenario that almost led to the demise of the Lynnhill Condominium.

Lynnhill Condominium in a Nutshell
The Lynnhill Condominium Association (Association) was directly responsible for utility and common maintenance expenses for all of the 219 individually titled units in two towers located in suburban Maryland outside Washington, DC. A death spiral of insufficient condominium dues receipts, utility shutdowns, damage by water, fire, vermin and other causes, forced evacuations, and numerous liens on individual units, which left the Association unable to pay its debts. The property became completely vacant and faced condemnation. The Association had tried three prior chapter 11 cases, which all failed.

Pillsbury designed and implemented a two-part strategy (a) to sell the property free and clear of liens without placing any of the 219 unit owners themselves in bankruptcy and (b) to pay for the process since the Association had no financial resources, while providing creditors and unit owners with a potential recovery. After persuading a state court to judicially collapse the condominium regime (thereby enabling the Association to control the property effectively as the owner), the bankruptcy took just 50 days from January 10, 2018 to March 1, 2018.¹

Although developers had expressed interest, none would purchase the property without obtaining unified (i.e., a single deed), insurable title to the entire condominium property, free of debts secured by the property or individual units.

Accordingly, success required (a) vesting in the Association the ability to convey unified title to the entire property even though 219 individuals owned the separate condominium units and (b) confirming a reorganization plan that respected the relative value of the 219 units and their separate lienholders.

Pillsbury leveraged preexisting litigation to obtain a state court order collapsing the condominium regime and giving the Association the power to sell all 219 units as a whole. The court did so to avoid the risk to the community posed by the property’s dilapidated condition. This was a first-time use of Maryland law to facilitate the bankruptcy sale by a condominium association.

Pillsbury then proposed an expedited sale-based chapter 11 plan with a distribution scheme that allocated net proceeds (after payment of Association debts and chapter 11 costs) to individual unit owners and used those net proceeds to satisfy the separate debts secured by their units, such as mortgages and taxes, returning the balance to unit owners.

With bankruptcy court approval, Pillsbury ran an auction process. In only 50 days, the initial “stalking horse” bid of $13.2 million was topped by a $17.04 million bid, and the plan ultimately received unanimous creditor support. The sale closed two weeks later, with proceeds used to pay taxes, Association creditors and expenses associated with the sale and bankruptcy case, and with the remaining net proceeds distributed to unit owners (after satisfaction of their individual mortgages). Significantly, $325,000 in transfer taxes were saved because the sale was done pursuant to a chapter 11 plan. The purchaser redeveloped the property as apartments, thereby converting a blighted, dangerous and burdensome property into one that adds value to the community and the economy.

Planning and Exploring Options
As Lynnhill Condominium’s prior (failed) bankruptcy attempts demonstrate, chapter 11 is not a panacea that provides solutions for debtors filing without a business strategy. Multifamily condominium regimes struggling in the COVID-19 world should not wait until unit owners stop paying dues, abandon their units, or worse, utilities are disconnected, and the property deteriorates. Instead, advance planning may help associations avoid a free fall and preserve value for individual unit owners.

Multifamily condominium associations need advisors to study their organizational documents and understand the requirements for terminating the regime under applicable state law. In truly consensual cases where a buyer is committed to buying the property and there are no disputes among stakeholders, terminating the condominium regime and selling the property may occur without a bankruptcy (though the issue of dispersed title remains). If, however, a buyer (and its title company) require a single insurable deed, one way to accomplish this may be through a fast-track chapter 11 confirmation and sale. In more complicated or contentious cases, the Lynnhill Condominium model—obtaining judicial regime termination and unified title conveyance through a chapter 11 bankruptcy plan—may help overcome the obstacles.

For more information, please reach out to your regular Pillsbury contact or the authors of this client alert.

Pillsbury’s experienced multidisciplinary COVID-19 Task Force is closely monitoring the global threat of COVID-19 and providing real-time advice across industry sectors, drawing on the firm’s capabilities in crisis management, employment law, insurance recovery, real estate, supply chain management, cybersecurity, corporate and contracts law and other areas to provide critical guidance to clients in an urgent and quickly evolving situation. For more thought leadership on this rapidly developing topic, please visit our COVID-19 (Coronavirus) Resource Center.

^{1  See In re The Condominium Association of the Lynnhill Condominium, No. 18-1034 (Bankr. D. Md. Jan. 10, 2018). In addition to the authors, the Pillsbury team in the case consisted of Andrew Troop, Jason Sharp, and Andrew Alfano; each of whom contributed substantially to this Client Alert.}