Assessment Collection in an Economic Crisis
California law affecting non-judicial and judicial foreclosure of assessment liens can be complex. Recent legislation illustrates a governmental policy favoring the resolution of many assessment disputes in Small Claims Court. This, coupled with reduction of property values and equity brought on by the current economic crisis and real estate meltdown, can make assessment collection in Small Claims Court an efficient (if not the most efficient) way to collect assessments.
Statutory Assessment Collection
The standard method of assessment collection employed by community associations follows the procedure set forth in the Davis-Stirling Act (Civil Code §§1350 et seq), concluding with a non-judicial foreclosure sale. Under this method, a community association writes to the delinquent owner and requests payment of past due assessments. If the informal letter is unsuccessful, the association typically engages a collection agency to pursue collection of the account. The collection agency prepares and mails via certified mail the statutorily required pre-lien notice, which usually includes an offer to meet and confer. At least thirty days later, if the account remains unresolved, the board of directors will meet and decide whether to authorize the agency to record an assessment lien against the delinquent owner's property (a unit in a condominium project or a lot in a planned development).
If the account remains unpaid 30 days after recording of the assessment lien, the association is free to enforce the lien in any manner permitted by law, including sale by the court (by bringing a lawsuit for judicial foreclosure), or sale by the trustee designated in the notice of delinquent assessment (without going to court via a non-judicial foreclosure). In the non-judicial context, the sale is handled pursuant to the statutory procedure for non-judicial sale of a mortgage or deed of trust (i.e. the process used by banks foreclosing on delinquent mortgage payments). Under this procedure, the trustee records a Notice of Default which triggers a ninety day period before which a Notice of Trustee's Sale can be recorded. If the account remains unresolved after ninety days, the trustee can the records a Notice of Trustee's sale setting forth the time and place of the sale.
If the sale occurs, and no one outbids the association, the trustee executes a Certificate of Sale putting title of the property in the name of the association. Completion of the sale commences a 90 day right of redemption period under which the (now former) owner has the right to regain title to the unit provided he or she pay the association the delinquent assessments and foreclosure charges owed. If the owner fails to redeem, the association receives a Trustee's Deed to the property. Importantly, the association's ownership is subject to existing debt secured against the property, including the first mortgage and deed of trust.
Under this process, the goal of the association is to have the owner pay the delinquent assessment or risk losing the unit, including its equity. Equity is calculated by taking the fair market value of the unit and subtracting all recorded and outstanding liens recorded against the unit. For example:
|Unit fair market value||$350,000|
|1st Mortgage to ABC Bank||($200,000)|
|2nd Mortgage to XYZ Bank||($ 50,000)|
|Assessment Lien||($ 5,000)|
The prospect of losing $95,000 in equity is the driving force that motivates the owner to pay the delinquent assessment before the non-judicial sale occurs. This is the association's desired result. Further, the opportunity to obtain a property, and its equity, for a relatively nominal amount (the unpaid assessment and the association's foreclosure costs) provides an incentive for third parties to attend the sale and bid at the non-judicial foreclosure sale, thereby completing collection of the delinquent assessment. The right of redemption reduces somewhat the marketability of a property because a third party bidder takes the property subject to the owner's right to regain title. However, to redeem the unit, the foreclosed owner would need to pay the third party bidder the amount paid at the sale to acquire the unit. During the right of redemption period, neither the association nor the successful bidder may evict the (now) former owner.
A successful bidder at a non-judicial foreclosure sale, be it the association or a third party, acquires the unit subject to all senior liens. This means that the successful bidder will either need to assume the loans relating to the senior liens, or pay them off. If the obligations owed to the senior lien holders go into default, through non-payment or otherwise, the party that acquired the unit at the non-judicial foreclosure sale faces the same fate as the delinquent assessment owner.
Assessment Collection in the Current Environment
In the scenario described above, the association's leverage lies in the fact that the property has equity and it is that equity that is the target of the foreclosure. This leverage is lost, however, if the property has little or no equity. This is the issue faced by many associations in today's economic climate and falling property values. The statutory method of assessment collection is no longer an attractive option to resolve delinquent assessments. Many times, an owner will stop paying maintenance assessments but continue to service the mortgage debt on the property. Non-judicial foreclosure of an assessment lien will not motivate this owner to pay the delinquent assessments because he has no equity to protect. Here, an association is saddled with an owner that refuses to pay his assessments with only the unattractive option of non-judicial foreclosure. The owner remains in the unit or lot, using his or her share of common area amenities and benefitting by association purchased services (including management and insurance), but failing to contribute his or her assessment dollars for these amenities and benefits.
Consider the following example:
|Unit value at purchase:||$ 350,000|
|Unit fair market value||$ 250,000|
|1st Mortgage to ABC Bank||($ 200,000)|
|2nd Mortgage to XYZ Bank||($ 50,000)|
|Assessment Lien||($ 5,000)|
Here, the association's lien attaches to nothing because there is no equity in the unit to secure it; the association is an unsecured creditor. Essentially, the association has not improved its position vis-a-vis the delinquent owner by recording the assessment lien. If the association completes a non-judicial foreclosure sale, it will obtain title to a unit worth $250,000 but encumbered with senior liens in the amount of $250,000; the association obtains nothing. Likewise, because there is no equity in the unit, third parties have no incentive to bid at the sale. Further, now the association will have to incur the expense of insuring the unit, and evicting the occupant. Worse, if the association does not service the senior mortgages, it will foreclose, leaving the association with nothing other than an obligation to pay collection and foreclosure charges.
In other common situations, the owner cannot pay his mortgage lender, which forces the lender to foreclose to protect its own equity position. If the association recorded an assessment lien, it is likely junior to the mortgage lien, and will be wiped out when the senior lender forecloses. In this situation, the property is no longer available to collect the assessment. Many times, associations assume that once their assessment lien is wiped out, they can no longer collect the delinquent assessment and so will write off the debt.1 This assumption is in error. Under California law, the obligation to pay assessments is the debt of the owner and it is personal to him or her. The ability to lien and foreclose is merely an enforcement technique. If an owner is foreclosed by his or her lender, wiping out the association's assessment lien, the now displaced owner still owes the association the amount of the delinquent assessment. Even though the unit is no longer available for collection, the owner may have other assets (a job, a bank account, brokerage accounts, a car) that the association may look to for collection.
Assessment Collection Emphasizing Collection Against Owner's Other Assets
An owner's other assets can be made available for assessment collection by filing a civil lawsuit, either in Small Claims Court or Superior Court. The object of such a lawsuit is obtaining a civil money judgment for the amount of the delinquent assessment, late charges, interest, collection costs, and attorneys' fees. These judgments are relatively easy to obtain and are enforceable for 10 years. Further, they can be renewed for another ten years if unsatisfied. Of particular note, judgments can be recorded with the county recorder to create a judgment lien. This lien can attach to after-acquired property. In other words, the association can obtain a lien on real property that the delinquent owner may own in the future.
Assigning Judgments for Money based on Non-Payment of Assessments
Under California law, judgments are tantamount to a judicial contract between the plaintiff and defendant and are freely assignable. In other words, an association can sell the judgment (usually at a discount) to an investor or collection agency that may be willing to track down the debtor-owner to collect the judgment amount. Hypothetically, an association can obtain a small claims judgment against a delinquent owner in the amount of $5,000. It can then sell that judgment to an investor for $.20 on the dollar - recovering $1,000 to meet its current operating needs. For large associations, the ability to bundle up many judgments for sale may be an untapped source of revenue needed to fund operations.
Significantly, assessment liens are very different than other types of real property liens. Under Civil Code §1367.1(g) an association may not voluntarily assign or pledge the association's right to collect payments or assessments, or to enforce or foreclose a lien to a third party. . . There is an exception to this rule when the association assigns or pledges the right to collect or foreclose to a financial institution or lender as security for a loan obtained by the association. Another exception permits the association to assign any unpaid obligation of a former member to a third party for collection. In other words, once a delinquent owner is foreclosed and no longer a member, the association is free to sell or assign the obligation to a third party.
What about a situation where the association obtains a small claims judgment against an owner that is still an association member? Can it still sell or assign the judgment? There is no California case that analyzes this situation. An aggressive reading of Civil Code §1367.1(g) suggests that it can. Subparagraph (g) prohibits assignment of assessment liens, not judgment liens. An assessment lien is created by an association board of directors without judicial oversight. A judgment lien, on the other hand, arises from a judgment entered by a court with jurisdiction over the parties and after review of the evidence presented. Therefore, an argument can be made that subparagraph (g) does not prohibit assignment or sale of a judgment lien arising from a money judgment for unpaid assessments.
Another unique feature of assessment obligations is that they are exempt from California's one action rule. Under this rule, the recovery of a debt or the enforcement of any right secured by real property must occur by a judicial foreclosure action. In other words, the one action rule compels a creditor to seek judicial foreclosure of a debt secured by real property. Enforcement of an assessment lien is exempt from this rule. This means that an association may record an assessment lien, and then proceed to civil court and obtain a money judgment for the delinquent assessments. This is an important right because it allows the association to make its claim for the delinquent assessment on the property itself, thereby ensuring payment in the event the unit is sold or re-financed. To the extent the unit has any equity, the association is secured. However, if the association determines that the unit does not have sufficient equity to secure the lien, it can still proceed to court to obtain a money judgment for the assessments owed, keeping its lien in place. On the other hand, it is doubtful that an association can complete the foreclosure process and then seek recovery against the owner for any shortfall.
What seems less clear is whether the association can non-judicially foreclose and having realized nothing on the sale, still pursue the owner in civil court for a money judgment. Principals of equity suggest that once the association completes the non-judicial foreclosure sale, it has effectively collected its debt. If the sale results in the association acquiring title to a unit with no equity, then the association has recovered nothing on its debt. Its collection is complete. Therefore, associations must be cautious in blindly going down the non-judicial foreclose track because it may result in no collection at all, with only collection costs and trustee's fees to be paid.
Suggested Collection Route
A better approach to assessment collection in the current market might look like the following:
Small Claims Court Procedure
Code of Civil Procedure section 116.540 authorizes an agent, management company representative, or bookkeeper for a community association to appear in Small Claims Court. Under the old law, a manager could appear in Small Claims Court only if he or she was an employee of the association. This is a radical exception to the basic rule that only attorneys can appear in court on behalf of a client or other third party.
Declaration confirming manager's authority to appear on association's behalf
To appear in Small Claims Court on behalf of an association, the manager will be required to provide the court with a signed declaration under penalty of perjury attesting to the fact that he or she is authorized to appear on the association's behalf and the basis for that authority. The manager will also need to make a representation that he or she was not hired by the association solely for the purpose of appearing in Small Claims Court. Until the new changes in the law become known, managers should take a copy of the statute to Court or at least be prepared to direct the Small Claims Court to the correct section of law so that the court will understand that a manager can appear on an association's behalf.
Tips for a successful presentation of the claim
Initiation of a Small Claims Court case is relatively easy. Many courts have small claims forms on-line which can be downloaded from the internet. A small claims complaint is a one page document which requires the plaintiff to provide name and address of the defendant and to briefly describe the nature of the dispute. Once the association files the case and pays the filing fee, the court will issue a hearing date. The association then needs to have a process server serve the owner with the complaint and notice of hearing at least 15 days before the hearing. The proof of service must be filed with the court five days in advance of the hearing. The association may recover the filing fee and service fee in the case.
When appearing in Small Claims Court, the key is to be prepared with your evidence and be as clear and concise as possible. The Judge may have 20 cases scheduled that day and a limited time within which to hear them. Therefore, the Judge will appreciate a party that gets to the point quickly. Remember that the Judge knows nothing about your case. A few brief statements about who you are, who you represent, and why you are in court will give the Judge a thumbnail sketch about what kind of evidence he or she is about to hear.
In making your presentation, you should have the following documents as evidence to support your delinquent assessment claim:
Presenting your case in chronological order will make the most sense to the Judge. Start with a brief discussion of the association. Tell the Judge where the development is located, how many owners there are, the amount of the monthly assessment, and that the association is governed by a set of CC&Rs that authorize it to charge assessments for the maintenance, repair, and reserves of the association. Explain to the Judge that under the association's collection policy (and the Davis-Stirling Act), an assessment is delinquent if not paid within 15 days of its due date. You will need to explain that the association is entitled to recover late fees and interest on the delinquent assessments. Also, tell the Judge that when one person does not pay his or her assessments, the other paying members are forced to bear added maintenance, repair, and reserve obligations.
Next, tell the Judge that the association maintains a statement of account for each member. Give the Judge the details on how the account is maintained. For instance, tell the Judge that the payments go to a lock box which gets digested into a report that the association uses to keep the statement up to date. Basically, the Judge needs to be able to rely on what the account statement shows as a delinquency. Tell the Judge exactly what is owed, the late fees, and the interest and ask the Judge for judgment in that amount.
After you conclude, the debtor will be able to present a defense. Many times the debtor will not appear because he or she will have no defense. Owners that have refused to pay because they are unhappy with management or the Board likely will appear and argue that they have not paid because they have not received the services for which they are paying. California cases have held that such an argument is not a good reason to withhold assessment payments. Further, the Davis-Stirling Act provides for an informal dispute resolution procedure within the community that allows the owner to meet with the Board or Board representative if he or she objects to something the Board has decided. Meet and confer provisions are found in the Civil Code beginning with section 1363.810.
At the conclusion of the hearing, the Judge will enter a judgment. If the judgment is in the association's favor, it can be enforced just like any other money judgment. Under the rules, the judgment is stayed for 30 days, which means it cannot be enforced during that time. After 30 days, the judgment can be recorded to create a lien on the owner's unit. The association can undertake an execution sale to foreclose on its judgment lien. The judgment can also be used to levy the owner's bank account or garnish his or her wages. If the Judge rules against the association, there is no opportunity to appeal. However, that does not mean that future assessments are not owed, it only means that the association has not persuaded this Judge in this circumstance. If the judgment is in the association's favor, the owner may appeal to the Superior Court and request a new trial. In such a case, the association can retain legal counsel to represent it in the trial proceeding.
In a good market, property appreciates and an assessment lien and the threat or actual foreclosure of the lien is likely to result in payment to the association. In a down market where property value collapses, there may not be enough equity to satisfy all debt holders, including the association. Thus, pursuing collection against the property may have little benefit (other than perhaps resulting in its ownership but a new paying owner). There are alternatives: suing in small claims court or, for larger claims in which it makes economic sense to hire a lawyer, suing in Superior Court.
1 The term write off is an accounting term used to describe the accounting function of recognizing that an account receivable can no longer be considered an asset of the corporation. To accurately report the association's financial condition on a balance sheet, the association must write off the delinquent assessment and recognize it as uncollectible. That does not mean, however, that the association is prevented from legally enforcing the debt.