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A Lender’s Minefield In ‘Taking Back’ Distressed Condominium Projects

Date

December 1, 2009

Read Time

3 minutes

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Over the last year and a half, many condominium developers have defaulted on construction loans, resulting in an explosion of Illinois distressed condominium projects. As a result, lenders are scrambling to enforce their legal remedies against the developer loan defaults. Lenders, however, must be mindful of the consequences of blindly filing a foreclosure complaint or quickly accepting a deed in lieu of foreclosure, and thereby unintentionally create a basis for a condominium association to assert a claim against the lender for successor developer liability.

While the arsenal of lender remedies per standard loan documents include a foreclosure, or deed in lieu of foreclosure, of all the developer’s right, title and interest in the property, lenders must be aware of potential successor developer liability issues, such as incurring the developer’s legal obligations to the association (including construction defects, accounting mismanagement and general financial issues like reserve funding or paying assessments) that may be asserted by a condominium association against the developer or successor developer. There are, however, strategies to mitigate any such successor developer liability.

Due to governing Illinois case law, there may be potential successor developer liability imposed on a lender when accepting all the developer’s right, title and interest in a distressed condominium project. In simple terms, while a lender still should obtain an assignment of a developer’s right, title and interest in the property as collateral, the most effective way to mitigate potential successor developer liability is for the lender to not exercise the assignment of the developer’s rights under the condominium declaration, and to otherwise not acquire (or, at least, minimize to the extent possible) all the developer’s rights. In such a case, the lender should be deemed to be acting in the capacity as an owner (as opposed to a developer) of multiple units, without the benefits or burdens of developer rights or obligations granted in the condominium declaration.

The lender needs to balance its aversion to the risk of potential successor developer liability against its needs, if any, to actually obtain the developer’s rights under the declaration to enable it to sell the remaining condominium units or land in the project. The most prudent approach to avoid successor developer liability is for a lender to refuse any assignment of any developer rights under the condominium declaration (such as construction rights and easements, marketing and signage rights and easements, rights to add additional units, control of the condominium board pre-turnover to the unit owners, etc.). The ability to implement the strategy largely depends upon the facts of a particular distressed condominium project.

Therefore, as a general statement, the greater the developer rights acquired, the more exposure a lender will have to successor developer liability; conversely, the less developer rights acquired, the more likely the risk is mitigated. Please note, to implement the aforementioned strategy requires a variety of legal assumptions that are fact specific to each condominium project and should be discussed with legal counsel.

As a lender, if you are at the initial stages of a developer default and/or are at the initial stages in exercising the lender’s remedies against the developer, please feel free to contact us to discuss the issues of successor developer liability and analyze the costs/ benefits of a mitigation strategy.


Filed under: Community Association

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