Court of Appeals Clarifies Condominium Lien Priority

Real Property Law Section 339-z provides that a condominium board's lien for unpaid common charges shall have priority over liens other than “sums unpaid on a first mortgage of record.” When a first mortgagee also extends a second mortgage loan, and consolidates the two mortgages, does the condominium's lien enjoy priority over the second mortgage? In Plotch v. Citibank, N.A., NYLJ 5/11/16, p. 22, col. 1, the Court of Appeals held that when both mortgages loans were extended before any default on common charges, both mortgages enjoy priority over the condominium's lien.

The Plotch Facts

In 2000, Citibank extended a $54,000 first mortgage loan to the owner of a condominium unit, and recorded the mortgage. The following year, Citibank extended a $38,000 second mortgage loan to the same unit owner, and the parties entered into a consolidation agreement. The second mortgage and the consolidation agreement were both recorded. Subsequently, the unit owner defaulted on its common charges and seven years later, the condominium filed a lien for unpaid common charges. The condominium foreclosed on its lien, and, in a 2010 foreclosure sale, Plotch bought the unit for $15,100, subject to “[t]he first Mortgage of record against the premises.” Plotch then brought an action for a judgment declaring that Citibank's second mortgage was subordinate to the lien for common charges, and that Plotch therefore owned the unit subject only to Citibank's first mortgage. Supreme Court and the Appellate Division both concluded that both of Citibank's mortgages enjoyed priority over the lien for unpaid common charges, and Plotch appealed.

In affirming, the Court of Appeals, in an opinion by Chief Judge DiFiore, acknowledged that when a lien intervenes between the execution of two consolidated mortgages, the intervening lien enjoys priority over the junior mortgage. For priority purposes, the mortgages would retain their status as separate liens, and the consolidation agreement would not be considered the first mortgage of record. In the Plotch case, however, there was no intervening lien; both mortgages were executed and recorded before the condominium recorded its lien for unpaid common charges.

The logic of the result in Plotch is easy to understand. As the Court of Appeals observed, if the original unit owner and Citibank had satisfied the original first mortgage and then negotiated a new first mortgage for a larger amount, the new first mortgage would certainly have enjoyed priority over the condominium association's lien. Creating an entirely new first mortgage, however, would have triggered a larger mortgage recording tax ' the primary reason parties avoid that result in favor of executing consolidation agreements. Other than the tax savings, there is no significant difference between a new $92,000 first mortgage and two consolidated mortgages totaling $92,000.

The court's construction of the statute does leave some anomalies. For instance, if the prior unit owner had obtained a second mortgage from a bank other than Citibank, the condominium's lien for common charges would certainly enjoy priority over the second mortgage loan. It is difficult to see why the result should be different because the first mortgagee, and not another bank, extended the second mortgage loan.

Rethinking RPL Section 339-z: The Policy Issues

Although the Plotch decision is consistent with the priority scheme expressed in
RPL 339-z, that scheme, which subordinated the condominium's lien to first mortgage liens, is difficult to defend as a matter of policy. Common charges go to pay for operations and maintenance that benefit all unit owners. Subordinating the condominium lien jeopardizes the association's ability to provide services, and places a heavier burden on those unit owners who have not defaulted on their mortgage or common charge obligations.

Because the New York condominium market was largely spared from the devastating effect of the recent real estate bust, New York did not experience the potentially damaging consequences of section 339-z. So long as foreclosure sale prices remain high enough to satisfy both the first mortgage and the lien for common charges, the relative priority of the two liens is of marginal consequence to condominiums. But when real estate prices drop so that condominium units are “under water,” and the unit owner defaults both on common charges and on a first mortgage loan, the condominium will never be able to recover the common charges associated with the defaulting unit. At any foreclosure sale, if the high bid is not enough to satisfy the first mortgage, the sale will extinguish the condominium's lien without any payment. This provides a windfall to the first mortgagee, because other unit owners are subsidizing the maintenance costs associated with the defaulting unit, while the first mortgagee obtains the benefit: a sale price that reflects the maintenance that neither the bank nor the defaultin owner has paid for.

Other states have long recognized this problem. The Uniform Condominium Act, drafted more than 20 years ago, provides a six-month superpriority for condominium assessments. That is, if a first mortgagee forecloses on a lien for common charges, the sale price will be used to satisfy six months of unpaid assessments before any proceeds are applied to the first mortgage loan.

In recent years, however, even the six-month superpriority has proven inadequate to deal with the needs of condominiums and other common interest communities. When banks choose not to foreclose quickly, either to spare existing unit owners or to wait for market recovery, even a six-month superpriority may provide condominiums with inadequate protection against loss of revenue from defaulting units. Faced with these issues, the Nevada legislature has extended the condominium superpriority to nine months.

Conclusion

The real challenge here is to persuade lenders that ultimately it is in their own interest to ensure that common charges are up-to-date. Especially in hard economic times, a lender holding mortgages on multiple units in a condominium community benefits from ensuring that the community is well-maintained so that the lender's security is not impaired. To date, lenders have been unable or unwilling to see beyond their short-term interests in obtaining first-lien priority. Banks and other lenders wield significant influence in the state legislature, and one can only hope that over time, the legislature ' with or without the support of lenders ' takes steps to modify the priorities embodied in section 339-z.

Stewart E. Sterk, Mack Professor of Law at Benjamin Cardozo School of Law, is the Editor-in-Chief of this newsletter.