In 2014, the Nevada Supreme Court sent shockwaves through the mortgage lending industry when it held that a portion of a homeowners’ association (“HOA”) or condominium owners association’s (“COA”) statutory assessment lien had priority over a properly recorded first deed of trust – and more importantly, that the HOA or COA’s nonjudicial foreclosure on its lien would extinguish the lender’s first deed of trust. This is true even when the HOA or COA’s so-called “super-priority” lien is a mere fraction of the outstanding loan balance. In light of the thousands of HOA and COA foreclosure sales in Nevada between 2009 and 2014, the Court’s stroke of a pen could have wiped out hundreds of millions in lenders’ collateral.
But as significant as that decision was, its impact has yet to be fully realized. Twenty additional states, the territory of Puerto Rico, and Washington, D.C. have statutes similar to Nevada that provide HOAs or COAs assessment liens that could be construed as having priority over a mortgage or deed of trust. Indeed, courts in in Rhode Island, Washington state, and Washington, D.C. have interpreted similar statutes as allowing an association’s sale to wipe out a lender’s mortgage or deed of trust.
Unfortunately for lenders and servicers that hold loans secured by real estate in Alabama, Ala. Code § 35-8A-316 provides an assessment lien for Alabama COAs that contains nearly the same language the Nevada Supreme Court held could allow a COA to wipe out a lender’s first security interest.
Alabama’s appellate courts have not issued a decision regarding the effect of a COA’s foreclosure of a super-priority lien. However, given the court decisions in other states that have interpreted materially identical statutes as giving COAs a true super-priority lien, lenders and servicers should adopt a conservative approach to COA foreclosure sales, and would be well-served by developing specific policies and procedures designed to protect collateral that could be subject to a super-priority lien foreclosure sale.
HOA and COA Super Priority Liens
On first glance, it seems odd, and maybe even unfair, that an association’s later-recorded lien could completely extinguish a lender’s collateral. The rationale underlying these assessment lien statutes involves the purported economic hardships suffered by associations and their members when individuals fail to pay assessments. Specifically, when an individual homeowner fails to pay, the costs are passed onto fellow property owners, whose increased dues often inure to the benefit of the lender.
In response, the Uniform Law Commission (“ULC”) developed model legislation, which has been adopted (sometimes with amendments) by the majority of “super-priority” lien states. Specifically, the ULC promulgated two model statutes that slightly altered the traditional “first-in-time, first-in-right” lien priority framework by splitting a community owners association’s assessment lien into two pieces: a super-priority lien and a sub-priority lien. The super-priority lien, which consists of six-months of past due assessments, is expressly prior to mortgages and first deeds of trust. The sub-priority portion of the lien, which consists of the remaining amounts, is subordinate to, among other things, mortgages and first deeds of trust. According to the ULC, this split lien system assumes that “if an association [takes] action to enforce its lien and the unit owner fail[s] to cure its assessment default, the first mortgage lender [will] promptly institute foreclosure proceedings and pay the unpaid assessments (up to six months’ worth) to the association to satisfy the association’s limited priority lien.”
Under Alabama law, COAs were formerly governed by Chapter 8 of Title 35 of the Alabama Code, which provided a COA with a lien for unpaid assessments that was subordinate to a first mortgage or deed of trust and had to be foreclosed judicially. In 1990, however, Alabama adopted a version of the Uniform Condominium Act and enacted Ala. Code § 35-8A-316, which contains the split-lien system developed by the ULC.
The SFR Decision and the Nature of an Association’s Super-Priority Lien
The uniform statutes did not expressly state whether the six-month super-priority lien is a true priority lien that can extinguish a first deed of trust, or whether it is merely a payment priority lien that springs into existence following a lender foreclosure. If the lien were truly prior, then under the basic rule that foreclosure on a lien extinguishes all junior interests a foreclosure on the HOA or COA’s super-priority lien would eliminate the supposedly “first” mortgage or deed of trust. On the other hand, if the prior nature of the HOA or COA’s lien simply meant that the association received a first cut from the proceeds at a lender’s foreclosure, then the lender could simply account for another expense at the time of foreclosure, without the lurking risk of losing its security interest.
It is in this context that the Nevada Supreme Court’s 2014 decision in SFR Investments Pool 1, LLC v. U.S. Bank arose–a decision that would set the interpretive standard for states that have adopted–in whole or in part–the ULC model legislation. In SFR, the Nevada high court considered whether the six-month super-priority lien was merely a payment priority lien, or a truly senior lien. Unfortunately for lenders and servicers, the court decided on the latter, relying primarily on the plain language of the statute. Specifically, the Court noted that the Nevada Statute, which was patterned after ULC model legislation, states that an association’s super-priority “lien . . . is prior to” a first deed of trust, and that the statute did not use the term “payment priority.” The Court also recognized that the ULC–in its interpretive comments to the model legislation that forms the basis of the Nevada statute–explains that “[a]s a practical matter, secured lenders will most likely pay the six-months’ assessments demanded by the association rather than having the association foreclose on the unit.” The Court reasoned that reference to a secured lender paying off the super-priority portion of the lien to avoid the association’s foreclosure would not have made sense if the lien was a payment priority lien.
High courts in Rhode Island, Washington, D.C., and Washington state have also used similar reasoning to determine that mostly parallel statutes afford an association a true priority lien that can wipe out a first deed of trust. Conversely, no state court has issued a published decision holding that a statute similar to the ULC model legislation provides an HOA or COA with only a payment priority lien.
Alabama’s COA Assessment Lien Statute
Ala. Code § 35-8A-316 gives COAs a lien for past-due assessments and other amounts due for “special assessments or services or charges . . . .” Because the statute is patterned after ULC model legislation, it has split priority. First, an amount consisting of six months of past due “common expense assessments” is given priority over “a first security interest on the unit recorded before the date on which the assessment sought to be enforced became delinquent.” The remaining amounts are subordinate to a first mortgage or deed of trust.
Alabama’s COA assessment lien statute also contains a notice provision. Specifically, prior to the foreclosure, a COA “shall send reasonable advance notice of its proposed action to the unit owner and all lienholders of record of the unit.” According to the drafter’s official comments, this requirement means that COAs are required to run a title search, and that this provision is not satisfied by merely posting an advertisement of the sale. Rather, the statute requires actual notice. In addition, a lender is entitled to request a statement from the COA or its collection agent setting forth the amount of the lien. If the COA fails to deliver the statement within ten days, the lien is released.
Under the statute, a COA can foreclose on its lien “in like manner as a mortgage on real estate provided the declaration is in conformity with Article 1A of Chapter 10 of this title and subject to the rights under Article 14A of Chapter 5 of Title 6.” This means that a COA can foreclose on its lien non-judicially, and that the borrower or lender may redeem the property within 180 days. In addition, a COA can still utilize Ala. Code § 35-8-17 to judicially foreclose on its lien. However, this lien is not afforded super-priority status.
What About Alabama HOAs?
HOAs are given a lien for past due assessments under Ala. Code § 35-20-12. However, the lien created by this statute is expressly subordinate to “deeds of trust securing an indebtedness.” Thus, HOAs in Alabama do not have a statutory super-priority lien.
However, while section 35-20-12 of the Alabama Code does not create a super-priority lien, lenders should keep in mind that this section does not preempt HOA assessment liens created by the HOA’s governing documents. In other words, if the HOA’s declaration of covenants, conditions, and restrictions, or other governing document, appears to subordinate a mortgage or deed of trust to some or all of an HOA assessment lien, there is still a risk that foreclosure of the HOA’s lien could extinguish the deed of trust.
How to Protect Your Lien
While COA and–to a lesser extent–HOA assessment liens pose a real threat to mortgages and deeds of trust, lenders with collateral in Alabama can protect their interest by implementing policies and procedures designed to minimize the risk of a super-priority foreclosure sale altogether. Servicers should also develop similar policies and procedures in order to protect their investor’s collateral. For instance, a lender or servicer can likely extinguish the super-priority portion of an association’s assessment lien by tendering the super-priority amount to the association or its agent before the association’s foreclosure sale. Lenders and servicers can also minimize, or even eliminate the risk of a COA or HOA foreclosure sale by advancing assessments to the association and–if the mortgage or deed of trust allows it–requiring the borrower to escrow the assessment amounts.
Lenders and servicers should also be aware that loans owned or guaranteed by Government Sponsored Enterprises (“GSEs”) such as the Fannie Mae, Freddie Mac, and Ginnie Mae are treated differently under the COA assessment lien statute, and may not be subordinate to the COA’s lien despite the statute’s super-priority provision. This is because, in 2018, Alabama amended Ala. Code § 35-8A-316 to add a provision subjecting a COA’s statutory lien to GSE rules, regulations, and guidelines when the subject property is encumbered by a mortgage owned by a GSE. Similarly, although Alabama courts have not addressed the issue, other jurisdictions have held that association assessment lien foreclosures involving properties owned by GSEs were void under the Housing and Economic Recovery Act of 2008.
These and other potential protections are made somewhat easier to utilize by the COA assessment lien statute’s notification requirements. However, because lenders are often required to act quickly and decisively in these situations, it can be easy to miss the steps required to protect a mortgage or deed of trust. As such, lenders and servicers should develop detailed and easy-to-use policies and procedures dedicated exclusively to the handling of association assessment lien foreclosure sales.
Aaron Chastain is a partner at Bradley law firm. He represents financial services institutions, healthcare companies, and other businesses in a broad range of litigation and compliance-related matters. Aaron has advised student loan and mortgage loan originators and servicers in complying with the complex universe of regulation and state lien laws, as well as in handling finance-related litigation, such as claims for violations of the Fair Debt Collection Practices Act (FDCPA), wrongful foreclosure, violations of the Truth in Lending Act (TILA), and violations of the Real Estate Settlement Procedures Act (RESPA). He has specific experience advising clients in the realms of student and mortgage lending, servicing, and operations.
Chris Friedman is also a partner at Bradley. He represents banks, servicers and other financial services institutions involved in civil litigation, as well as compliance and regulatory matters. Chris has defended financial institutions against claims of fraud, breach of contract, and misrepresentation. He has also advised institutions regarding lien rights and has experience in HOA and COA super-priority lien litigation. Chris also represents lenders and other housing providers involved in Fair Housing matters, and has written extensively on the topic of social media and fair housing.