Professional Documents
Culture Documents
By Samuel H. Levine, Partner On November 6, 2009, the Federal Housing Administration (FHA)
issued two documents related to FHA mortgage insurance require-
Receiverships are becoming a popular tool for creditors to manage ments for condominium associations. These two documents: HUD
distressed real estate and to realize upon their collateral. Lenders are Mortgagee Letter 2009-46A and Mortgagee Letter 2009-46B provide
looking at receiverships as a faster and more efficient and cost effective an overview of the FHA proposed transitional criteria and successor
strategy than forcing a debtor into bankruptcy. They offer the lender criteria for condominium association requirements for FHA mort-
flexibility as opposed to well established procedures under bankruptcy. gage insurance.
The current economy is also resulting in increased use of receiverships
What is FHA mortgage insurance?
to complete unfinished buildings.
FHA mortgage insurance is a policy that protects lenders against
some or most of the losses on a mortgage if the borrower defaults
There exists legal and practical differences among the various states
on the mortgage. FHA insurance is typically required on mortgages
regarding situations in which a receiver may be appointed, the standards
where there is less than a 20 percent down payment. The insurance
for appointment, notice required to be given to adverse parties, the
is funded by a fee on the overall mortgage amount and a small annual
party who has the burden of proof in connection with the appointment levy on the loan amount.
of a receiver, the nature of evidence required for appointment of a re-
ceiver, and the requirement of a bond. A federal district court also has FHA insurance is important, as it provides a mechanism to recover
the power to appoint a receiver in the event a party meets the require- losses associated with default and ensures a continuing flow of money
ments for federal jurisdiction. into the mortgage markets.
Receivers may be appointed in a multitude of settings and for multiple Why should a developer care
purposes. Circumstances in which a receiver may be appointed in Il- about the FHA requirements?
linois include: This is an issue of interest for developers of condominium and town-
1. The foreclosure of a mortgage in order to collect rents or home associations as FHA insured mortgages are playing an increas-
profits from the mortgaged real estate, or manage, conserve or ingly important role as a financing mechanism for those seeking to
operate the mortgaged real estate. purchase condominium units. While traditionally, FHA-insured
2. Completion of unfinished buildings or other improvements; mortgages played a small role in the housing markets (approximately
3. Remedying violations of municipal or state building codes; 5 percent in 2007), that number increased to roughly 20 percent of
4. Winding up a fraudulent conveyance; mortgage originations in 2008, and more than 30 percent in 2009.
5. Winding up a dissolved corporation or one that is insolvent;
6. Winding up a dissolved partnership or limited liability com- As lenders continue to reexamine and tighten lending criteria, quali-
pany, and fying for FHA mortgage insurance provides potential buyers with an
7. A court’s exercise of its own equitable powers. additional financing option and, thus, makes units in your condo-
minium association marketable to a larger pool of potential buyers.
A recently enacted statute allows a municipality to obtain court permis-
RECEIVERSHIPS Continued on Page 4 GUIDELINES Continued on Page 5
Bankruptcy Taxation
By Robert E. McKenzie, Partner
Downsizing and Rent Abatement: The Landlord and Lender get squeezed
By Joel M. Hurwitz, Partner & Real Estate Group Co-Chair As a preliminary step and essential tool for negotiations, a well pre-
pared Tenant must be ready to present detailed financial statements,
It is the call that Commercial Landlords dread. But, it is the call cash flow projections and other documentation to make its case to
received frequently in the current economy. A Tenant is downsizing, the Landlord. Such documents should include reliable data showing
experiencing cash flow problems or both. The Tenant needs a reduc- a specific hardship and a business plan for returning to profitability.
tion in space or a current or permanent rent reduction in order to stay An astute Lender and Landlord will accept nothing less. The Land-
afloat. Each Tenant in such position carries the implicit (or some- lord and Lender should scrutinize such material presented by the
times explicit) threat to the Landlord that it will go out of business or Tenant to determine the type of rental abatement or space reduction
move elsewhere. Space is now plentiful and relatively inexpensive. the Tenant might realistically need to continue conducting its busi-
In many instances, the Landlord does not stand alone to deal with ness. If the statements indicate that the Tenant is spiraling toward
the Tenant. Often, standing behind the Landlord is a Lender which bankruptcy, then the Landlord and Lender may wish for the Tenant
has financed the Landlord’s building in reliance upon cash flow to to vacate its space, and the negotiations will shift to lease termina-
be generated by the Tenant and others. The Tenant and particularly, tion.
the Landlord, must be cognizant of the Landlord’s loan covenants.
A potential breach of such covenants caused by any relief granted to If the Tenant can make a compelling case for continuing the Lease
Tenant, will in all likelihood compel the Lender’s active participa- with amended terms, there are provisions the Tenant may offer and
tion in negotiations. the Landlord should consider demanding which make the overall
ABATEMENT Continued on Page 7
TAXATION Continued from Page 2 gross income. This rule is subject to the exceptions noted below in
sections 2.10, 2.11, 2.12, and 2.13.
specifically allowed a deduction for administrative expenses allowed
under section 503 of the Bankruptcy Code and for any fee or charge
Conversion to Chapter 13
assessed against the estate under chapter 123 of title 28 of the United
If a chapter 11 case is converted to a Chapter 13 case, the Chapter 13
States Code. I.R.C. § 1398(h)(1).
estate is not a separate taxable entity and earnings from post-conver-
sion services and income from property of the estate realized after the
1040’s
conversion to Chapter 13 are taxed to the debtor. I.R.C. § 1399.
The individual debtor must continue to file his or her own individual
tax returns during the bankruptcy proceedings. I.R.C. § 6012(a)(1).
Conversion to Chater 7
If the Chapter 11 case is converted to a Chapter 7 case, section 1115
Pre BAPCPA
will not apply after conversion and earnings from post-conversion
For bankruptcy cases filed before October 17, 2005, the property
services will be taxed to the debtor, rather than the estate. 11 U.S.C.
of the estate does not generally include any post-petition property
§ 541(a)(6). In such a case, the property of the Chapter 11 estate will
acquired by an individual Chapter 11 debtor. Nor in those cases does
become property of the Chapter 7 estate. Any income on this prop-
the property of the estate include the individual Chapter 11 debtor’s
erty will be taxed to the estate even if the income is realized after the
earnings from post-petition services, because section 541(a)(6) of the
conversion to Chapter 7.
Bankruptcy Code specifically excluded those earnings from the estate.
See, e.g., In re Fitzsimmons, 725 F.2d 1208 (9th Cir. 1984); In re
Dismissal
Larson, 147 B.R. 39 (Bankr. D.N.D. 1992). Therefore, in these cases
If a Chapter 11 case is dismissed, the debtor is treated as if the bank-
income from post-petition property and earnings from post-petition
ruptcy case had never been filed and as if no bankruptcy estate had
services are not generally includible in the estate’s gross income.
been created. I.R.C. § 1398(b)(1).
Instead, such income and earnings are generally includible in the
debtor’s gross income.
Taxation of Income From
Property Excluded From the Estate
Post BAPCPA
For Chapter 11 cases filed by individuals on or after October 17,
Section 321 of BAPCPA made several changes to Chapter 11, effective
2005, the estate’s gross income includes gross income from property
for bankruptcy cases filed by individuals on or after October 17, 2005.
held by the debtor when the case commenced (pre-petition property),
Although many of the provisions that apply to individual Chapter 11
as was the case under pre-BAPCPA law. There are certain excep-
cases now operate in a manner similar to the provisions that apply in
tions to this general rule, however. The gross income on pre-petition
Chapter 13 cases, section 1398 of the Internal Revenue Code has not
property is included in the gross income of the debtor, rather than
been amended and continues to apply to individual Chapter 11 cases,
the estate, if the pre-petition property is excluded from the estate and
but not to Chapter 13 cases. Based on section 1115 of the Bankruptcy
the gross income is subject to taxation. Also, the gross income on pre-
Code, read in conjunction with section 1398(e)(1) of the Internal
petition property is included in the gross income of the debtor, rather
Revenue Code, the debtor’s gross earnings from post-petition services
than the estate, after the pre-petition property is removed from the
and gross income from post-petition property are, in general, includ-
estate by exemption or abandonment.
ible in the bankruptcy estate’s gross income, rather than in the debtor’s
Recent Changes to FHA much more than a showing of the mortgagor’s default and a provision
in the mortgage entitling the mortgagee to a receiver upon default.
Approvals and Recertifications The burden then shifts to the mortgagor to show the absence of a
for Condominium Properties default or good cause why a receiver should not be appointed.
w w w. a r n s t e i n . c o m
5
• Projects must consist of two or more units. If the documents do not meet these standards, the mort-
• Projects must be covered by hazard and liability insur- gagee may request a reserve study to assess the stability of the
ance and flood and fidelity insurance where applicable. project. The reserve study cannot be more than 12 months
• Right of first refusal is permitted, provided it does not old. In reviewing the reserve study, consideration must be
violate the Fair Housing Act regulations found in 24 given to items that have been replaced after the time that the
CFR Part 100. reserve study was completed.
• No more than 25 percent of the total floor area can be
used for commercial purposes. The commercial portion Insurance Requirements. Condominium projects must be covered by
must also be of a “nature that is homogenous with hazard, flood, liability, and other insurance as required by state or local
residential use.” The Fannie Mae standard for a mixed laws, or acceptable to FHA under the following criteria:
use building is not more than 20% of the project can be
devoted to commercial use. • Hazard Insurance: The Condo Association is required
• No more than 10 percent of the units may be owned by to maintain a master or blanket property insurance
one investor. This limitation also applies to developers/ equal to 100 percent of current replacement costs
builders that subsequently rent out vacant and unsold exclusive of land, foundation, excavation, or other
units. For projects with 10 or fewer units, no single normal exclusions. If the association does not maintain
entity can own more than one unit. Fannie Mae also 100 percent coverage, unit owner gap coverage does not
limits the number of units to one investor at 10% of satisfy meeting this requirement.
the units, and delinquencies to 15% of the total units • HO-6 Coverage: In cases in which the master policy
cannot be in arrears more than 30 days. does not include interior unit coverage, the borrower
• Delinquent Homeowners Association Dues [Assess- must obtain a “walls in” coverage policy (H0-6).
ments]: No more than 15 percent of the total units • Liability Insurance: The association is required to main-
can be in arrears (more than 30 days past due) of their tain comprehensive general liability insurance covering
condominium association fee payments. all common elements, commercial space owned and
• At least 30 percent of the total units must be sold prior leased by the owner’s association, and public ways of the
to endorsement of a mortgage on any unit. After De- condominium project.
cember 31, 2010, the pre-sale requirement increased to
GUIDELINES Continued on Page 6
• Pending special assessments. Calculating the level of FHA concentration in a project declared with
• Pending legal action against the condominium associa- legal phases will follow the same methodology as the owner-occupancy
tion or its officers or directors. requirements.
• Adequate hazard, liability insurance, and when ap-
plicable, flood insurance coverage. Impact of Resale Disclosures Under the
Illinois Condominium Property Act
For qualified associations, how many Illinois condominium associations along with their attorneys and
units will FHA provide financing for? managing agents, should be careful when distributing Section 22.1
Concentration Limits (Temporary). During the transition period disclosures under the Illinois Condominium Property Act. Section
of December 7, 2009, to December 31, 2010, FHA increased its 22.1 provides that in the event of any resale of a condominium unit
temporary concentration limits (the percentage of units that it will by a unit owner other than the developer such owner shall obtain
insure in a project) to 50 percent. from the Board of Managers, and shall make available for inspection
to the prospective purchaser, upon demand, copies of certain docu-
FHA will also consider increasing concentrations up to 100 per- ments and the disclosure of certain information. Among the informa-
cent if a condominium project meets additional criteria that include: tion to be disclosed is (i) statement of the status and amount of any
w w w. a r n s t e i n . c o m
7
reserve for replacement fund, and any portion of such fund earmarked early termination rights;
for any specified project by the Board of Managers, (ii) a copy of the • waiver of co-tenancy clauses;
statement of financial condition of the unit owner’s association for • waiver of exclusive-use clauses or other provisions which
the last fiscal year for which such statement is available, and (iii) a limit the Landlord from leasing to certain tenants;
statement of any capital expenditures anticipated by the unit owner’s • insertion of relocation clauses;
association within the current or succeeding two fiscal years. These • transfer of responsibility for certain maintenance from
fiscal disclosure items will of course have an impact upon a prospec- Landlord to Tenant;
tive buyer’s ability to obtain an FHA loan, or a loan from a lender • with respect to retail leases, (i) waiver or elimination of the
who intends to assign the mortgage for sale in the secondary mortgage “kick-out” clause, or (ii) increase in potential percentage
market place (i.e. Fannie Mae or Freddie Mac). Section 22.1 also re- rent to offset a reduction in fixed rent;
quires disclosure of any pending litigation in which the association is • waiver of existing Landlord defaults;
a party. These disclosures may be given prior to the granting of a loan • backend or escalating payments of abated rents; or
to the prospective buyer, and may very well be taken into consider- • in exchange for requested reductions in CAM charges in
ation by the buyer’s mortgage lender. leases which have escalation provisions, a new lower base
year.
It should also be noted that recently enacted Section 22.2 of the Il-
linois Condominium Property Act provides that in the event of a sale The Landlord may have relief, other than rent reduction which can
of a condominium unit by a unit owner, no condominium associa- be offered to the Tenant. Such relief includes:
tion shall exercise any right of refusal, option to purchase, or right • in the case of a triple net lease, a credit toward operating
to disapprove the sale, on the basis that the purchaser’s financing is expenses, an offer to contest the real estate taxes or a tem-
guaranteed by the FHA. porary abatement of common area charges;
• a reduction or deferral of CAM charges;
ABATEMENT Continued from Page 5 • an easing of the lease terms with respect to subletting.
transaction more palatable to the Landlord and its Lender. These
terms include the following: By creative, thoughtful and flexible negotiation, the Landlord, Lend-
er and Tenant can work together to navigate the current economic
• a guaranty from a financially reliable source; downturn. A well negotiated lease modification can position all par-
• waivers of rights of first refusal or options to expand; ties to benefit when the economy improves.
• an extension of the lease term coupled with a forfeiture of
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