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Legal Research Library   >   Title Requirements...

Title Requirements for Insurance on the Foreclosure of a Cooperative Unit
By Donna Reichner, Esq.

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Today, it is a common scenario for an individual to obtain a loan to purchase a cooperative apartment. What isn�t so common is when the individual (debtor) defaults on its loan obligations. How does a secured party foreclose on its collateral-the cooperative unit? Also, what issues would a title company raise if requested to issue title insurance on the conveyance out of the foreclosure? These issues, plus more, will be discussed in this article.

It is established law that the ownership of a cooperative unit is personalty. The owner of a co-op receives shares of stock in the co-op corporation that owns the building and in return received a proprietary lease. The borrower may pledge the shares and lease as security for a loan. The lender, also, known as the secured party, receives a security agreement on the shares and an assignment of the proprietary lease. Because the stock and the lease are pledged to the lender, the co-op indicates its consent to the loan by the issuance of a Recognition Agreement. This agreement allows the lender to cure any default on the obligations the unit owner may owe to the co-op. Although it is frequently said in the legal community that the borrower gives a co-op mortgage to a lender, technically this is not true. The borrower gives the lender a security interest in the shares of the corporation and a uniform commercial finance statement is filed. A mortgage is not filed in connection with the loan and consequently, no mortgage tax is due.

An important consideration to a foreclosure is how title is held. Before 1995, title could be held only in individuals or as tenants in common. In August of 1995, Governor Pataki signed a law amending Sections 6-2.1 and 6-2.2 of the Estates, Powers and Trust Law to provide that a husband and wife may own a co-op as tenants by the entirety. Previously, a husband and wife could hold title to a coop only as joint tenants with right of survivorship or as tenants in common as only title to real property could be held as tenants by the entirety. This law became effective to all conveyances of a co-op after January 1, 1996. Either party cannot sever a tenancy by the entirety unilaterally while both parties are living. Thus, the creditors of one spouse cannot force the sale of the property held by the spouses as tenants by the entirety unless and until the debtor spouse survives the non-debtor spouse This provides some protection for a debtor against a creditor that seeks to enforce his or her personal judgment against the co-op unit.

This article will not discuss the foreclosure of the underlying mortgage on the co-op building itself. That is a real estate foreclosure and the secured party has the remedy available to him under the RPAPL #13.

When a borrower defaults on his co-op loan, the secured party has a few remedies available to him. A lender may resort to the provisions of RPAPL #13 and conduct a judicial foreclosure. In some ways this is a better method than non-judicial foreclosure in that its judgment is final and less subject to be challenged than a non-judicial foreclosure sale but this method is infrequently used because of the time and expense involved in conducting the foreclosure (This method is not discussed in this article). The more universally accepted method of foreclosure is an auction sale of the coop unit. This method is governed by Article 9 of the Uniform Commercial Code (UCC)

To commence a foreclosure under the first method available pursuant to the UCC, a secured party may foreclose by first sending out a notice to the borrower that the borrower is in default and that the lender plans on retaining the collateral (the shares of stock and lease) in satisfaction of its obligation. This notice must contain the nature of the debt or agreement under which the lien arose, with an itemized statement of the claim and time when due; a brief description of the personal property against the lien exists; the estimated value of the property and the amount of the lien at the date of notice. Notice must be given to anyone úwho is known by the secured party to have a security interest in the collateralî as well as to anyone who has filed a financing statement indexed in the name of the debtor. The borrower has twenty-one days to file an objection. If he fails to object within this twenty-one day period, the secured party is free to keep the collateral. Notice of this intention must be sent to the borrower and to any other person entitled to notice. However, retention of the collateral precludes pursuit of a deficiency action. If the lender receives notice of objection from the debtor, the lender must then dispose of the collateral pursuant to UCC # 9-504 (in a commercially reasonable manner) and the failure to do so will incur penalties under UCC # 9-507. The purchaser takes free of all rights and interests and discharges the security interest. A problem with this method is that if the borrower sends a letter of objection, you have lost 21 days. Finally, because of the informal nature of this method, most title companies would not insure good title in the name of the secured party and would require compliance with the next method of foreclosure. Furthermore, there is the inherent risk that the co-op may not recognize the lender as the new owner of the shares as so little has been done to obtain them. The unit is not sold by auction sale. Thus, this method is not used very often. In addition, if the debtor has paid 60% of the loan, the secured party who has taken possession of the collateral, must dispose of the collateral pursuant to the provisions of UCC #9-504. His failure to do so may make him subject to an action for conversion by the debtor.

The universally accepted method of foreclosure is by auction sale. In the past, it was rare that a title insurer would insure title to a purchaser who buys a coop unit out of foreclosure. However, in today�s market, an attorney will frequently request a title insurer to insure the sale of a coop from foreclosure. This title insurance is cautiously given. Before insuring clear title to the purchaser at the foreclosure sale, the title insurer would review the following documents: the proprietary lease, the UCC security agreement, the notice of default upon the debtor and other necessary parties with proof of service, the notice of sale made upon the debtor on any lien-holders with proof of service, notice of public sale, and the auctioneer�s report. The insurer would also run a bankruptcy search against the debtor. Since UCC sales are non-judicial, title insurers would require proof that the notice of sale was delivered personally to the debtor and any subordinate lien-holders. Or notice may be sent by the method specified in the security agreement and other loan documents. A Certificate of Mailing is required. Furthermore, the debtor must surrender possession of the unit. The lender and co-op board would be required to issue affidavits that the unit is presently vacant. The title insurer must be assured that the unit is vacant.

The letter of notice to the debtor must provide formal notification of the sale. The notice must further advise him of his option to pay the amount owed and redeem the property, his responsibility for any deficiency and must identify the date, time and location of the sale, the identify the auctioneer, the collateral, the method of sale, the method of payment, the secured parties reservations of rights, the auctioneer�s reservation of rights, the availability of the terms of the sale and must invite the debtor to contact the lender for further information. As in the above situation, the notice must be sent to the debtor and to anyone having an interest in the collateral. The notice of sale should then be published on three different occasions in a newspaper with circulation in the area where the co-op is located, or the secured party may follow the procedure used in a real estate foreclosure, that is once a week for four weeks or twice a week for three weeks. An affidavit of publication is obtained. The notice must contain the location and time of the sale. It also must identify the auctioneer, identify the secured party, contain the terms of sale and the address and telephone number of the attorney for the secured party. The opportunity to inspect the unit must also be provided. The terms of the sale and the description of the unit is distributed to all attendees of the auction sale. The auction is usually conducted at the courthouse or at the office of the secured party at least twenty-one days after distribution of the notice.

The terms of the sale should state that time is of the essence in connection with purchaser�s closing. It also explains the condition of the unit and occupancy and describes the procedure upon buyer�s failure to complete the purchase. It will also explain the payment of the transfer fees and taxes, the secured parties reservation of rights and that the sale is made without recourse to the secured party. At the outset of the auction sale, the licensed auctioneer will read the terms of the sale and will read the description of the apartment. The auctioneer will sell to the highest bidder. All of the attendees at the auction will be required to give their names and addresses to the auctioneer prior to the start of the auction. The proprietary lease, cooperative share offering plan, recent cooperative financial statements, floor plans and the description of the unit or units available may be inspected either at the auction or at the office of the attorneys for the secured party. The prospective purchaser must be given an opportunity to inspect the unit.

New shares of stock and a proprietary lease are issued to the new owners. The foreclosing attorney should not expect that the title insurer would be in a position to inspect and approve the above documents. The attorneys should send all of the documentation to the office of the title insurer well in advance of the closing for their review and approval. Furthermore, if the auction does not make the creditor whole and if the sale was performed in a commercially reasonable manner, a secured party may obtain a plenary action for a deficiency judgment after the sale of the coop unit.

Although this is a stock purchase, the State of New York considers the sale of the co-op unit as a taxable event and requires the parties to file a TP-584 Combined Real Estate Transfer Tax Return and Credit Line Mortgage Certificate. This form is sent directly to The Department of Taxation and Finance in Albany with the payment of the transfer tax, presently at $2 per $500 or $4 per $1,000. If the consideration is over one million dollars, payment of the mansion tax of 1 percent of the consideration is also due. Furthermore, if the co-op is located within the five boroughs of New York City, the New York City Real Property Transfer Tax form, along with the appropriate fee, must also be filed with the City of New York. Up and until the date of the auction, the debtor has the right to redeem the collateral by paying the amount due under the obligation and reimbursing the secured party for his expenses in arranging for the sale and for his reasonable attorney fees and legal expenses. It is important that the practitioner makes himself aware of the technicalities and requirements of his jurisdiction regarding a coop foreclosure. Failure to conduct a sale in a commercially reasonable manner or the failure to properly give a debtor notice of sale are just a few examples that could render the foreclosure to be void and uninsurable.

Donna Reichner, Esq., is the Underwriting Counsel in our Westchester office. Donna is responsible for clearing and closing residential as well as commercial transactions.

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