September 29, 2016
What is a Community Development Authority?
Every community is supposed to have a downtown as a destination for people to live, shop and play. The town center ideally keeps retail dollars and tax income from leaving the community. When these developments pop up, you hear discussions about whether “gentrification” helps or harms blue-collar people who live or work there. How does a developer decide where to place a new town center? In many places in Virginia, the local government offers to help finance the project with a special assessment district called a Community Development Authority (“CDA”). A CDA is where millions of dollars are financed through issuance of bonds paid off over many years by owners of real estate in the CDA district. The locality collects the assessments for the Community Development Authority. I take a personal interest in these CDAs because there is one in Fairfax County near me called the Mosaic District. Like many CDAs, Mosaic mixes residential homes and retail development.
“The Residences at the Lofts at SodoSopa”
A few days ago the Supreme Court of Virginia issued a new case opinion that provides an example of CDAs’ particular vulnerability to changes in the economy. Before I describe the case, I must first share something from pop culture with insight into recent trends in town center developments. A year ago, the television show South Park aired an episode called “The City Part of Town.” This episode lampooned these kinds of developments. I don’t often watch South Park because of some toilet bowl type humor they employ in other episodes. As a denizen of Northern Virginia, I love this particular episode. In this show, the “socially conscious” leaders of South Park wanted something that would, “Instantly validate us as a town that cares about stuff.” They created a new town center designed to lure Whole Foods Market to South Park. They named the district SodoSopa, shorthand for “South of Downtown South Park”. The episode focuses on a boy named Kenny whose family struggles financially but manage to keep their heads above water. SodoSopa develops around their “historic” home. Hipsters at trendy SodoSopa bars cause nighttime disturbances. The episode also features Mr. Kim and his asian restaurant, City Wok. The residents of South Park lose interest in City Wok when swank new restaurants open in SodoSopa. Mr. Kim takes desperate measures to try to keep City Wok from going out of business. City Wok hires a “child labor force.” Mr. Kim broadcasts commercials for his own restaurant district in an effort to compete with SodoSopa. In classic South Park fashion, the moronic adults engage in foolish behavior in vain attempts to achieve vainglorious objectives. According to Wikipedia.com, Whole Foods Market does open a store in fictional South Park, but not in SodoSopa. South Park’s gentrified district becomes abandoned because it failed to land the desired anchor tenant.
[embedyt] http://www.youtube.com/watch?v=miXMWJyOdgw[/embedyt]
CDAs & “Overlapping Debt”
Unfortunately, the cartoon’s satire is not too far from reality. On September 22, 2016, the Supreme Court of Virginia published a new opinion in Cygnus Newport-Phase 1B, LLC v. City of Portsmouth. The case confronted the issue of “overlapping debt” in CDAs. Both bank loans and the CDA bonds finance these developments. If the local government records the CDA ordinance in land records after the bank files their deed of trust, which takes priority in foreclosure? Does the Community Development Authority have “super-priority” over “ordinary” liens? This case is of interest to anyone who conducts real estate settlements, foreclosures or wants to understand what it means to own real estate in a CDA.
New Port CDA
In 2004, Portsmouth Venture One, LLC (“PVO”) acquired a 176-acre developable tract of land in Portsmouth, Virginia. PVO used a Bank of America (“BOA”) mortgage to finance the purchase. In 2005, PVO successfully petitioned the city to set up New Port Community Development Authority. New Port CDA entered into a “Special Assessment Agreement” with PVO for finance of almost $17 million in infrastructure, including roads, utilities and lighting. PVO agreed that the City of Portsmouth could collect the special assessments to pay off the bonds financing the infrastructure improvements. The agreement provided that the special assessments, “does not exceed the peculiar benefit to the Assessed Property … resulting from the improvements,” and that PVO’s successors would be bound by the agreement. In 2006, the CDA’s resolution authorizing the bonds, the city’s ordinance establishing special assessments on the CDA properties and a declaration of notice of special assessment were recorded in the land records. The declaration provided that its provisions would “run with the land” and bind future owners of the subject property. The CDA handed approximately 75% of the bonds proceeds over to PVO to make the infrastructure improvements. PVO then began selling individual lots.
This is a particularly powerful type of financing. CDAs allow a developer to obtain millions of dollars up-front to pay for public infrastructure required in large projects. The Community Development Authority, as a local government entity, issues the bonds. The millions are supposed to be paid back by special assessments owed by the present (and successor) owners of the properties in the CDA. In addition to federal income tax, county property tax, state and local sales taxes, mortgage payments and community association dues, owners in a CDA must pay the special assessments collected by the city or county. Some of New Port CDA’s bonds would not be retired for 30 years.
Mortgage Foreclosure Crisis
2006 was a particularly unfortunate time to undertake an ambitious real estate project. A few years after the mortgage crisis began, PVO defaulted on its debt obligations, eventually losing its investment. In 2011, BOA sold its real estate loans to a company called Cygnus VA, LLC (“Cygnus”). Cygnus instructed the foreclosure trustee to conduct a sale. Cygnus itself purchased the property at the foreclosure sale, thus becoming the succcessor. Cygnus conveyed the property to other holding companies, but for the sake of brevity I will refer to all of them collectively as “Cygnus.”
Once Cygnus acquired these vast tracts, New Port CDA demanded the outstanding special assessments. Cygnus refused, insisting that the foreclosure stripped off the latter-recorded CDA lien that PVO allowed to encumber the property. Not wanting to pay the money or lose the property in a subsequent foreclosure, Cygnus filed a lawsuit. Cygnus argued that the foreclosure sale extinguished the special assessment lien. BOA was never party to the agreements with the CDA and city. Cygnus alleged that, physically speaking, there was very little to show for the millions provided to PVO by the CDA. The property purchased at the foreclosure was largely unimproved by infrastructure. How could New Port CDA claim a lien when there was little or no improvements to the foreclosed property that the new owner would be benefitting from? The circuit court found that this didn’t matter. Circuit Court Judge William S. Moore dismissed the lawsuit on the CDA’s motion. The Supreme Court of Virginia granted Cygnus’ petition for appeal.
Race-Notice Land Recordation & Super-Priority Liens
This New Port CDA case was a closely decided case by a 4 justice majority over 3 dissenters. Virginia appellate law blogger Steve Emmert describes this opinion as a “bar fight” among the members of the Supreme Court. I like his bar fight analogy because it makes me think of South Park’s fictional restaurant districts. The court majority decided that the bank foreclosure did not extinguish what was found to be a “super-priority” CDA lien. Virginia is a “race-notice” jurisdiction as far as real estate law is concerned. This means that between two parties who both recorded liens against real estate, the first one to record has priority. Cygnus appealed the case confidently – its title derived from BOA’s earlier-recorded deed of trust. However, the majority found that a special assessment lien is paramount over other encumbrances including a prior-recorded lien. They explained that a tax lien is superior in dignity because it is made by local governments for purposes of public improvements. The court found that it is not proper for a prior mortgage to defeat the process by which municipalities make property tax liens.
In response to this argument, the dissent points to the sections of the Virginia Code that specifically authorize the attachment of these CDA special assessment liens to real estate. The statutes mirror the “race-notice” rules that apply generally to land recordings. How can these special assessment liens enjoy “super-priority” status if the statute specifically provides otherwise? The Court ruled that because the city filed the ordinance before the foreclosure trustee’s sale, when Cygnus purchased the property, it was on notice of the special assessment liens.
The Shelter Doctrine:
Cygnus’ litigation strategy relied upon what is called the “shelter doctrine,” which has nothing to do with the habitability of any physical construction. Cygnus took title through BOA as a party without notice of any special assessment liens at the time the deed of trust was recorded. Under the “shelter doctrine,” if the mortgage lender’s interest in the real estate had priority over a later-recorded lien, then any party which takes title through the bank foreclosure enjoys the same lien priority. Under the shelter doctrine, the successor in interest of one who purchases the real property in good faith stands in the same position as the good faith purchaser even when the successor had notice of the lien through title examination. The shelter doctrine underlies the nonjudicial foreclosure system in Virginia. The purchaser at the trustee’s sale takes title from the trustee whose authority comes from the deed of trust made to benefit the lender.
The majority remarked that, “To permit such belated challenges would not only be contrary to the [Virginia] Code, it would completely unravel the entire legislative system of local improvements funded by special assessments.” The dissent argued that the majority rewrites the super-priority feature into the special assessment legislation which says otherwise.
“The Villas at Kenny’s House”
Remarkably, a CDA only requires the approval of the locality and 51% of the landowners’ interests in order to set it up. The 51% might be calculated by relative acreage or tax assessment appraised values. If non-consenting landowners oppose formation of the CDA, they have a very short deadline in which to petition the court to block it. In the South Park episode, Kenny’s family owned a small home included within the encompassing SodoSopa district. Of all the townspeople, only Kenny’s family attended a hearing where South Park heard public input on the creation of SodoSopa. If an owner has a larger developable tract as a neighbor, potential imposition of a CDA by the 51% and the county upon other landowners is a legitimate concern. The local government, not the owners, appoint the members of the CDA’s board.
What Might All of this Mean to Buyers and Owners?
I expect lenders to re-write their commercial loan underwriting and documentation processes in the wake of the Cygnus case. I can’t imagine Bank of America now agreeing to finance a project like this without forcing the developer to agree to obtain lender consent before petitioning for a Community Development Authority, or otherwise protecting their interests in writing. Why would a bank knowingly permit overlapping debt to obtain priority over their mortgage? Look for underwriting standards and loan documentation to tighten. Industry and governmental leaders want town center developments to continue and will want the players to get along.
The term “Community Development Authority” seems like a euphemism, like calling serfs “agricultural interns.” Someone who runs across the term might think that it is in charge of parks, libraries or children’s sport programs. CDAs are more accurately called a Higher Tax Area.
What does this new Cygnus case mean to owners of condos or townhouses in CDAs? An owner in one of these districts must pay the special assessments in order to avoid a sale to satisfy the liens. Like everything else in real estate, the owner must understand what the ordinances, abstracts, agreements and memoranda of liens mean. Owners should not assume that every CDA has the same governing provisions as one elsewhere. Likewise, anyone shopping for real estate should check whether it is located in a CDA and what those assessment obligations might be.
Independent Professionals Can Help with Understanding CDA Documents
Between HOAs, CDAs, mortgages and taxes, property owners have many potentially overlapping obligations and rules. HOAs & CDAs provide developers and local governments with means of shifting burdens to build and maintain common areas and infrastructure off of the county budget. While these strategies may work fine for creating these communities, they don’t always work well for owners, as shown by the South Park episode and the Supreme Court of Virginia opinion.
CDAs are a relatively new and potentially confusing phenomenon. Owners or prospective buyers should seek a qualified attorney to help them understand the obligations that come with the benefit of living in one of these districts. Investors should protect themselves against the potential risks that come with unanticipated responsibilities and town center developments that might fail.
For Further Reading:
Cygnus Newport v. City of Portsmouth, Supreme Court of Virginia, Sept. 22, 2016
Photo Credit:
m01229 The new Target store, coming to Merrifield via photopin (license)
September 14, 2016
Does an HOA Disclosure Packet Effectively Protect a Home Buyer?
There is an interesting September 14, 2016 article in the Washington Post by Ilyce Glink and Samuel Tamkin entitled, “Why you should look carefully at an HOA’s plans for that community before buying a home there.” The article responds to Virginia home buyers who have great questions that aren’t answered in an HOA disclosure packet. The purchasers know that the roads the HOA owns need major repairs. It is overall a great article. The HOA disclosure packet doesn’t say how this will be paid for. They are concerned that their dues might increase from $1,000 to $3,500. This is a make or break question. Virginia law entitles the buyer to disclosure of HOA governing documents, corporate records and financial reports before going to closing on purchase of property. These disclosures are supposed to educate buyers about their rights and responsibilities to the HOA for as long as they own the property. In reality, buyers have many things on their minds during this exciting and stressful time. Their busy lives are consumed with urgent matters. They attend the home inspection and negotiation of any repairs. They come up with the down payment and approval from their mortgage lender. An excited family member may be dismissive of any questions or red flags about the property. The purchase will require the buyers to move and have their lives disrupted. Many home buyers feel worn down by demands of the process. They want to avoid cancelling and starting all over. All the buyers know about the HOA may be from seeing neighboring houses, maybe some common areas like a pool or playground. What’s in the HOA disclosure packet or condominium resale certificate give the association great influence over the financial affairs and home life of the buyers. Virginia law requires that HOA disclosure packet to include the following statements and documents:
Statements:
1. Name and registered agent of the association.
2. Approved expenditures that will require a special assessment.
3. Ordinary assessments or mandatory dues or charges.
4. Whether there are any other parties to which the lot owner may be liable for fees or charges.
5. Reserve study report or summary.
6. Current budget and financial balance sheet.
7. Any pending lawsuit or unpaid judgment that could have a material impact.
8. Insurance coverage provided and not provided by the association.
9. Whether any improvement to the property being sold is in violation of the governing documents.
10. Flag display restrictions.
11. Solar panel use restrictions.
Documents:
1. Declaration & any amendments.
2. Articles of incorporation, bylaws & any amendments
3. Rules, regulations or architectural guidelines
4. Approved minutes of the board and owner meetings for previous six months
5. Notices of any pending architectural violations
6. Disclosure Packet Notice Form prepared by the Virginia Common Interest Community Board
7. Annual Report form filed with the state with officers and directors and other information
8. Federal Housing Administration lending approval statement
While many people aren’t familiar with these kinds of documents, they reflect the family’s future financial obligations to the HOA and restrictions on the use of the property. The 2008 subprime mortgage crisis was caused in part by mortgage lenders giving borrowers loan documents that they didn’t understand. The HOA covenants are also a source of confusion. Many buyers would never buy a home without using a home inspector, but they try to tackle the HOA disclosure packet themselves. Unfortunately, it is easier for an unaided consumer to eyeball things in the home that need repairs than make sense out of the HOA documents. The federal government requires mortgage lenders to provide borrowers with simplified statements of the loan terms to make them transparent. For HOAs, consumer protections are weaker. Virginia law gives the buyer only three days to cancel the purchase contract after receipt of the HOA disclosure packet. That might give a professional working in the real estate industry enough time to digest them. However, many ordinary consumers struggle to make this three-day review period a meaningful part of their decision-making. A buyer could negotiate with the seller for this three-day period to be lengthened in the language of the sales contract. Few ask for this because the disclosures in the sales contract do not suggest to the buyer that additional time might be necessary.
As more HOA horror stories appear in news articles and social media posts, consumers are more likely to read the HOA disclosure packet and ask questions like in today’s Washington Post article. Even if the buyer is familiar with community associations law, the governing documents may be vague, ambiguous or unclear about issues critical to the buyer’s use and enjoyment of the home. This is what the home buyers in the article discovered. Glink and Tamkin recommend that the buyers knock on the door of the HOA president and ask her point-blank about how the road repairs will be paid for. An officer who understands their leadership responsibilities well might provide a sufficient answer upon a direct request. However, in most situations this probably won’t achieve a satisfactory result. Educated officers and directors know that the HOA or condo board is only required to provide the information and documents referenced in the statutes. If the buyer is unsatisfied, they have to either exercise the contingency within the deadline or negotiate for an extension of the cancellation period and a follow-up request to the board. The HOA could employ dilatory tactics, inducing the buyer to inadvertently waive the right of cancellation while pursuing an answer to the question. The road expense issue is probably already a hot-button issue for this board with lots of HOA politics in play.
There is a disturbing issue about the facts described in this newspaper column that isn’t addressed by the article. The HOA is managed by its board and not by a property management company. The monthly dues for the property are $1,000. This means that the officers and directors are handling a huge budget themselves, making day-to-day property management decisions. Maybe the board consists of retired real estate professionals who do this as a hobby to benefit the community at no added benefit to themselves. Given the commitment required to manage such a large budget, this is probably not the case. This would be my number one question.
If the purchasers have questions about what the documents mean, they might ask their real estate agent. Realtors provide a lot of value to their clients because they negotiate sales transactions all the time. The agent may not be the best person to ask because she won’t receive a commission on the sale if the buyer gets cold feet and backs out. The disclosure packets contain legal documents that are designed to enforce restrictions in court should disputes arise. If an attorney or real estate agent might struggle to make sense out of the disclosure packet, a buyer who is not familiar with HOAs may only read a few pages before setting them aside and focusing their attention elsewhere. If consumers understood the HOA disclosure packet and made an intentional decision to go to closing or back out based on what they read, consumer trends and demands might force home builders to make HOAs more owner-friendly.
In theory, a buyer can retain independent attorneys and CPAs to review the HOA disclosure packet and answer questions. This would allow an educated decision whether to cancel within the short deadline. In reality, if the buyer doesn’t already have an attorney and/or CPA lined up at the beginning of the three-day period, it may already be too late. Let’s say the buyer spends a day trying to make sense of the HOA disclosure packet on his own. If the family cannot figure things out themselves, on the second day he might start calling around for an attorney. Unfortunately, almost all community association lawyers represent the associations themselves, big investors or developers. They do not normally represent homeowners. My firm is an exception – in my solo practice I never represent HOA boards. General practice attorneys often represent individual persons. However, to effectively advise the purchaser on short notice, the attorney must be familiar with the appellate court decisions concerning the HOA statutes and governing documents. Much of the law pertaining to community associations matters is found in court opinions, not just acts of the general assembly. Many general practice lawyers are very good but may not be familiar with these things. Assuming that the buyer does find an attorney who is a good fit, there still are time constraints. The buyer has to talk to the lawyer, hire him, and provide the documents. It may take the attorney more than an hour or two to review the documents to prepare to provide an overview and answer questions. All of this must be completed within 3 days (or whatever extended period agreed with the seller) so that the buyer can make a meaningful decision to exercise or waive the HOA contingency. Otherwise the buyer might lose their deposit and some other fees if they want to get out of the contract. The three-day period might work if the buyer hired the attorney beforehand. However, the terms and disclosures in the sales contract do not alert the buyer that such might be desired.
Don’t get me wrong. The HOA disclosure packet provides critical information and documents to consumers and does contain a right of cancellation. Doing away with it entirely would be a huge setback to property owners. Unfortunately, the deadlines and procedural features of the disclosure laws don’t do enough to protect consumers. My professional experience working with owners leads me to believe that many of them go to closing unaware of what they are getting into. This is not really their fault. Sometimes they don’t understand the extent of some restriction or obligation that the property is subject to. Also, owners have rights that they are often unaware of and could improve their situation if they knew about them.
One of the key statements in the packet is the Virginia Common Interest Community Board Disclosure Notice Form. This is a kind of “Miranda” warning to consumers about what it means to live in an HOA or condo. The current version is useful but could be improved. It doesn’t mention fines for rule violations. It states that the buyer is subject to all of the decisions of the Board. Yet an adverse decision of the board might be legally void or voidable if the owner acts promptly. The notice does not reference the statutes or common law principles that may dramatically affect the rights and obligations of owners. The packet notice does not point out to the buyer that they have a right to have their own attorney review the documents and answer their questions. If the buyer received a useful disclosure notice form at the time they signed the contract, then they might more carefully consider whether to hire an attorney, CPA or other professional to help them with the HOA disclosure packet. Also, if the statute allowed for a longer period of time for the contingency than three days, the buyer would not need to negotiate that in advance. These additional protections are necessary because the system that exists has a practical effect of limiting home buyers’ right to counsel.
Based on my own personal experiences with real estate, the stories I have read about other people’s experiences and homeowners I have spoken to, I believe that on a practical level, the HOA disclosure packet is an ineffective system of consumer protection. This is shown by the surprise that owners experience when they are victim of an abusive debt collection practice, an arbitrary architectural review decision or any other infringement of their property rights by an association. Fundamentally, the HOA disclosure packet procedure doesn’t work because consumers don’t understand how its contents help them find answers to any questions they might have.
What does a buyer need to know that isn’t found in the HOA disclosure packet? The courts are the branch of government that oversee HOA boards. The Supreme Court of Virginia has repeatedly held that the declaration is a written contract or agreement between the owners and the HOA. If you go to the Virginia Code looking for guidance on something not explained in the packet you might not find the answer there because of the nature of the legal system. The declaration, along with other real estate contracts are interpreted by court precedents for many issues. For example, if a party breaches a contract, they are entitled to remedies which might include money damages, attorney’s fees or an order for the other side to do something. An owner has an interest in knowing whether the declaration even makes the association qualify as an HOA. The system of remedies for breach of covenants is very important in the HOA context because that’s where the owner finds means of enforcing his rights. A wide variety of rules that pertain to HOAs are found in court opinions that aren’t neatly summarized in the disclosure packet or even in legislation.
Because the governing documents are written in legalese interpreted by court opinions and legislative enactments, the disclosure packet is not effective as a summary of the rights the HOA has over the property. The Washington Post column illustrates this. A buyer does not have the time to take a law class on community associations or enforcement of real estate covenants in the three days in which the disclosure laws give them to review it.
I hope that the General Assembly amends the statutes to provide stronger protections for buyers. If buyers knew what they were getting themselves into beforehand, they would be better educated to be owners or even board members. In the meantime, home buyers should prepare to retain advisors to help them understand the documents. If necessary, the buyer and seller can agree to expand the three-day waiting period. Ultimately, families must work with their own team to stick up for themselves and protect their rights. Owners owe it to themselves to adequately understand all of the rights and burdens that may come with the sacrifices made to purchase the property to begin with. Buyers should retain a qualified attorney to help them understand the documents before they even receive the HOA disclosure packet or condominium resale certificate.
For Further Reading:
Common Interest Community Board – Virginia Property Owners’ Association Disclosure Packet Notice
Va. Code Section 55-509.5 (Contents of association disclosure packet; delivery of packet)
Va. Code Section 55-79.97 (Va. Condominium Act – Resale by Purchaser)
Photo Credit:
160404-neighborhood-sidewalk-morning-clouds.jpg via photopin (license)(does not depict property referenced in blog post)
