A Dangerous Case

In the many years I've been writing about condominiums, I can't remember ever having strongly suggested owners change their Declaration or Bylaws. This time I am. But in order to understand why, I need to take a step back and explain something.

Generally, associations are required to have a Master Insurance Policy to cover all of the structures on the Property, including units, a swimming pool, a pump station, a clubhouse, etc. If a catastrophe strikes such as lightening hits a roof, a fire breaks out, or a water pipe breaks, and the Master Policy kicks in, then it (generally) covers both anything outside the boundaries of the Unit, such as the roof and siding, as well as everything inside the Unit (even though it is the owner's) that is attached to the Unit.

This “attachment” provision usually results in the association's policy covering damage on the inside of the Unit including finished flooring, cabinets, wall-to-wall carpeting and even appliances. So the Association gets a big check, less the deductible of course, and starts making the repairs. This is where problems can begin, and where a case has created even more of a problem.

Since it is the association's Master Policy that paid the money (and the association's money that paid the premiums) it is the Association's money. Or so you would think, but one recent case has made what was logical and fair something else.

In Woodland Condominiums Homeowners Association, Inc. v. Federal National Mortgage Association (Fannie Mae) a case that came out of Michigan in February of this year there was a Master Policy claim. The management company endorsed the insurance proceeds check to the mortgagee, not the association. The bank decided the money was insufficient to repair the Unit, took the unit at foreclosure, and kept the money. The association sued under the seeming simple logic that the money was that of the association not that of the bank.

The case hinged on language in the mortgage that said any insurance proceeds would be applied to the restoration of the Property, but only if the repairs were economically feasible and the mortgagee's interest in the property was not threatened. Of course, this is a little vague. Values go up and down, and no one knows what “economically feasible” means. Does it mean the bank has to make a lot of money? A little? Not lose too much?

The interesting part is that the mortgage is a contract between the owner and the lender. It has nothing to do with the condominium, and the condominium is certainly never a party to the mortgage. Yet that lack a relationship did not stop Fannie Mae from arguing or the Court from finding that mortgagees are more important than owners when it noted nothing in the Declaration or Bylaws of the Association gave the Association priority over the mortgagee's rights in a mortgage contract to the Association's money.

To summarize, the unit mortgagee was allowed to keep the condominium insurance proceeds without restoring the damaged Unit, decreasing the value of the neighboring Units, of course, and throwing the status of all future insurance claims into doubt. As I tell my daughter all too often, “It's all about the money.”

If it has not already, I'm sure word will spread through the mortgage industry, so that forevermore when there is an insurance claim, the mortgagees will, depending upon the amount of the claim, be seeking a payday rather then repairing the Unit. This is not good. And since Fannie Mae is a huge player in the mortgage market, you can rest assured the chances are very high your association, if there is an insurance claim in your association, will have to deal with this and try to fend off having to pay Fannie Mae the proceeds and have a destroyed condo unit in your association. The solution?

Unfortunately, most Declarations I have seen have language that could be interpreted as suggesting if not outright stating that nothing stands in the way of the mortgagee in the case of the distribution of insurance proceeds. If you have similar language, you are just as liable to losing tens of thousands of dollars on an insurance claim as Woodland did.

The very simple solution would be to strike any such language and add this one sentence in order to save you and your Association a lot of grief and financial pain. “Notwithstanding anything herein to the contrary, nothing in this Paragraph or in the Declaration or Bylaws of this association shall give any mortgagee priority over the association to the proceeds of the Master Policy.”

Amending your documents this way shouldn't cost your association more than a few hundred dollars, and could potentially save you tens of thousands of dollars.

You really should do it.