ILLINOIS CONDOMINIUM DECONVERSION
Getting It Right
By: R. Kymn Harp
WHAT IS A CONDOMINIUM DECONVERSION?
The term “Condominium Deconversion” is not a legal term, but rather is a colloquial term that refers to the process of removing property from the provisions of the Condominium Property Act. In the typical case of a residential condominium, the legal effect is that there will no longer be individual condominium units subject to ownership or transfer. Instead, the project will become a typical multifamily rental apartment building.
WHY IS CONDOMINIUM DECONVERSION A HOT TOPIC?
The current residential condominium deconversion craze is entirely market driven. Multifamily rental apartment buildings are currently sought-afterby investors as highly desirable investment properties. This is in part due to rising rental rates, low capitalization rates, and attractive financing options available for multifamily rental apartments. The supply of available apartment buildings for sale is relatively low by comparison. As a consequence of the supply/demand imbalance in the marketplace, prices for apartment buildings are currently high.
By comparison, the market demand for individual condominiums is fairly flat in most markets. Many condominiums have still not fully recovered from the economic effects of the Great Recession. This is especially true in financially distressed condominium associations with high levels of deferred maintenance and oftentimes depleted reserves. In some cases, due to foreclosures or short sales, high concentrations of investor owned units, the potential for increased monthly assessments and possible imposition of special assessments to deal with deferred maintenance on aging buildings, and/or ineffective management, the ability to sell or finance individual condominium units is impaired. As a consequence, the fair market value for individual condominium units may be depressed.
In the current marketplace, it is not unusual for the aggregate fair market value of all condominium units in a condominium building to be substantially less than the fair market value of the same building if it were owned and operated as an apartment building. The value difference can be as much as 30% to 40% or more. Because of this spread in values, the “deconversion” market is hot.
The spread in values can pose an opportunity for both the investor seeking to acquire and deconvert and condominium project and the selling unit owners. Because of the value spread, unit owners acting in concert to sell the project as a whole are in a favorable position to negotiate an aggregate sale price for their respective units which is higher than the aggregate fair market the individual condominium units being sold on their own. When acting together to sell the entire property as a whole, it is not uncommon to achieve a price point per unit which is several percentage points higher than fair market value for the individual units. The investor seeking to deconvert has room to pay more if the investor can be assured of acquiring all units because the investor will almost immediately see a spike in value upon deconversion.
Of course, the investor may need to make substantial capital expenditures in addition to acquiring the units to cover the costs of performing deferred maintenance, and/or the cost and expense of renovating or updating units to make them suitable for rental by the investor/developer’s target consumer. The amount of those costs will impact the investor’s profitability, and may affect the margin over fair market value an investor may be willing to pay to acquire the units for deconversion. If an investor plans to acquire, deconvert, demolish, and rebuild, the investor’s risks, development costs, and required profit margin may also impact the price a investor is willing to pay.
HOW IS PROPERTY DECONVERTED?
Removing property from the provisions of the Condominium Property Act requires action by 100% of all unit owners and the consent of the holders of all liens affecting the units. It is governed by Section 16 of the Condominium Property Act. To remove the property, 100% of the unit owners simply sign an instrument to that effect, with the consent of all lien holders, and record it.
If at the time of removal there is more than one unit owner, the entire property will be owned by the former unit owners as tenants in common with each other, with each owning an undivided tenancy in common interest proportionate to their previously owned percentage interest in the common elements. While this is legally permissible, it is highly unusual, and would in most circumstances create a legal and practical nightmare due to the legal attributes of the former unit owners owning a multifamily property as tenants in common.
It is beyond the scope of this article to discuss in detail the issues tenancy in common ownership may cause, but one of the biggest obstacles is that each tenant in common has an equal right to possess the entire property. While there may be solutions in special circumstances, this can present practical issues in a multifamily building occupied by the former unit owners. It is also likely to present unfavorable issues for any lenders on individual units, who after deconversion would have only a lien on an undivided fractional interest in the property as a whole.
WHAT IS THE SOLUTION?
The typical solution is for all unit owners to sell their units to a single buyer. When all units are owned by a single unit owner, that sole owner of all units cansign and record a notice of removal with the consent of its lender, thereby terminating the status of the property as a condominium, and causing the property to revert to being a unified apartment building with only one owner.
The sale of units may be by separately negotiated contracts between the respective unit owners and the prospective buyer, although this approach has many risk and challenges. From the buyer’s perspective it creates a logistical nightmare, especially if each unit owner engages its own attorney to handle its closing, and all attorneys/sellers do not use the same title company. From a practical standpoint, most investors with a plan to deconvert, and their lenders, do not wish to acquire any of the units unless they are assured they will acquire all of the units. The only practical way to do this is to acquire all units at the same time, on the condition that if any unit owner fails to close, none of the closings occur.
In practice, proceeding in this manner is the metaphorical equivalent to herding forty or more cats the length of a football field with the intent to have them all cross the opposing goal line at precisely the same time. In theory it can be done, but it is almost certainly going to be a gut-wrenching nightmare.
Is there another way? Yes – a sale pursuant to Section 15 of the Condominium Property Act.
WHAT IS A SECTION 15 SALE – AND HOW DOES IT HELP?
Section 15 of the Condominium Property Act provides that the unit owners owning at least seventy five percent (75%) of the common elements in a condominium association with four or more units may elect to sell the entire property comprising the condominium. The declaration or bylaws could require a higher percentage, but the minimum percentage is the seventy five percent (75%) required by Section 15.
If unit owners owning seventy five percent (75%) or more of the common elements elect to sell the entire property pursuant to Section 15, that election is binding upon all unit owners. By statute it becomes the “duty of every unit owner to execute and deliver such instruments and to perform all acts as in manner or form may be necessary to effect such sale”.
Section 15 includes limited protections for unit owners who do not vote in favor of the sale, but even if a unit owner avails itself of the statutory protections, the unit owner is nonetheless obligated to sell.
HOW ARE NON-CONSENTING UNIT OWNERS PROTECTED?
Section 15 provides that if a unit owner does not vote in favor of a sale approved by a seventy five percent (75%) majority, that unit owner may, within twenty (20) days after the approval vote, file with the manager or the board of managers a written objection to the sale. Upon doing so, the unit owner is still under a statutory duty to proceed with the sale, but has the right to receive from the sale an amount equivalent to the greater of:
(i) the value of his or her unit as determined by fair appraisal, less the amount of any unpaid assessments or charges due and owing from the unit owner; or
(ii) the outstanding balance of any bona fide debt secured by the objecting unit owner’s interest which was incurred by the unit owner in connection with the acquisition or refinance of the unit owner’s interest, less the amount of any unpaid assessments or charges due and owing from the unit owner.
The objecting unit owner is also entitled to reasonable relocation costs, determined in the same manner as under the federal Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970, as amended.
In determining the fair appraisal value under (i), above, the parties are to establish a panel of three (3) expert appraisers. For the panel, the objecting unit owner has the right to designate an expert appraiser to represent the objecting unit owner’s interest. If the objecting unit owner does so, the Section 15 buyer is to select an expert appraiser, and then those two expert appraisers are to select a third expert appraiser, creating a panel of three (3) expert appraisers. The panel of appraisers will then determine the fair value of the objecting unit owner’s interest by of vote of at least two (2) of the three (3) expert appraisers.
RISKS TO THE OBJECTING UNIT OWNER
An objecting unit owner should consider the risk of following the statutory appraisal process described in Section 15. Note that, except in the circumstance where the unit owner’s bona fide mortgage debt exceeds the amount the unit owner would otherwise receive from the sale, the unit owner is entitled by statute to “the value of his or her unit as determined by fair appraisal” less any unpaid assessments or charges due and owing from the unit owner. If the “value . . . determined by fair appraisal” as determined by at least two of the three expert appraisers on the panel of appraisers is less than the amount the unit owner would otherwise receive pursuant to the Section 15 sale, the unit owner will be entitled to receive only the reduced fair value amount. In the common circumstance where the prospective Section 15 buyer is offering to pay a premium over the aggregate fair market value of all units to motivate unit owners to sell, the risk of ending up with a lower appraised value through the statutory appraisal process is real and significant.
The other major risk faced by an objecting unit owner who refuses to cooperate with the sale by filing litigation to try to stop it, or otherwise refusing to close, is the risk of being liable for damages. Section 15 is a statutory process. As a process duly enacted by the Illinois legislature, Section 15 expresses the public policy of the State of Illinois which courts are bound to abide. By its express terms, it is the “duty of every unit owner to execute and deliver such instruments and to perform all acts as in manner or form may be necessary to effect such sale.”
A breach of that duty may result in personal liability to each non-cooperating unit owner. That liability may extend to: (i) the buyer for all damages it may incur as a consequence of the transaction failing to close; (ii) each other unit owner who may miss out on selling its unit for an amount it has agreed to accept; and (iii) to any unit lenders with an underwater mortgage, who, by statute, would be paid off in full upon completion of the Section 15 sale (provided its mortgagor unit owner has likewise objected to the sale).
If an objecting unit owner is going to refuse to cooperate with a sale, notwithstanding its statutory duty to facilitate the sale, it had best be certain that the basis for objecting to the sale is well grounded in fact, and warranted by existing law. To do that, the unit owner must consider existing law, and determine whether its objection is well grounded in fact as applied to the existing law. The starting point for making that determination is to understand the statutory framework for conducting a Section 15 sale.
WHAT IS THE PROCEDURE FOR CONDUCTING A SECTION 15 SALE?
Although the Condominium Property Act sets forth a fairly clear procedure for approving a sale pursuant to Section 15, many condominium associations and attorneys go astray. This can result in needless litigation and a potentially defective sale. Often law suits challenging a Section 15 sale are baseless because they are premised on a lack of understanding of the scope of authority of the board of managers. Conversely, a board of managers may needlessly expose itself to liability by overstepping its authority based upon the same lack of understanding of the scope of authority of the board of managers in conducting a Section 15 sale.
WHAT IS THE ROLE OF THE BOARD OF DIRECTORS IN A SECTION 15 SALE?
Absent specific authority granted to the board of managers by the unit owners, the board of managers has virtually no authority to act relative to a Section 15 sale.
By its terms, Section 15 is an owner action. Under Section 15, the sole statutory authority of the board of managers is to serve as a repository for an objecting unit owner’s statutory objection to sale. Nothing in Section 15 provides for participation in the sale by the board of managers. Any interference in, or obstruction of, a Section 15 sale by the board of managers is likely a breach of fiduciary duty owed to all unit owners unless a requisite percentage of units owners has granted the board of managers authority to act. The authority of the board to act is not inherent under the Condominium Property Act, or the Declaration or bylaws. It must be specifically granted in accordance with law and the condominium instruments.
Attorneys and board members sometimes claim that because of the general fiduciary duty (and responsibility) of the board of managers to the association and to all unit owners, the board of managers is inherently invested with the power and authority to market the property as a whole, review and approve (or disapprove) any contracts for the sale of the property as a whole, and to otherwise interject itself in the Section 15 sale process. It is not. To test this conclusion, one need only look at the statutory source of the general fiduciary duty (and responsibility) owed by the board of managers to the association and unit owners.
Section 18.4 of the Condominium Property Act sets forth the powers and duties of the board of managers. Notably, Section 18.4 says nothing about a board of managers having the power or authority to market the property as a whole, seek offers for sale of the property as a whole, review and approve (or disapprove) contracts for the sale of the property as a whole, or to otherwise participate in promoting or opposing a Section 15 sale.
What Section 18.4 does say is that “the board of managers shall exercise for the association all powers, duties and authority vested in the association by law or the condominium instruments except for such powers, duties and authority reserved by law to the members of the association.”
Section 15 provides that only the unit owners have the authority to authorize a sale of the entire property. Approval is required by unit owners owning not less than seventy five percent (75%) of percentage interest in the common elements. It is a power and authority reserved by law to the members of the association. It is one of the powers and authority referred to in Section 18.4 as being excluded from the authority vested in the board of managers. The authorization and conduct of a Section 15 sale is a unit owner action, pure and simple.
Nothing in the Condominium Property Act or in the Declaration or bylaws of any Illinois condominium grants the board of managers authority to market the property as a whole, to seek offers for sale of the property as a whole, to review and approve (or disapprove) contracts for the sale of the property as a whole, or to otherwise participate in promoting or opposing a Section 15 sale. Absent an express grant of authority from the unit owners to the board of managers, as required by law, only the unit owners have this authority.
If there is any doubt about the foregoing statement, one can examine the statutory requirements specified at Section 18 of the Condominium Property Act, setting forth the minimum requirements for condominium association bylaws.
Subsection (a) of Section 18 sets forth the minimum requirements for bylaws governing the board of managers and meetings of the board of managers. Subsection (b) of Section 18 sets forth the minimum requirements for bylaws governing the unit owners and meetings of the unit owners.
Specifically, Section 18(b) of the Condominium Property Act provides that the bylaws shall provide for at least the following:
(13) that matters subject to the affirmative vote of not less than 2/3 of the votes of unit owners at a meeting duly called for that purpose shall include, but not be limited to:
(i) merger or consolidation of the association;
(ii) sale, lease, exchange, or other disposition (excluding mortgage or pledge) of all, or substantially all of the property and assets of the association; and
(iii) the purchase or sale of land or of units on behalf of all unit owners. (Emphasis added).
Clearly, the intent of the Condominium Property Act is that the decision to sell (or not sell) the condominium property as a whole on behalf of all unit owners is a decision reserved exclusively to the unit owners, not the board of managers.
It is pertinent to note the concluding paragraph of Section 18 which provides as follows:
“The provisions of this Section are applicable to all condominium instruments recorded under the [Condominium Property Act]. Any portion of a condominium instrument which contains provisions contrary to these provisions shall be void as against public policy and ineffective. Any such instrument which fails to contain the provisions required by this Section shall be deemed to incorporate such provisions by reference.”
WHAT IS THE PROCEDURE FOR APPROVING A SECTION 15 SALE?
One might ask: how does the minimum 2/3rds unit owners approval requirement specified in Section 18(b)(13)(iii) reconcile with the Section 15 requirement for approval by 75% unit owners? Using ordinary rules of statutory construction which require that the entire statute be read together as a whole, and interpreted in a way that does not invalidate any provision, it appears the answer is as follows:
1. If (a) an offer to purchase the entire property is received by the president or the board of managers from an interested third party; or (b) if twenty percent (20%) [the percentage required by 18(b)(5)] of the unit owners desire to call a special meeting to consider the question of selling the property as a whole; a special meeting of unit owners must be called to consider the question
2. At the special meeting of unit owners, not less than 2/3rds of the votes of unit owners in attendance at the special meeting called for that purpose must affirmatively vote to pursue a sale of the property as a whole. If they don’t, then there is nothing else to be done. The issue is dead, unless at a future special meeting of unit owners called for such purpose at least 2/3rds of the unit owners in attendance at the meeting affirmatively vote to pursue a sale on behalf of all unit owners. This approval is necessary to start the process. To actually bind all unit owners to sell, it is still necessary to comply with Section 15.
This issue of whether Section 18(b)(13) requires the affirmative vote of only 2/3rds of the vote of unit owners in attendance at a special meeting called for the purpose of considering a sale of the property as a whole vs. the affirmative vote of 2/3rds of the ownership percentage of all unit owners in the Association is a matter of some confusion and disagreement. In an unpublished opinion of the Illinois Appellate Court, First District, filed March 17, 2017, at least one appellate panel considered this specific issue and has ruled that the provision clearly requires the vote of only 2/3rds of those present at the meeting. Geraci v. Cramer, et al, 2017 IL App (1st) 151555-U at ¶13-14. Although by Rule, an unpublished opinion may not be cited as binding legal precedent, it is reasonably considered as persuasive precedent as to how the Illinois Appellate Court is likely to rule in a binding published opinion. This interpretation of Section 18(b)(13) is also consistent with Section 60 of the Illinois Not for Profit Act (805 ILCS 105/107.60), which is made applicable to the Condominium Property Act by Section 18.1 of the Condominium Property Act. Section 60 of the Not for Profit Corporation Act expressly states: “If a quorum is present, the affirmative vote of a majority of the votes present and voted, either in person or by proxy, shall be the act of the members, unless the vote of a greater number or voting by classes is required by this Act, the articles of incorporation or the bylaws.” Since the Condominium Property Act at Section 18(b)(13) requires the affirmative vote of 2/3rds (rather than a mere simple majority) of the unit owners in attendance at the special meeting call for that purpose, the affirmative vote of 2/3rds (rather than a mere simple majority) of the votes present and voted . . . shall be the act of the members.
3. If the requisite approval is given by the unit owners to pursue a sale of the property as whole, the unit owners could authorize the board of managers, the president, or conceivably a committee of unit owners, to engage on behalf of the association a broker, appraiser, legal counsel, and/or such other professionals as they may deem appropriate to explore or pursue a sale of the property as a whole.
4. Alternatively, with the approval of 2/3rds of the votes of unit owners in attendance at the special meeting, the unit owners could simply enter into negotiations with a buyer who has offered to purchase the property. Nothing in the Condominium Property Act creates a fiduciary duty among unit owners. Absent affirmative vote of the required percentage of unit owners directing otherwise, the unit owners have no duty, fiduciary or otherwise, to market the property as a whole or to seek a higher price or better offer.
5. Within the limits of the express authority granted at the special meeting of unit owners called to consider the question of selling the property as a whole on behalf of all unit owners, the board of managers, president, or committee of unit owners, as may be applicable, could undertake to pursue a sale of the property as a whole. Once again, the Section 15 sale remains an owner action. The board of managers has only the authority expressly granted by the unit owners at the special meeting called for such purpose, and the sale must still be approved by affirmative vote of the unit owners owning at least seventy five percent (75%) of the common elements to bind all unit owners.
Pursuant to Section 15 of the Condominium Property Act, only the approval of seventy five percent (75%) of unit owners by percentage interest in the common elements (or such greater percentage as provided in the declaration or bylaws) will authorize a sale of the entire property, and require all unit owners to participate and cooperate.
BOTTOM LINE SUMMARY
— A Section 15 sale is an owner action requiring owner approval.
— The board of managers has no right or authority to participate in or obstruct a Section 15 sale absent express authority granted by 2/3rds of the unit owners at a special meeting called for the purpose of approving pursuit of a sale of the property as a whole; except that the board of managers or manager shall serve as a repository for objections which may be filed by unit owners objecting to the Section 15 sale within twenty (20) days after its approval.
— Claims and lawsuits by objecting unit owners asserting that the board of managers has breached its fiduciary duty to seek and obtain the highest and best price for the property as a whole are baseless and without foundation, absent a breach of express authority to take such actions as granted by 2/3rds of the unit owners in attendance at a special meeting to consider the issue.
— Any action taken by the board of managers to market the property as a whole without having first received the requisite vote of unit owners granting that authority is an ultra vires act, and may be a breach of fiduciary duty owed to the unit owners under Section 18.4 of the Condominium Property Act. Section 18.4 provides, in pertinent part, that: In the performance of their duties, the officers and members of the board, whether appointed by the developer or elected by the unit owners, shall exercise the care required of a fiduciary of the unit owners.
UPDATE NOTE: See also White Paper Supplement published August 7, 2019 entitled Illinois Condo Deconversion – Challenging Unauthorized Board Action.
— A sale of the entire property pursuant to Section 15 of the Condominium Property Act was never intended by the legislature to be easy. Any argument that the legislature did not intend to make a Section 15 sale an exacting and cumbersome process is without legal support. A Section 15 sale forces objecting unit owners to sell their homes when they do not wish to sell. Still, the legislature recognized that in an association of condominium unit owners, a few dissenting unit owners should not be able to obstruct the will of a super majority. The risk of being forced to sell is part of the statutory regime a unit owner buys into when it decides to own a condominium unit. There are other preventive actions the association could take to minimize the risk that a Section 15 sale will be approved, but that is outside the scope of this article.
USE OF THIS ARTICLE
This article is published solely for educational purposes and not with the intent of providing legal advice. Receipt or review of this article does not create an attorney-client relationship with the author or with Robbins, Salomon & Patt, Ltd., which attorney-client relationship shall only be created by execution of a formal engagement letter. This work may be reproduced or republished only with proper attribution to its author.
© 2018, R. Kymn Harp – All Rights Reserved