Explaining Co-Ops


15 March, 2005


Mortgage Lender and Servicer Alerts

For whatever reason, we have had more calls on this lately, suggesting that this is a proper moment to review what is often a difficult subject for mortgage servicers.  If these are in your portfolio, you have some idea of how different and confusing co-ops can be. The documents are different. They don’t look like mortgages. And the rules and relationships are unlike real estate.  (Needless to say, if these are not in your portfolio at the moment they could be in the future.).

That being so, when there is a default, what papers are to be sent to counsel?

Our article in the July, 2004 issue of Servicing Management entitled “Enter the Co-Op Beast” is a primer on the subject and answers many of the questions.  For those who may not have seen the piece, the text which follows is what appeared in the article and we invite your attention to it.

The co-op is a strange beast. Servicers who have not encountered them may not be instantly entranced by this excursion, but when suddenly a group of such loans appear in a portfolio, understanding the manifest obscurities will be most helpful. Those who already noticed co-ops on their screens have been understandably asking the questions: What are they?  What are the documents like?  How do we service them?

Although more common in New York State, that odd creature called a co-op exists in other states as well. While they tend to appear most often in urban areas, they could exist anywhere.  And because they are so different from mortgages on real estate, it is genuinely important for servicers to know what they have and what to do with them.  In that regard, the good news is that foreclosing on a co-op is non-judicial and so it is much faster than a typical judicial foreclosure.  The bad news is the danger and lack of flexibility this form of ownership imposes upon the servicer.

First, how it differs from a real estate mortgage.  For real estate (e.g., a house, a shopping mall, a condominium) the borrower owns real property (evidenced by deed), promises to pay back a loan (evidenced by a note) and pledges to the lender security for that promise in the form of a mortgage (or deed of trust in some states). The mortgage is filed with an appropriate recording officer (like a county clerk) and retains priority over all later interests (except real estate taxes and certain super liens).

But a co-op isn’t real estate; that’s the overwhelming basic difference.  It is personal property.  In a nutshell, a co-op corporation owns a building. By virtue of owning shares in the corporation, shareholders  are entitled to a proprietary lease on units in the structure.  What that person owns then are shares and a lease — personalty.  If the person borrows money to “buy” the unit (which as can be seen doesn’t really happen) the pledged security consists of the shares of stock and the proprietary lease.  All this is evidenced by a security agreement (not a mortgage).  And to demonstrate that interest to the world, a UCC financing statement is filed — not a mortgage.

So, the borrower obtains a loan to buy not real estate, but shares in a corporation, which happens to be the co-op corporation.

Instead of a deed, the borrower gets a lease — and is thereby a tenant of a unit, not an owner.  Pursuant to that lease, the borrower (called a proprietary lessee by the co-op) must pay monthly maintenance charges to the co-op for building expenses, which would include real estate taxes on the building and mortgage installments for the underlying building mortgage. Default by the borrower on those maintenance payments to the co-op becomes a very serious matter. In essence, the co-op, which holds a senior position, can cancel the lease and take or have the shares sold — all of which extinguishes the lender’s security agreement.  (This would be the equivalent of wiping out a lender’s mortgage when a senior mortgagee forecloses.)

The promise to pay could be in a note, but it is often combined with the security agreement.  As mentioned, there is no mortgage (because there is no real estate to pledge as security) so the security agreement is the rough equivalent — the pledging of a security interest in personal property which in turn are the shares in the corporation and the interest in the lease.

In order to gain a position of priority, the lender should obtain and file a UCC- 1.  That places the world on notice of the lender’s prior claim to the shares and lease so that another lender cannot try to assert seniority for another loan.

Although real estate is, of course, incapable of being moved or removed, personal property could be.  That is, the borrower could physically give the shares and lease to someone else as purported security.  Consequently, the lender should take actual possession of the shares and the lease. If there will ever be a foreclosure sale, the bidder (be it the lender or a third party) needs to become the owner of the shares and the lease. This is accomplished via assignment. Since an ultimate owner of this personalty is unknown, the lender would require an assignment of the shares in blank (meaning the assignee’s name is not filled in) as well as an assignment in blank of the lease.

In sum, the servicer’s file should contain (and copies should be forwarded to counsel when there is a default) the following:

  • Security Agreement
  • Certificate of shares in the co-op corporation
  • Assignment of shares signed in blank by the borrower
  • Proprietary lease
  • Assignment of proprietary lease signed by the borrower in blan
  • Filed UCC-1
  • Co-op recognition agreement

That last document is perhaps the most perplexing. Understand that the co-op has virtually unassailable authority over its units and its shareholders.  As noted, monthly maintenance charges are assessed to the lessee/borrower and for neglect  to pay, the co-op can take the shares and lease away, thereby extinguishing not only the borrower’s lease and share ownership, but the lender’s security interest as well. To protect itself, the lender must have that recognition agreement signed by the co-op whereby the co-op is obliged to give notice to the lender of any maintenance default. That affords the lender or servicer the opportunity to pay the sums and protect its interest.  Additionally, because the co-op has essentially total power to reject any purchaser of the co-op unit when sold, the recognition agreement binds the co-op to accept the lender either as a purchaser at a foreclosure sale or as owner for the equivalent of a deed in lieu of foreclosure.

Yet more peril lurks.  Because there is typically a mortgage on the co-op building, a default on the underlying mortgage can lead to wiping out the security interests on each of the units.  How lenders and servicers for the various units are to obtain protection for this eventuality is a continuing mystery.

Even this briefest of recitations exposes the likely breadth of issues relating to co-op servicing.  But having a basic familiarity with this form of ownership should help.

Mr. Bergman, author of the four-volume treatise, Bergman on New York Mortgage Foreclosures, LexisNexis Matthew Bender (rev. 2017), is a partner with Berkman, Henoch, Peterson, Peddy & Fenchel, P.C. in Garden City, New York. He is also a member of the USFN, The American College of Real Estate Lawyers, The American College of Mortgage Attorneys, an adviser to the New York Times on foreclosure issues and writes a regular servicing column for the New York Law Journal. He is AV rated by Martindale-Hubbell, his biography appears in Who’s Who In American Law and he has been for years listed in Best Lawyers In America and New York Super Lawyers.