Partial Termination, Good Things Can Happen to Bad Projects
During the past decade we have experienced unprecedented market conditions: first the exponential growth in real estate market values and now the precipitous fall and slow recovery of the markets. Many developers, with and without experience, failed to see the pending burst of the real estate bubble. Developers throughout the state created condominium projects based upon historic absorption levels that were unsupportable. Condominium projects were built for purchasers that did not exist, designs the market no longer wanted, and absorption rates that were, in hindsight, far too aggressive. Today we have failed, or failing, condominium projects that cannot be revitalized unless redesigned or restructured to allow for new market conditions, including product redesign and slower absorptions. Partial termination is one possible approach to successful revitalization for unit owners, developers, and municipalities.
It is well established that condominiums are “creatures of statute”1 and their creation and termination are subject to the provisions of the Condominium Act. The statutory provisions authorizing the creation of the condominium2 segregate the property into condominium parcels that vest portions of the property into parcels subject to exclusive individual ownership and portions in which a unit owner owns an undivided interest with others.3
A condominium unit is created by recording a declaration in the public records of the county in which the land is located.4 A developer may create a condominium utilizing various structures, including a phased structure.5 Upon the recording of the declaration, or an amendment adding a phase to the condominium, all units described in the declaration or phase amendment come into existence, regardless of the state of completion of planned improvements in which the units may be located.6 If the units in the condominium have not been constructed when the declaration is recorded, the recording creates the problem of “phantom units.” These are unbuilt condominium units created by the recording of a declaration in conformity with F.S. Ch. 718 and are subject to assessment for common expenses of the condominium.7
Impact of Phantom Units
Condominium projects burdened with unbuilt, phantom units are negatively impacted in many ways. One of the most obvious impacts is fiscal. The association has the power to make and collect assessments from condominium unit owners.8 A unit owner may not be excused from payment of the unit owner’s share of common expenses unless all of the unit owners are likewise proportionately excluded from payment. However, if authorized by the declaration, the developer may elect to be excused from payment of assessments against unsold units for a stated period of time, provided the developer deficit-funds the common expenses incurred during such time period.9 If the developer elects to fund the deficits in collection of funds for the common expenses, but fails to make those payments, since the phantom units are developer-owned until created and conveyed, the assessments for those units are not paid. This shifts a disproportionate assessment burden to the remaining nondeveloper condominium unit owners. Further, additional costs and expenses are incurred by the condominium association to prosecute the payment of the assessments, which may include the ultimate foreclosure of the association lien. Even with the completion of the foreclosure, the phantom units offer no option for sale or occupancy and are a permanent, nonperforming component of the condominium property, since they are not constructed.
Overall market perception of the project is also impacted. In addition to the imposition of condominium assessments, once a condominium unit is submitted to the form of condominium ownership, ad valorem taxes are also assessed against the unit owners.10 Similar to the non-payment of assessments, if a developer fails to fund the association deficits, the developer may not be paying the ad valorem taxes associated with phantom units, resulting in the public sale and redemption of tax certificates. The holders of tax certificates may file for tax deeds after the statutorily prescribed time period, which can depress the values of the other constructed units in the project. Because of the increased fiscal burden of unpaid assessments and the depressed values created by tax deeds, a condominium project is stigmatized by the phantom units. The pool of prospective purchasers will look to other condominium projects, which further depresses market values within the condominium project containing the phantom units. If a potential purchaser is interested in buying within a condominium project containing phantom units, financing may be a challenge.11 All of the issues created by phantom units add to the public perception that a condominium project is a less than desirable place in which to live and invest.
Evolution of the Concept
An initial optional termination process was enacted by the Florida Legislature following the physical destruction caused by Hurricane Andrew and applied the concept to condominium properties impacted by natural disasters.12 The provisions were extended to other circumstances by the legislature, including “economic waste” and “obsolescence” in 2000.13 Yet the focus of the legislature in each of these circumstances was on the total termination of the condominium and partial termination was not contemplated.
While the focus had always contemplated a complete termination, the language adopted by the legislature in 2000 provided an imperfect option for partial termination that resulted in the successful elimination of phantom units at the condominium known as Grande Oaks Preserve in 2010. The events at Grande Oaks Preserve provided a new and innovated perspective. In 2011, the legislature adopted additional changes to F.S. §718.117 recommended by the Real Property, Probate and Trust Law Section of The Florida Bar based upon the experience at Grande Oaks Preserve that clarify the procedures for the partial termination of a condominium property. This action formalizes a viable alternative for resolving the problems inherent with phantom units.14
Partial Termination — A Solution
The provisions of F.S. §718.117, when properly followed, take priority over other provisions of the Condominium Act and the declaration of condominium that might otherwise require a higher threshold of approval. Specifically, the provisions of F.S. §718.110(4) do not apply to changing the character of the property.15 The termination process is statutorily prescribed, and requires consent by the required number of condominium unit owners to adopt a plan of termination (plan). The statute also requires implementation of the plan by the termination trustee (trustee), recorded evidence of the plan, and affirmation that all of the conditions of the plan have been met. The effect of the plan, if properly adopted and implemented under the act, is to convert the parts of the condominium property being terminated from condominium parcels — that is, units, together with an undivided percentage of the common elements — into property unencumbered by the declaration of condominium. Title to the unencumbered property vests automatically in the trustee.16
If there are conditions contained in the plan, the vesting of title in the trustee does not occur until the plan is recorded in the public records and a certificate executed by the condominium association confirming that the conditions have been satisfied or waived has also been recorded.17 For a period of 90 days following the recordings, any unit owner or lienor may contest the plan, but if the challenge is not brought within the statutory time period, unit owners and lienors are permanently barred from asserting or prosecuting any claim against the association, the trustee, any unit owner, or any successor in interest to the condominium property.18
Once title has vested in the trustee and the period to contest the plan has expired, the property may be transferred, unencumbered by the covenants of the declaration of condominium and any liens previously encumbering the individual condominium parcels.19 operation of statute, individual liens that previously encumbered the condominium parcels are removed from the condominium when the conditions in the plan have been met and the certificate recorded. The liens are automatically transferred to an interest in the sale proceeds attributed to the appropriate ownership interest designated in the plan.20
The condominium parcels that are to remain subject to the declaration of condominium or an amended and restated declaration of condominium must be specifically identified in the plan.21 Ownership interests in the remaining condominium parcels and the priority of any liens encumbering these parcels remain unchanged once the plan is implemented.22
Grande Oaks Preserve first introduced the concept of partial termination. The Grande Oaks partial termination would have been useless unless title to the remaining units and the land that was removed from the declaration under the partial termination could be insured by a title insurance company in a subsequent conveyance or refinance.
The first issue that a title insurance underwriter will review is whether the plan of termination was properly approved by the requisite number of unit owners. In order to make the determination, the underwriter will first need to determine the type of termination. If the termination is for economic waste or impossibility under F.S. §718.117(2), the plan of termination must be approved by the lesser of 1) the lowest percentage of voting interests required to amend the declaration, or 2) as otherwise provided in the declaration (for example, the declaration may specifically provide that it can be terminated by a certain percentage of unit owners). A condominium can be completely or partially terminated for economic waste or impossibility if either the total estimated cost of construction or repairs exceeds the combined fair market value of the terminated units after completion of construction or repairs or the land use laws or regulations make it impossible to operate or reconstruct the condominium as it existed.
If the termination is an optional termination under F.S. §718.117(3), unless otherwise provided in the declaration, the plan of termination must be approved by at least 80 percent of the total voting interests in the condominium provided the plan has not been rejected by more than 10 percent of the total voting interests. It is more difficult to establish proper approval for an optional termination, since one must prove that the plan of termination was approved by the requisite voting interests and not rejected by more than 10 percent of the total voting interests. In other words, one must prove a negative. Pursuant to F.S. §718.117(4), a partial termination is not a material amendment that would require the approval of all of the unit owners if the ownership interest in the common elements of the owners of the surviving units that are not terminated remains in the same proportion as prior to the partial termination. If the proportion is the same, there is no increased burden on any individual unit owner, and the unit owner has not lost his or her interest in the common elements. With a partial termination, this is actually a benefit to the surviving unit owners, who will no longer be responsible for the burdens of maintenance without contribution from the phantom units.
Pursuant to F.S. §718.117(5), once the termination is effective and the terminated units or property is subsequently sold, the lien of any mortgage encumbering such property is transferred to the proportionate share of the sales proceeds in accordance with the plan of termination. If those proceeds are not sufficient to satisfy the mortgage lien encumbering a terminated unit, that mortgage holder must approve of the plan of termination. With a partial termination, this requirement will apply only to those units that are being terminated. The requirement does not apply to the surviving units, since their lien will not be affected by the termination, so one need not obtain the approval of the mortgage holders on any of the surviving units. For lienholders other than mortgagees (such as a judgment lien), F.S. §718.117(12) (d) provides that the liens that encumbering a terminated unit should be transferred to the proceeds from a sale of that property in the same priority.23
Grande Oaks Preserve
The declaration of condominium for Grande Oaks Preserve, a condominium (declaration) satisfying all of the requirements of F.S. §§718.104 and 718.403, was recorded on August 16, 2004, thereby creating the subject condominium (Grande Oaks Preserve). Grande Oaks Preserve was to be developed in three phases. Phase I was planned to consist of three buildings, each containing 12 units per building, for a total of 36 units. Phase II was planned to consist of four buildings, containing a minimum of 45 units and a maximum of 53 units. Three buildings would contain a minimum of 10 to a maximum of 12 units, and the fourth building would contain a minimum of 16 to a maximum of 20 units. Phase III was planned to consist of three buildings containing a minimum of 30 units and a maximum of 36 units. The recreational areas and facilities were a swimming pool, two tennis courts, and a clubhouse including a community room, library, fitness room, media room, indoor kitchen, and restroom (common elements). Phase I was submitted to condominium form of ownership on August 16, 2004. Phase II, containing 53 units, and Phase III, containing 36 units, were submitted to condominium ownership on January 5, 2007. A total of 125 condominium units were legally created under F.S. Ch. 718.
All of the buildings in Phase I were constructed and 31 of the 36 units conveyed to third parties. One building in Phase II was constructed and 12 of the 53 units were conveyed to third parties. One building in Phase III was built and six of the 36 units were conveyed to third parties. As of July 2009, 49 units were conveyed to third-party purchasers and the developer owned 11 completed units and 65 phantom units.
In early 2009, Grande Oaks Preserve was a failing condominium project. The delinquent assessments, interest, and late fees for the phantom and developer-owned units were approximately $1.3 million, and delinquent real estate taxes, interest, and penalties were approximately $80,000. The inexperienced developer did not have the capital to continue building the project; the cost to complete the unbuilt units exceeded the fair market value of the phantom units. Paving of the project roadways was not completed. The then-current unit owners were unable to refinance or finance the resale of their condominium units. This resulted in the condominium units being sold on a cash only basis, further depressing the marketability and value of condominium units.
The owners of the condominium units were eager to change the status quo of the failing condominium project. To make negotiations more productive and to better avoid conflict issues, the developer turned over control of the condominium association to its unit owners. The newly owner-elected board of directors of the condominium association then embarked on an extensive effort to educate the existing unit owners. They did so through open board of directors meetings and letters to the membership explaining the dire status of the association and the inability of the unit owners to obtain financing for future unit sales. The advantages and disadvantages of partial termination of the condominium versus the status quo were extensively discussed by the board and the membership of the association. Both the developer and the condominium association retained attorneys that had substantial experience in condominium law. The attorneys were able to successfully guide their clients through productive settlement discussions. After educating the unit owners and rallying their support for partial termination of the condominium, the board and the developer reached a written agreement for partial termination of the condominium.
To revitalize Grande Oaks Preserve, a plan was negotiated and voted upon by the members of the Grande Oaks Preserve Condominium Association, Inc., a Florida not-for-profit corporation (association).24 In pertinent part, the developer agreed to relinquish control of the association, pay the association attorneys’ fees related to the partial termination, escrow money necessary to complete paving of the roadways, and pay all of delinquent assessments and real estate taxes.25 The declaration was restated and amended (restated declaration) to reflect that each owner of constructed condominium units would be subject to the restated declaration. The undeveloped condominium property owned by the developer was severed from Grande Oaks Preserve by a quit claim conveyance from the termination trustee to the developer, after the recording of the restated declaration (adjacent property).26 The restated declaration also provided that the recreational facilities located within the condominium property would be made available to the owners of certain adjacent property pursuant to a mutually agreed membership agreement that was subject to payment of proportional costs and expenses, as well as to reciprocal easements.
The partial termination of 65 phantom units was achieved because the plan of termination was approved by more than 80 percent of the total voting interests of the association and no more than 10 percent of the total voting interests in the condominium rejected the plan of termination. In fact, no rejections or objections to the plan of termination were received.27 In addition, 100 percent of the mortgage lienholders approved the plan of termination.28 Lastly, although unit owners or lienors may contest a plan of termination by initiating a summary procedure within 90 days after the date the plan of termination is recorded, no contests were made concerning the Grande Oaks Preserve partial termination.29
1 Woodside Vill. Condo. Ass’n Inc. v. Jahren, 806 So. 2d 452, 455 (Fla. 2002).
2 Fla. Stat. §§718.104, 718.105 (2011).
3 Fla. Stat. §718.103(12) (2011); see also Daytona Dev. Corp. v. Berquist, 308 So. 2d 548, 550 (Fla. 2d DCA 1975) (explaining property ownership status of condominium property).
4 Fla. Stat. §718.104(2) (2011).
5 Fla. Stat. §718.403(1) (2011).
7 See Hyde Park Condo. Ass’n v. Estero Island Real Estate, Inc., 486 So. 2d 1(Fla. 2d DCA 1986); Welleby Condo. Ass’n One, Inc. v. William Lyon Co., 522 So. 2d 35 (Fla. 4th DCA 1987); Estancia Condo. Ass’n, Inc. v. Sunfield Homes, Inc., 619 So. 2d 1008 (Fla. 2d DCA 1993); Winkelman v. Toll, 661 So. 2d 102 (Fla. 4th DCA 1995); RIS Inv. Group, Inc. v. Dep’t of Bus. & Prof’l Regulation, Div. of Florida Land Sales, Condominiums and Mobile Homes, 695 So. 2d 357 (Fla. 4th DCA 1997).
8 Fla. Stat. §718.111(4) (2011).
9 Fla. Stat. §718.116(9)(a) (2011).
10 Fla. Stat. §718.120(1) (2011).
11 See Federal National Mortgage Association, Announcement 08-34, Project Eligibility Review Service and Changes to Condominium and Cooperative Project Policies (Dec. 16, 2008), available at https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2008/0834.pdf.
12 Ch. 95-234 and Ch. 98-195, Laws of Florida.
13 Ch. 00-302, Laws of Florida. See also Fla. Stat. §718.117(1) (2011) (most current version of the law).
14 Ch. 11-196, Laws of Florida.
15 Fla. Stat. §718.117(4) (2011).
16 Fla. Stat. §718.117(17)(a) (2011).
17 Fla. Stat. §718.117(11)(b) (2011).
18 Fla. Stat. §718.117(16) (2011).
19 Fla. Stat. §718.117(6)(g) (2011).
20 Fla. Stat. §718.117(14) (2011).
21 Fla. Stat. §718.117(11)( a) (2011).
22 Fla. Stat. §§718.117(11)(a), (b) (2011).
23 Fla. Stat. §718.117(5), which transfers the lien of the mortgage to the proceeds, and Fla. Stat. §718.117(12)(d), which transfers other liens that encumber a terminated unit to the sale or distribution proceeds in their same priority, cannot be relied upon to eliminate federal liens because of the Supremacy Clause.
24 Fla. Stat. §§718.117(9), (10) (2011).
25 See Plan of Termination of Grande Oaks Preserve, a Condominium, recorded January 13, 2010, in the Official Records Instrument Number 201005065 of the Public Records of Sarasota County. Authors Taft and Dunbar represented Milwaukee, LLC, a Florida limited liability corporation that owned the undeveloped phantom units, and Wells represented Grande Oaks Preserve Condominium Association, Inc.
26 Fla. Stat. §718.117(19) (2011).
27 Fla. Stat. §718.117(3) (2011).
28 Fla. Stat. §718.117(5) (2011).
29 Fla. Stat. §718.117(16) (2011).
Peter M. Dunbar is a 1972 honors graduate from Florida State University College of Law and teaches condominium and community housing law at the college. He is legislative counsel for the Real Property, Probate and Trust Law Section of The Florida Bar and a member of the American College of Real Estate Lawyers.
Wilhelmina F. Kightlinger is a vice president and Florida state counsel for Old Republic National Title Insurance Company, where she handles underwriting for all types of commercial and residential transactions throughout Florida. She is an active member of the Title Insurance Committee, chair of the Real Estate Entities and Land Trust Committee, vice chair of the Sponsorship Committee, and an executive council member of The Florida Bar Section of Real Property, Probate and Trust Law.
Eleanor W. Taft is the sole shareholder of Eleanor W. Taft, P.A., in Naples. Her practice areas include real estate, commercial, transactional, construction, condominium, and planned development law. Taft is a former chair and current member of the Governmental Regulation Committee, member of the Real Property Problem Study Committee and Condominium and Planned Development Committee, a 20th Circuit at-large member and executive council member of the Real Property, Probate and Trust Law Section of The Florida Bar.
Kevin T. Wells is the sole shareholder of the Law Offices of Kevin T. Wells, P.A., in Sarasota. He graduated cum laude from Stetson University College of Law in 1995 and for the last 16 years has limited his practice to representing community associations. Wells currently represents more than 475 community associations located primarily in Manatee and Sarasota counties.
This column is submitted on behalf of the Real Property, Probate and Trust Section, William F. Belcher, chair, and Kristen Lynch and David Brittain, editors.