By: Timothy A. Raty; Sr. Regulatory Compliance Specialist
“A cooperative apartment house is a multi-unit dwelling in which each
resident has an interest in the entity owning the building and an
agreement entitling him to occupy a particular apartment within the
building. The interest in the owner-entity is usually that of a stockholder
and the occupancy agreement is generally referred to as a ‘proprietary
lease.’ The difficulty in classifying or defining the owner-occupant status
in legal concepts has caused confusion, and a cooperative is frequently
described as a building in which each ‘tenant’ ‘owns’ an apartment, an
obvious contradiction in terms.” (Plaza Rd. Co-op., Inc. v. Finn, 201 N.J.
Super. 174, 174 [App. Div. 1985])
Loans secured by shares in, and a lease by, a cooperative association (aka “cooperative share loans”) are one of the more frustrating loans to work with in the mortgage industry. Much of this stems from the peculiar nature of cooperative housing (as well explained above by the Appellate Division of the Superior Court of New Jersey), the disorganization of the laws governing cooperative share loans, and the fact specific nuances of each loan.
The following is a “high-level” overview of what cooperative share loans are and how they are typically structured. They may be structured differently and the mortgage loan documents used will differ depending upon facts and circumstances. This article should be considered a rough sketch rather than a blueprint – but hopefully one which will be of some value.
Essentials of Cooperative Housing
Cooperative housing presupposes two things: (1) a cooperative form of ownership; and (2) property which is used for housing.
Fundamentally, cooperatives are formed to utilize a service to achieve a common goal among participants. Cooperatives are not limited to housing and are often formed for agricultural or retail purposes. They are organized and incorporated in the manner permitted by State laws, which can vary on a state-by-state basis. Many are formed as corporations, but they can also be structured into other types of entities. For this article’s purpose, all of these types will be referred to collectively as “cooperative associations” or “associations”.
Once formed, an association will either purchase or lease some type of real estate to be used for housing (also known as a “cooperative project”). It is fairly common for the association to obtain a mortgage loan when purchasing the real estate, but this is not to be confused with a cooperative share loan, which is obtained by individuals to own/lease a unit (or more) within a cooperative project (the former is obtained by the association to obtain the cooperative project).
A cooperative project is not restricted to certain types of real estate. While images of high-rise apartment buildings in New York City first come to mind for most, a cooperative project can also be a converted condominium in New Jersey, a mobile home park in Florida, or a 19th century mansion in California converted into a multi-unit building. What makes a cooperative project such is the legal structure of the ownership of the project, rather than its physical characteristics.
Tenants by Ownership
Unlike condominiums and planned unit developments, wherein the borrower obtains direct title ownership (solely or jointly) over some of the housing project, a borrower does not obtain any direct title ownership over the cooperative unit they will occupy. Rather, the borrower will have an ownership interest in the cooperative association (which has title to the cooperative project), and the association will then lease to the borrower a unit (or more), granting the borrower a possessory interest in such unit(s).
There are two key documents involved in this arrangement. The first is some type of legal instrument which grants the borrower an ownership share in the association. What type of instrument is used will depend greatly on how the association is legally structured. For example, if it is structured as a corporation, the association may sell stocks to the borrower. Membership certificates are also commonly used (all types of these instruments will be collectively referred to as “certificates”). Each of these certificates are assigned a value proportional to the units within the cooperative project (e.g., in a cooperative project with four units wherein only four certificates are issued by the association, one certificate may represent one unit). The borrower will need to purchase as many of these certificates as necessary to be approved for a lease in one (or more) of the units.
When these documents are purchased, the borrower becomes a joint owner in the association (and, indirectly, a joint owner in the cooperative project). A proprietary lease is then extended to the borrower, granting the borrower a possessory interest in the unit(s) – thus making the borrower a tenant of the association the borrower is a part owner in. To maintain the cooperative project, the borrower will likely agree (within the lease) to make periodic payments to the association to be applied to expenses applicable to the entirety of the cooperative project (e.g., property insurance, taxes, etc.)
Because these two documents (the membership certificates and the proprietary lease) form the entirety of the borrower’s ownership interest in the cooperative unit possessed, a cooperative share loan is structured so that both documents are secured by a security instrument. This is done to enable the lender to sell and re-assign these documents upon the borrower’s default on the loan.
Real or Personal Property?
Due to the nature of the security of a cooperative share loan, there is a conundrum in determining which laws apply to such loans. The cooperative unit and project which the borrower leases/indirectly owns are, for sure, real property, but the security for the loan is not the real property itself (i.e., the lender does not take title to the cooperative project or unit upon default), but the borrower’s ownership interest in the association (represented by certificates, which are not real property) and in the lease (which is subject to real property law).
Thus, cooperative share loans are a “hybrid” between a real property loan and a chattel loan (e.g., one used to purchase an automobile). This creates a conundrum in determining which legal documents must be used for cooperative share loans (e.g., mortgage v. UCC-1) and how a lender can foreclose upon the security after default. For real estate mortgage loans, a mortgage/deed of trust is used and under such, foreclosure is accomplished either through judicial or non-judicial proceedings, in accordance to real estate laws.
However, personal property loans are generally governed by the Uniform Commercial Code (“UCC”) and dispossession proceedings are much different than foreclosure proceedings involving real estate – particularly in the fact that they favor lenders more than under real property law (e.g., foreclosures on real estate typically involve court proceedings, a sheriff’s auction, as well as other restrictions used to ensure that the borrower is not losing their homestead without just cause; under the UCC, generally a lender can sell the shares without a court order and in a manner deemed reasonable by law).
What makes this conundrum more acute are the facts that: (1) State laws vary as to whether real or personal property laws apply to cooperative share loans; and (2) With few exceptions, laws applicable to cooperative share loans are not contained in a single chapter or title of code, but are “scatter-shot” throughout statute and case law (the latter, in some jurisdictions, comprising the bulk of the laws impacting these types of loans).
Thus, it is commonly difficult to pinpoint with exactitude which body of law (real or personal) applies to any particular aspect of a cooperative share loan. It is also possible for these two bodies of law to apply to a singular share loan, dependent upon the aspect.
Mortgage Loan Documents
Based on research by outside counsel and by ourselves, we have developed a “Cooperative Matrix” which lists which body of law generally applies to cooperative share loans in the states currently listed in FNMA’s “Co-Op Share Loan Documentation Requirements” (see https://compliance.docutech.com/matrices/). This Matrix also includes a list of the legal documents which we support in each of these states for these loans. The following is a general overview of the main documents:
Whether real or personal property applies, a promissory note is used for all cooperative share loans (we use FNMA/FHLMC’s uniform promissory notes).
In real property states, a mortgage or deed of trust is used, like the ones used for other types of mortgage loans. However, it must be structured to apply to the unique circumstances applicable to cooperative share loans (e.g., property insurance is provided by the association, foreclosure proceedings may need to reference how the certificates will be dispossessed, etc.). This may be done by modifying the text of the document itself or through a rider (we use a rider).
In personal property states, the security instrument is typically a combination of a loan security agreement and Form UCC-1. The loan security agreement is similar to a mortgage in that it sets forth the terms under which the borrower agrees to treat the property and fulfill other fiscal obligations (e.g., timely payment of association dues, not using the unit for illegal purposes, etc.) and promulgates the conditions under which the lender may foreclose on the secured interests.
Loan Recognition Agreement
This agreement is between the lender and the cooperative association, in which both parties agree to recognize the lender’s legal interests in the borrower’s cooperative documents and it sets forth mutually agreeable parameters for handling the loan. For example, the cooperative association may agree to inform the lender if the borrower has failed to pay association dues (thus breaking their lease agreement) or if the cooperative project has been the victim of some disaster (impacting the value of the cooperative unit). The lender may agree to limit, upon foreclosure, the sale of the certificates and the assignment of the lease to only those persons approved by the association.
Assignment of Proprietary Lease
To protect itself in the case of foreclosure, the lender may require the borrower to assign the lease to the lender, thus enabling the lender to unilaterally re-assign it upon default and foreclosure.
Irrevocable Stock Power
A blank stock power signed by the borrower and given to the lender allows the lender to control the certificates upon the borrower’s default and as part of the dispossession process.
Assignment of Security Instrument
Like other mortgage loans, an assignment of the mortgage or deed of trust may be used by the lender to sell the loan to an investor, such as FNMA and FHLMC. Form UCC-3 accomplishes something similar for cooperative share loans secured by personal property.
Cooperative Pledge Agreement
The borrower pledges and assigns the certificates to the lender.
Other documents may be required by state law, investor requirements, or simply as “good practice” forms. For example, Pennsylvania requires written documentation of the cooperative association’s consent to the lender’s loan (“Cooperative Consent to Security Instrument”). A lender may wish to protect itself from superior lienholders by having the borrower sign an affidavit that there are no other encumbrances on the property securing the cooperative share loan (“Affidavit of No Further Encumbrances”).
Summary of State Laws
The following is, by no means, an exhaustive list of laws which apply to cooperative share loans. However, they do illustrate how scattered cooperative share loan laws are and, we hope, the following list will be a useful starting point for clients and interested readers.
All States: The Uniform Commercial Code (citations will vary per state).
Alaska: Alaska Uniform Common Interest Ownership Act (Alaska Stat. §§ 34.08.010 et seq.)
California: Cal. Civ. Code § 4640. Windsor Properties, Inc. v. JPMorgan Chase Bank, N.A., No. B261709, 2016 WL 1056810 (Cal. Ct. App. Mar. 17, 2016); Kempis v. NCB, FSB, No. H040911, 2015 WL 7571746 (Cal. Ct. App. Nov. 24, 2015); Spahi v. NCB, FSB, No. B251977, 2015 WL 4656478 (Cal. Ct. App. Aug. 6, 2015); Golden Rain Found. v. Franz, 163 Cal. App. 4th 1141, 78 Cal. Rptr. 3d 226 (2008), as modified on denial of reh’g (July 8, 2008); Nahrstedt v. Lakeside Vill. Condo. Assn., 8 Cal. 4th 361, 878 P.2d 1275 (1994); California Coastal Com. v. Quanta Inv. Corp., 113 Cal. App. 3d 579, 170 Cal. Rptr. 263 (Ct. App. 1980)
Connecticut: Connecticut Common Interest Ownership Act (Conn. Gen. Stat. Ann. §§ 47-200 et seq.)
District of Columbia: D.C. Code Ann. §§ 26-1151.01(21), 42-306(b), 42-401, & 42-815.01 et seq. Zoob v. Jordan, 841 A.2d 761 (D.C. App. 2004); Willens v. 2720 Wisconsin Avenue Co-Operative Assoc., 844 A.2d 1126 (D.C. App. 2004); Lemp v. Keto, 678 A.2d 1010 (D.C. 1996); First Sav. Bank of Virginia v. Barclays Bank, S.A., 618 A.2d 134 (D.C. 1992); Snowden v. Denning Heights Cooperative, 557 A.2d 151 (D.C. App. 1989)
Florida: Cooperative Act (Fla. Stat. Ann. ch. 719) and Fla. Stat. Ann. § 697.07. S. Walls, Inc. v. Stilwell Corp., 810 So. 2d 566 (Fla. Dist. Ct. App. 2002); State, Dep’t of Revenue v. Swinscoe, 376 So. 2d 1 (Fla. 1979); In re Wartels’ Estate, 357 So. 2d 708 (Fla. 1978)
Illinois: CitiMortgage v. San Juan, 976 N.E.2d 563 (Ill. App. 2012); Maher v. Harris Trust and Savings Bank, 506 F.3d 560 (7th Cir. 2007); In Re McNair, 90 BR 912 (Bankr. N.D. Ill. 1988); Brandzel v. Koretzky, 66 Ill. App. 3d 717, 384 N.E.2d 128 (1978); Bros. v. McMahon, 351 Ill. App. 321, 115 N.E.2d 116 (Ill. App. Ct. 1953).
Indiana: Ind. Code Ann. §§ 24-4.4-1-301(11), 24-4.5-1-301.5(14), 32-21-3-3, & 32-21-4-1. Merrillville 2548 v. MBO Harris Bank, 39 N.E.3d 382, 393 (Ind. App. 2015) (review denied, 42 N.E.3d 520 [Ind. 2015]); Hoang v. Jamestown Homes, 873 N.E.2d 208, 2007 WL 2670261 (Ind. App. 2007); Cunningham v. Georgetown Homes, 708 N.E.2d 623 (Ind. App. 1999).
Maryland: Md. Code Ann., Corps. & Ass’ns §§ 5-6B-16(a) & (b) and 5-6B-17(a) through (c),
Massachusetts: Mass. Gen. Laws Ann. ch. 183, § 4
Michigan: Mich. Comp. Laws Ann. §§ 445.1601(g), 565.29, 565.35, 565.901(d) & 600.5701 et seq. Wentworth v. Process Installations, 122 Mich. App. 452, 333 N.W.2d 78 (Mich. App. 1983)
Minnesota: The Common Interest Ownership Act (Minn. Stat. Ann. ch. 515B) and Minn. Stat. Ann. §§ 510.01 et seq.
New Jersey: Cooperative Recording Act of New Jersey (N.J. Stat. Ann. §§ 46:8D-1 et seq.) and N.J. Stat. Ann. §§ 46:15-5(a) & 54:4-8.55. Chase Manhattan Bank v. Josephson, 135 N.J. 209 (1994); In Re McGuinness, 139 B.R. 3 (Bankr. D.N.J. 1992); Anchor Savings Bank v. Waters Ebb Owens, 1992 WL 182204 (D.N.J. 1992); In Re Robertson, 147 B.R. 358 (Bankr. D.N.J. 1992); Drew Assocs. of N.J., L.P. v. Travisano, 122 N.J. 249, 584 A.2d 807 (1991); Drew Assocs. of N.J., L.P. v. Travisano, 235 N.J. Super. 194, 561 A.2d 1177 (App. Div. 1989), aff’d in part, rev’d in part, 122 N.J. 249, 584 A.2d 807 (1991); Presten v. Sailer, 225 N.J. Super. 178, 542 A.2d 7 (App. Div. 1988); Plaza Rd. Co-op., Inc. v. Finn, 201 N.J. Super. 174, 492 A.2d 1072 (App. Div. 1985)
New York: N.Y. Banking Law §§ 6-c & 235. Chase v. Wells Fargo Bank, N.A., 135 A.D.3d 751, 24 N.Y.S.3d 673 (2016); Marion Blumenthal Tr. ex rel. Blumenthal v. Arbor Commercial Mortg. LLC, 40 Misc. 3d 1215(A), 977 N.Y.S.2d 667 (N.Y. Sup. 2013), aff’d sub nom. Marion Blumenthal Tr. v. Arbor Commercial Mortg., LLC, 133 A.D.3d 419, 21 N.Y.S.3d 4 (2015); Emigrant Mortg. Co. v. Greenberg, 34 Misc. 3d 1236(A), 950 N.Y.S.2d 608 (Dist. Ct. 2012); LI Equity Network, LLC v. Vill. in the Woods Owners Corp., 79 A.D.3d 26, 910 N.Y.S.2d 97 (2010); Klingsberg v. River Terrace Apartments, 7 Misc. 3d 1029(A), 801 N.Y.S.2d 235 (Sup. Ct. 2005); In re Estate of Balsome, 6 Misc. 3d 1040(A), 800 N.Y.S.2d 342 (Sur. 2005); Matter of Estate of Carmer, 71 N.Y.2d 781, 525 N.E.2d 734 (1988); State Tax Comm’n v. Shor, 43 N.Y.2d 151, 371 N.E.2d 523 (1977);
Pennsylvania: Real Estate Cooperative Act (68 Pa. Cons. Stat. Ann. §§ 4101 et seq.), 68 Pa. Stat. Ann. § 250.204
Virginia: The Virginia Real Estate Cooperative Act (Va. Code Ann. §§ 55-424 et seq.) and The Virginia Property Owners’ Association Act (Ibid. §§ 55-508 et seq.). Va. Code Ann. §§ 15.2-979, 55-2, 55-57.1, & 55-516.01
Washington: The Uniform Common Interest Ownership Act (Wash. Rev. Code Ann. §§ 64.90.001 et seq.) and Wash. Rev. Code Ann. §§ 61.24.005 et seq., 64.90.020(1), 64.90.075(1), & 64.90.095(1). Firth v. Lu, 146 Wash. 2d 608, 49 P.3d 117 (2002); Firth v. Lu, 103 Wash. App. 267, 12 P.3d 618 (2000); State ex rel. Leavell v. Nelson, 63 Wash. 2d 299, 387 P.2d 82 (1963).
Other useful sources include the GSE’s cooperative share loan requirements:
FNMA: FNMA 2021 Selling Guide B4-2.3-02 through B4-2.3-05 and “Co-Op Share Loan Documentation Requirements”.
FHLMC: FHLMC Single-Family Seller/Servicer Guide chs. 5705 & 8801.