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A condominium is a form of real property ownership in which one or more parcels of land are subjected to certain covenants, restrictions and easements that allow for those parcels to be owned in fee simple by multiple parties. The condominium form of property ownership has historically been popular in dense urban areas with limited horizontal living space and in resort areas where condominium owners enjoy second homes or just hold an investment property. Increased suburban congestion and a trend toward redevelopment of many previously blighted downtowns, has resulted in developers focusing on this form of property ownership as a new principal residence homeownership model.
A condominium developer's counsel must assist its client in constructing an appropriate project structure that complies with federal, state and local laws and minimizes the developer's liability, while not losing sight of the project's intended market. The following is a summary of certain considerations when counseling your developer client and preparing residential condominium documents on its behalf. This is not intended to be an exhaustive description of all condominium project types and potential associated issues. For instance, certain considerations and disclosures may be required for condominium projects that are conversions from existing multifamily rental projects, are located within a larger community association, a mixed-use project in which the residential component may be above or surrounded by commercial uses, a project in which the developer intends to ultimately retain some interest (e.g., leasing retail units or residential units as apartments), a condo-hotel, or an age-restricted community.
Condominium as a Legal Property Regime
In the United States, condominiums are generally regulated by a condominium or common interest community statute that is a sub-section of a state's real property laws. If authorized by state law, certain local city and county jurisdictions also have condominium-related laws and regulations on their books. Additionally, a state's non-stock corporation statute may be applicable if the condominium's unit owners association must be incorporated. Familiarity with all of the state and local laws and regulations that will govern a client's project is absolutely necessary before undertaking the preparation of any condominium disclosures, covenants or governance documents.
Fundamentally, a condominium must contain two or more "units" as well as certain "common elements," or shared common areas. A unit owner owns a fee simple interest in its unit, and an undivided interest in the common elements referred to as its "percentage interest," "common interest," or "common element interest," depending upon jurisdiction. A "declaration of condominium" is the primary instrument for imposing a condominium regime's covenants, restrictions and easements on the underlying real property. Condominium "plats" or "plans" are renderings of the overall site plan and individual unit plans within a condominium, and are typically prepared by a licensed surveyor or engineer who certifies as to the accuracy and compliance of the plats and plans with surveying industry standards. A thorough review of the plats and plans should be made by the attorney preparing the condominium documents to ensure consistency with the condominium statute and the declaration. In many jurisdictions, the recordation of both the declaration and the plats and plans is required to create the condominium.
The declaration must contain a detailed description of what constitutes the units and common elements. Certain common elements may be designated in the declaration and on the plats and plans as "general" and for the use of all unit owners, and certain common elements may be designated as "limited" or "reserved" and for the use of one or more, but not all, unit owners. Limited common elements may also be referred to as "appurtenant" common elements, in that they do not stand alone as a property interest, but must be appurtenant to certain units.
As the drafter of the covenants creating the condominium regime, the attorney's role is to ensure that the statutory disclosures, documentation and renderings when taken together balance a developer client's rights and control with the project's marketing goals and operational requirements, while attempting to also limit a developer's liability.
Disclosures and Registration: Prerequisites for Sales of Condominium Units
Consumer homebuyers comprise the majority of condominium unit buyers (although a robust market is often marked by an early influx of investor purchasers), thus consumer protection mechanisms are built into most jurisdictions' condominium disclosure requirements. This requirement is commonly referred to as a "prospectus" or "public offering statement," and may need to be reviewed by and registered with an agency of the state responsible for regulation and licensing of condominiums and other common interest communities. There is often a time period for such disclosure review, and clients should be advised as to this "waiting period" before entering into contracts for units that may later be unenforceable. The required disclosures may include a form of the condominium declaration, bylaws and other governance documents, a form of deed, a plain-English description of the condominium and its planned amenities, and an operating budget, including estimated unit assessment amounts. These disclosures are typically provided to a purchaser before or at the time a contract is entered into for the sale of a condominium unit. Purchasers then typically have a review period, for example, 15 days in Maryland for a new condominium, during which they may rescind their unit purchase contract without forfeiting any deposits. However, if statutory disclosures are not adequately provided, a purchaser may have a unilateral contract rescission right at any time prior to the settlement date. Therefore, a developer may wish to err on the side of more, rather than less, disclosure so as to limit a purchaser having a valid claim for a contract rescission right in the future. The attorney should also review its client's unit marketing and sales materials and purchase contract forms not only for adequate statutory disclosures, but also for sufficient disclaimers, particularly with respect to unit floor plans, condominium operating budgets, and model units, and other facilities or amenities availability. Particularly for projects under construction at the time of contract, the disclosures and contract should contain plain English statements that a purchaser should not rely entirely upon such models and disclosures, and that the developer has the right to change the condominium during the development and construction process.
A residential condominium project must also comply with, or be exempt from, the Interstate Land Sales Full Disclosure Act, 15 USC §§ 1701-1720. ILSDA is a federal consumer protection statute that requires a developer who sells lots (including condominium units) in a residential project to register the project with HUD unless it is fully or partially exempt from the registration requirements. A developer whose project is in violation of ILSDA may face both civil and criminal liability for violations of ILSDA, in addition to rendering void any pending contracts of sale. Therefore, the attorney must ensure that, if the project is not eligible for a full exemption (e.g., the Improved Lot Exemption whereby the project must be complete within 2 years of contract) or a partial exemption (e.g., the 99-Lot Exemption for projects that contain less than 100 lots), the project is duly registered and information regarding such registration provided to purchasers. As there is significant recent case law on interpretations of ILSDA exemptions, the attorney should review and examine recent ILSDA in light of such case law before moving ahead with document preparation.
Preparing Condominium Governing Documents
A declaration of condominium is typically the instrument that subjects the underlying real property to the condominium regime and related covenants, easements and restrictions. The initial consideration for drafting the declaration is to understand which real property will be encumbered by the condominium regime. Subject to any jurisdictional conditions or nuances, a condominium may be located on single lot or multiple lots, however it may not be located on only a portion of a single lot unless the local zoning laws permit this as a form of legal subdivision. Furthermore, certain jurisdictions do not permit the creation of a residential condominium on a leasehold estate, or do so with limited exceptions, for example, where a ground lease is for 99 years and the fee interest is held by a government agency. Finally, if the regime is to be expandable or contain withdrawable land, the declaration must expressly reserve rights to the developer, and the association, if desirable, for the purposes of annexing or de-annexing property. The bylaws of the association generally provide governance and operating procedures for the association and its board of directors, including delegation of operating obligations to a third party manager, and imposing rules on the regime.
Units and Common Elements
The declaration will contain definitions for and descriptions of what constitutes units and common elements, which may refer back to the condominium plats and plans. Unit definitions should generally describe the boundaries and components of a unit, for example, interior walls not part of the building structure and centerlines of party walls, but should expressly exclude any portions of the building or any equipment that serve more than one unit. Anything not contained within a unit that serves more than one unit will be common elements, including certain utilities, pipes, support systems, equipment, and project amenities. Common elements for use by all unit owners may be designated as "general" common elements, and common elements that serve one or more, but less than all, condominium may be designated as "limited" or "reserved" common elements. When determining whether a component will be a limited common element appurtenant to a unit, or part of that unit, consideration should be given to whether the association should have operation and maintenance control over that component. For example, a parking space in a structured garage may be a limited common element for the exclusive parking use of a unit owner, but maintained and repaired at the discretion of the association, versus a parking unit that is wholly maintained and repaired by a unit owner. Additionally, most jurisdictions give a unit a separate tax parcel identification number for property tax assessment purposes, whereas a limited common element, as merely an appurtenance to a unit, will be included in the unit's real property assessed value. Finally, if a jurisdiction's statutory warranty obligations differ for units and common elements, an attorney may be able to limit the developer's liability by carefully designating what is part of a unit or a common element.
Easements, Rights and Restrictions
The declaration should contain a reservation of a unit owner's right of enjoyment of its unit, including an easement for access, ingress, and egress over the common elements, and emergency access, ingress and egress over the entire property. Unit owners should also be expressly granted the right to delegate their use rights, and pursuant to certain conditions, subdivide their unit or consolidate adjacent commonly-owned units. The declaration should provide guidance for reallocation of percentage interests and voting rights after unit subdivision and consolidation. Certain use restrictions should also be contained within the declaration or bylaws for the condominium, some of which may be obvious, for example, no activities that may reasonably be deemed to be a nuisance by other unit owners. Other restrictions may need to be vetted with the developer, for example, limitations on pet type, number or size. In a residential condominium, subject to any applicable local laws, a covenant restricting units for residential use only should expressly exempt the developer such that it may carry on its marketing, sales and leasing operations on the property. This exemption must be carefully drafted to ensure it covers any successor-developer to whom such right has been assigned in writing. Other examples of use restrictions that may be applicable are those related to signage, exterior alterations, maintenance of terraces and/or decks, window coverings, antennae/satellite dishes (subject to federal law), structural interior alterations, changes that affect condominium insurance rates, general compliance with laws, and prohibitions on timesharing, transitory housing and hotel uses.
Certain specific easements should be reserved in the declaration for the developer and the association. In particular, the declaration should reserve broad development and construction rights over the property to the developer including ingress and egress, construction staging and storage rights (including a noise disclaimer), and easements for drainage and irrigation purposes. The developer should also have an easement over the common elements for conducting its marketing, leasing and sales activities, including the right to maintain sales office in its units and use the common elements, including parking spaces and other facilities, by itself and its tenants. Easements for the benefit of the association should also be reserved as necessary for the association to undertake any obligations with respect to maintenance, repair, and replacement of the common elements. The entire property may also be burdened by a general easement for the installation, maintenance, repair and replacement of public utilities and equipment serving it. A right should be reserved to both the developer and the association for the purpose of granting additional easements if so required for public or private utilities, or by any governmental or quasi-governmental authority or agency. The attorney may also wish to consider including broad language generally governing the exercise of all easements that affect a unit. For example, the association may be required to give a unit owner reasonable notice of its intent to exercise its easement over that unit owner's unit, except in the case of an emergency, and release a unit owner from liability resulting from damage or injury occurring during the exercise of such easement.
Lenders also want to see provisions in the governing documents that enable a project to obtain Fannie Mae and HUD approval, as well as rights reserved for lender consents and approvals. The developer or association must have sufficient flexibility under the documents to amend them for compliance with mortgagee or agency requirements, if necessary. The declaration may include an "eligible mortgagee" provision, whereby only those mortgagees that have given notice to the association are entitled to notice of certain occurrences, as well as provide that an eligible mortgagee shall be deemed to have consented to amendments if it has received notice and not responded within a certain number of days. Lenders may also require certain blanket notice and cure rights in the event of a unit owner's default.
Lien for Assessments.
The declaration should establish the obligation of every unit owner to pay assessments for the common expenses of the association, as well as any special assessments or related fees that may be incurred. Subject to any statutory requirements related to a developer's obligation to pay full assessments, including a contribution for capital reserves, for units it owns, the declaration may also limit the developer's liability for assessments, possibly by providing that the developer will fund operating deficits for such time as it retains a unit in the condominium. The developer and the association should have the right to impose a lien for nonpayment of assessments against a unit, which will be enforceable in accordance with local law for enforcing mechanics liens.
Maintenance, Repair, Replacement Responsibility
In general, the maintenance, repair and replacement of a unit are the responsibilities of the owner of that unit. However, the developer may wish to reserve a right to the association to maintain, repair and replace certain components of a unit, such as windows, doors and terraces, for the purpose of retaining a common theme and consistency in project upkeep. However, if the association is to retain this right, it should also reserve a right to charge a unit owner for any costs it incurs related to such maintenance, repair and replacement activities of unit components.
Insurance and Reconstruction
In addition to any statutory requirements, the condominium governing documents should clearly identify the types of insurance that must be held by unit owners and by the association, with the ultimate goal of having property and liability insurance policies that cover every component of the condominium. Typically, unit owners are responsible for the property and liability insurance over their unit, and the association is responsible for maintaining the same policies over the common elements, including machinery and flood insurance, if applicable. The association should also maintain insurance policies covering directors and officers liability and workers compensation. In the event of a casualty or condemnation of all or any portion of the condominium, the governing documents must address issues related to the obligation to repair or reconstruct, who will control disbursement of insurance proceeds, ensuring that the process generally complies with local and state laws, and the extent of mortgagee notice rights.
Governance; Additional Developer Protection Provisions
The bylaws of the condominium association typically contain procedures related to owner and Board meetings, election of directors, and the budgeting for and management of the condominium, including promulgation of rules or design review guidelines. For residential condominiums, developer control of the association is typically limited by the condominium statute, however it may be possible to include certain developer consent rights, for example, for any decision of the board that would materially or adversely affect the developer's rights under the condominium governing documents. Procedures for amending the governing documents also are typically proscribed by statute, but if possible, the declaration should include a limited power of attorney to the developer for the purpose of amending the governing documents for scrivener's errors, engineer errors, to comply with local, state or federal laws, including lender requirements, or for other non-material changes to the documents. Additionally, the inclusion of specific dispute resolution and claims procedures, for example, related to unit or common element warranty claims, may limit future litigation against the developer and provide the developer with an initial cure right after it has relinquished control of the condominium to the unit owners. Finally, the exhibits to the declaration typically include a copy of the initial bylaws of the association, a copy of the recorded condominium plats and plans, as well as a list of unit owner common element interests and a description of any expandable or withdrawable property.
This overview of considerations for preparing condominium documents describes the primary issues related to a residential condominium project in the United States. Of course, it is critical to consult state and local laws, which will ultimately govern the specifics of each condominium regime. While not meant to be exhaustive, this summary does provide basic guidance for creating a framework of covenants to provide a developer client undertaking a residential condominium project with maximum flexibility while minimizing its future liability as much as feasible.
About the Author
Marni G. Lefkowitz is an associate in the Real Estate group at Ballard Spahr Andrews & Ingersoll, LLP in Bethesda, Maryland. Her practice includes structuring, negotiating and creating common ownership property regimes for mixed-use and condominium developments and community associations.