Borrower beware: Most co-op foreclosures get fast-tracked.

Foreclosing on a co-operative apartment is accomplished in a fundamentally different manner than the traditional methods employed in foreclosing real property. Foreclosing on real property requires lengthy and often costly legal procedures, resulting in a judicial decree awarding a lender title to the property. However, because a co-operative apartment is considered personal property, not real property, foreclosure can be accomplished without resort to the courts, which results in a much quicker and less costly process. The speed of this process has a dramatic impact on all parties involved, from the bank or institutional lender, to the co-operative board, its managing agent and of course, the defaulting borrower.

The security interest in a co-operative apartment is created under the Uniform Commercial Code. Under the U.C.C., a lender creates a security interest in a coop by having the borrower execute a security agreement and this security interest is then perfected by filing a financing statement known as a U.C.C.-l. It is no longer necessary for the lender to take possession of the stock certificate or proprietary lease in order to perfect its security interest (8.8 was the case under the prior versions of the law).

Although not a mortgage, the U.C.C.-l essentially acts in a similar manner, providing notice to all others that a lien has been filed against the premises and that the premises are securing an obligation for an indebtedness -- typically the loan to the borrower, which enables him or her to buy the co-op apartment. The priority of these liens is decided by the order in which the financing statements are filed, with the statements filed earlier in time receiving priority over subsequently filed statements.

Because the security interest is perfected under the U.C.C., the lender must resort to this Code to foreclose upon that collateral.

The lender is not the only party that may have a security interest in the co-operatives shares and proprietary lease. The co-operative corporation typically has a first lien for repayment of maintenance charges and other obligations under the lease, which is superior to the lender's lien. This lien is set forth under U.C.C. 8-209 (formally 8-103) and is called a "first issuer's lien," granted to a corporation issuing the initial shares. The co-operative corporation's rights arising from this lien will be discussed in a subsequent article.

Simply put, foreclosure is a remedy available to a lender where the borrower defaults under a loan agreement. In a coop setting, a default can also occur if the borrower fails to pay its monthly maintenance to the co-operative corporation, or adhere to some other material obligation under the proprietary lease. For instance, if the borrower fails to maintain the premises in good repair, he or she may be subject to a foreclosure proceeding.

There are two methods to foreclose under the U.C.C, which are set forth in U.C.C. 9-504 and 9-505. Neither of these methods requires the lender to start a foreclosure lawsuit.

The easiest and fastest method is governed by U.C.C. 9-505, which simply allows the lender to retain the collateral in its possession: the stock certificate and the proprietary lease. The lender may then re-sell the apartment. If the borrower refuses to vacate the premises, the lender must then resort to traditional legal proceedings (i.e., summary proceedings in landlord/tenant Court). In order to facilitate the foreclosure process, the lenders make it a practice to take possession of the stock certificates and lease at the closing (even though such possession is not necessary for the lender to establish its lien under the U.C.C.).

Under U.C.C. 9-505, the lender need only send a written notice to the debtor and any other secured party who has filed a financial statement or other security interest in the collateral. The notice simply has to state that the debtor is in default; that the lender is retaining the collateral pursuant to U.C.C. 9-505; and that the debtor or secured party has the right to object to this retention by serving a written objection within 21 days. (The 21-day notice period does not substitute for or relieve the lender of his obligation to provide notice of the default under the loan agreement.)

Although foreclosure under U.C.C. 9-505 is fast and inexpensive, it has a number of disadvantages, which explain why its not often employed. To begin with, if the debtor or any other secured party objects within the 21-day period, the lender's right to keep the collateral is defeated. Another disadvantage to this section is that it deprives the lender of a deficiency judgment. If the collateral does not satisfy the debt owed under the loan agreement, the lender cannot pursue the borrower for the balance owed.

As a practical matter, even if the lender retains the collateral, the obvious next step is to sell the collateral so that the lender can apply the proceeds against the sums owed under the loan agreement.

U.C.C. 9-504 -- This section of the law is the more common method for foreclosing upon a co-op, Under this section, the lender may dispose of the collateral at a public or private sate, as long as it does so in a commercially reasonable manner.

The lender must first notify the borrower in writing of his or her default and allow him or her time to cure the default. If the default is not cured, the next step is for the lender to provide notice in writing to the borrower that it intends to sell the collateral at either a public auction or through a private sale. The lender's intention to accelerate the principal balance must also be set forth in the notice. Notice must also be sent to other secured parties, including the co-operative corporation.

Frequently, the co-operative corporation has a right of first refusal on the shares, which means that they have the first right to buy the shares from the lender, usually at book value. This type of restriction has been upheld by the courts.

Upon receiving notice of the sale, the borrower has an absolute right to "redeem" the collateral by curing the default. (See U.C.C. 9-506.) In fact, even after the foreclosure auction, a borrower may redeem the collateral, providing he does so before a final contract of sale or final transfer has occurred.

The only restriction on the sale is that it must be held in a "commercially reasonable manner." This means that every aspect of the sale must be calculated to achieve the "mutual best advantage of the parties." If the borrower believes the sale was not commercially reasonable, he or she can bring an action LU overturn the sale, although these are difficult suits to win.

Generally, if the collateral is disposed of through a recognized market, in a customary manner, the sale will be upheld. The sale is not unreasonable even though there may he a substantial discrepancy between the price for which the borrower bought the collateral and the price at which the lender sold it. With respect to co-operatives or real property, the Courts typically uphold the sale if the lender advertised the sale in a widely circulated newspaper for a minimum of three weeks (once per week) and sold it the highest bidder at the auction.

After the sale, the lender may apply the proceeds to satisfy the reasonable expenses of the sale, including attorney fees and auctioneer fees; the satisfaction of the borrower's outstanding balance under the loan; and the satisfaction of any sums owed to subordinate lien holders or secured parties. If there is any surplus left over, the excess funds must be turned over to the borrower. If there is a deficiency, the lender may pursue the borrower in a court of law for the deficiency.

After the collateral is disposed of by sale, the security interest in the collateral held by the lender and any subordinate lien-holders is extinguished. The purchaser at the sale takes the collateral free and clear of any competing claims.

The lender's rights under the Uniform Commercial Code to foreclose against co-operative apartments can be exercised without resort to the courts and not surprisingly is faster, easier, and less expensive than the traditional method of foreclosing against real property under Article 13 of the Real Property Actions and Proceedings Law. As long as the proper notice is provided, and the foreclosure sale is conducted in a commercially reasonable manner, the lender will be able to sell the collateral and if necessary, pursue the borrower for any deficiency.