Chapter 22 TERMINATION, INSOLVENCY AND BANKRUPTCY OF COMMON INTEREST COMMUNITIES

• Jurisdiction: North Carolina

22 TERMINATION, INSOLVENCY AND BANKRUPTCY OF COMMON INTEREST COMMUNITIES

§ 22.01. In General

There are few statutes and cases relating to how associations are terminated or what happens when these associations are in serious financial trouble that jeopardizes their ability to meet current financial obligations. However, associations do fail and they do get into financial trouble, just like other businesses. Since associations are usually funded by mandatory assessment obligations from owners, their failure, receivership or reorganization raises unique legal issues different than the dissolution of a private business. Primarily, associations fail because their members do not conduct the affairs of the association seriously and apathy of the members abounds over a period of many years. Occasionally, dissolution of an association may be voluntary and not necessarily the result of board neglect. For example, the Condominium Act contemplates the sale of an entire condominium building and the termination of its corresponding association. Either way, there are essentially two different dimensions of an association termination: the termination of the underlying restrictive covenants and the termination of the corporate entity itself. Because an association is usually both a corporate entity as well as a real estate cooperative of sorts, termination or dissolution of the entire structure involves aspects of both corporate law and real property law.

The PCA and the Condominium Act both deal explicitly with how a planned community or condominium is terminated and the applicable covenants will generally prescribe the manner in which the underlying covenants can be terminated. Where appropriate, the Nonprofit Act will prescribe some of the technical procedures for dissolving the corporate entity itself. Succinctly, the following steps should be considered in terminating any planned community or condominium:

(1) When was the planned community or condominium formed? If the PCA or Condominium Act are applicable, follow the termination provisions in the PCA or Condominium Act.¹
(2) If the Condominium Act is not applicable, follow the steps for withdrawing the condominium from the Unit Ownership Act.²
(3) If the PCA is not applicable, follow the provisions in the association's declaration for terminating the declaration.³
(4) Regardless of when formed or whether the PCA or the Condominium Act are applicable, follow the provisions in the recorded declaration for terminating the declaration.⁴
(5) Lastly, dissolve the association's corporate status with the Secretary of State in accordance with the association's articles of incorporation and the Nonprofit Act.⁵

In addition to terminating an association voluntarily, there are remedies for members and creditors against associations with woefully dysfunctional boards or associations in dire financial straits. Involuntary receivership — essentially a state court version of bankruptcy — is a possibility for homeowners and condominium associations in extreme circumstances, although usually a last resort when all other measures have failed. North Carolina has very specific statutes for when an entity can be put into receivership. Although there are no reported appellate cases in North Carolina involving associations in receivership, there are a number of associations that have been put into receivership outside North Carolina that are instructive. As a general rule, these cases deal with situations where the association is struggling financially, oftentimes because of the negligent or intentional actions of its board, or perhaps in situations where a judgment has been entered against the association that the association refuses to satisfy. The prospect of receivership is yet another reminder of why it is important for board members to take their responsibilities seriously.

§ 22.02. Terminating the Condominium Association

The provisions related to termination of condominiums in the Condominium Act are not applicable to condominiums formed prior to 1986.⁶ Unique to condominiums, the Condominium Act contemplates the sale of all the units and common elements to a third party in the case of a high-rise or "stacked" condominium, even when not all the owners consent to the sale. This means that an owner can essentially be forced to involuntarily convey his unit. Because of the significance in the termination of condominiums, therefore, it is important that the procedures for termination be followed closely. The termination provisions in the Condominium Act will apply in most instances in which there is a conveyance of an entire condominium building to a third party. However, a condominium can also be terminated if all the units are acquired by eminent domain as well.⁷ The termination provisions speak in terms of the termination of the "condominium." "Condominium" is defined under the Condominium Act as follows:

[R]eal estate, portions of which are designated for separate ownership and the remainder of which is designated for common ownership solely by the owners of those portions . . . real estate is not a condominium unless the undivided interests in the common elements are vested in the unit owners.⁸

It is this concept that is terminated when the steps for termination in the Condominium Act are followed.

Like planned communities, a condominium may be terminated only by agreement of owners of units to which at least 80% of the votes in the association are allocated, or any larger percentage the declaration specifies.⁹ North Carolina has not adopted the portion of the Condominium Act that allows a lender to require that the declaration specify a larger percentage.¹⁰ The execution and recordation requirements for the termination agreement are essentially the same for a condominium as they are for a planned community.¹¹ The termination agreement has to specify the effective date so as to avoid the project being "in limbo" indefinitely.¹² For condominiums having only horizontal boundaries, a termination agreement may provide for the sale of all units and common elements after termination.¹³ Thus, in the case of a condominium having horizontal boundaries, less than all units may essentially agree to sell all the units and common elements. However, with respect to condominiums not having horizontal boundaries, a termination agreement may provide for sale of the common elements, but may not require that the units be sold following termination, unless the declaration allows for this or unless all the unit owners consent to the sale.¹⁴ The Official Comments cite, as an example, a single-family home project where some of the units include title to land, as a situation where all owners must consent to selling both the units and the common elements.¹⁵ This would include "townhome"-like condominiums where, in addition to the owner's undivided interest in the common elements, the owner has title to land separate and apart from the common elements.

An association can theoretically contract for the conveyance of the units and/or common elements at any time it wishes. However, the contract is not binding and would not be enforced against third parties or the association until approved by the requisite number of owners under the Condominium Act.¹⁶ Assuming the requisite termination agreement has been properly executed, title to the property being conveyed (whether units or common elements) vests with the association in order to effectuate the sale.¹⁷ If the units or common elements are sold as part of the termination, then proceeds of the sale must be distributed to unit owners and lienholders as their interests may appear, in proportion to the respective interests of unit owners.¹⁸ The interests of unit owners for purposes of distributing the proceeds of the sale are the fair market value of the units, limited common elements, and common element interests immediately before the termination, as determined by one or more independent appraisers selected by the association. The decision of the independent appraisers has to be distributed to the unit owners and becomes final unless disapproved within 30 days after distribution by unit owners of units to which 25% of the votes in the association are allocated. The proportion of any unit owner's interest to that of all unit owners is determined by dividing the fair market value of that unit owner's unit and common element interest by the total fair market values of all the units and common elements.¹⁹ The one exception to the "fair market value" rule is when a unit or limited common element is destroyed in a fire or some other casualty loss such that an appraisal before the loss cannot be made.²⁰ In such cases, the compensation to the owners is based on their interests in the common elements.²¹ In Howe v. Links Club Condominium Ass'n, ___ S.E.2d ___ (N.C. App. 2018), the Court of Appeals held that an association owes a fiduciary duty as trustee in the sale of a condominium.

A condominium may terminate without all the property — the units and common elements — being conveyed. Like planned communities, if property is not to be sold following termination, then title to all the real estate in the remaining portions of the condominium, vests in the unit owners on termination as tenants in common with the owners owning the same percentage of the remaining properties as they would the settlement proceeds from the sold property.²²

Dealing with lenders and their interests in the encumbered units of owners can be particularly challenging with a condominium termination. Unsecured creditors of the association are given special secured creditor like status under the Condominium Act and are to be treated as if they had perfected liens on the units immediately before termination.²³ Following termination, secured creditors may enforce the terms of their liens in the same manner as any lienholder.²⁴ If an owner has not paid his or her assessments at the time the proceeds of the...