A co-op is a strange beast to begin with (remember it is personalty, not real estate), but adding to the basic confusion is a new danger highlighted in a court case decided this year. The court determined that the purchaser at the co-op foreclosure sale (and that could be the foreclosing lender) can be personally liable for rent overcharges for which the prior owner had been responsible. [Muscat v. Gray, N.Y.L.J., Jan. 14, 2004, at 18, col. 1 (Civ. Ct., Housing Part, N.Y. Co.]

The practical danger of this should be apparent. If the lender or servicer is the successful bidder at the sale (and, of course, it happens), it assumes the liability. (In the cited case which made the point, that amount was a whopping $61,000, plus years of interest.) If a third party intended to purchase, this principle could have a chilling effect on bidding. And what makes all of this particularly insidious is that the result is the opposite of what happens in a real estate mortgage foreclosure action.

In the cited case, there was a rent-stabilized apartment in New York City (meaning that the rents are controlled by law), and there was a tenant in that apartment as of 1985. The apartment building was converted to a cooperative use in 1990, and when the tenant did not pay rent to the sponsor who owned that particular unit, the sponsor sued for the unpaid rent. The tenant counterclaimed (for what is called breach of the warranty of habitability) and was awarded a substantial judgment — none of which was paid.

By mid-2001, there was a UCC Article 9 foreclosure sale. After the closing, the successful bidder — the new owner — sought rent from the tenant from the date of the closing. The tenant responded with a claim to hold the new owner liable for the judgment it had obtained against the prior owner. The new owner was held liable for the prior owner’s debt on the theory of carryover liability. A section of the rent stabilization code in New York makes the current owner responsible for a prior owner’s rent overcharges unless, among other things, the new owner purchased at a judicial sale — which does not happen in a co-op foreclosure — and hence the potential danger to any purchaser at a co-op foreclosure sale.

Concededly, the situation of tenants (rather than owners) being in the co-op premises is likely to be a minority of the cases. Moreover, rent overcharge judgments should represent an even smaller percentage of the cases, so that in the end the peril presented here, fortunately, will not be that common. Nevertheless, it can occur and is something that is better avoided. As noted before, to the extent that this concept becomes widely recognized, bidders at co-op foreclosure sales may be reluctant to purchase, thus diminishing the value of secured loans on co-ops.