B4-2.3-03, Legal Requirements for Co-op Projects (11/06/2024)

The co-op project’s documents must provide for the tenant-stockholders to have the right to amend them. In addition, the co-op corporation must be legally bound to notify the holder of a co-op share loan about any proposed material changes to the co-op project with respect to allocation of membership interests, voting rights, insurance coverages, and any other provisions that are for the express benefit of the lender.

The project documents must require that the sale or transfer of stock, shares, or membership certificates in the co-op corporation be in compliance with federal and state security disclosure laws. The documents also must require tenant-stockholders to own stock, shares, or a membership certificate, and permit the stock, shares, or membership certificates in the co-op corporation to be pledged and registered.

The project documents must give the tenant-stockholder a right to occupy the unit for a period that extends at least to the maturity date of the share loan, although this right should be subject to the terms and conditions of a proprietary lease or occupancy agreement between the tenant-stockholder and the co-op corporation. The documents also must prohibit the co-op corporation from imposing unreasonable limitations on the tenant-stockholder’s ability to sell, transfer, or convey their membership, or to sublease their unit. If the purchaser’s right to membership or occupancy is subject to any right of the co-op corporation to give approval, the lender must furnish evidence to clearly show that such approval has been given before Fannie Mae will purchase or securitize the co-op share loan.

The share loan must be secured by the assignment (in pledge or trust) of the borrower’s leasehold estate; a pledge or trust of the corporation stock, shares, or membership certificate; and any other documents that are appropriate under individual state or local laws and practices.

The lender that is financing the share loan must receive an assignment of the proprietary lease, occupancy agreement, or other similar evidence of the right to occupy the unit for all share loans that it delivers to Fannie Mae. The lender must also obtain a stock power, assignment, or other similar document that authorizes the lender to transfer ownership interest in the event of a default. Valid financing statements and assignments of financing statements must be executed and filed, if necessary to perfect Fannie Mae’s security interest under the Uniform Commercial Code of the state in which the property is located. Information searches or equivalent evidence of filing financing statements and assignments of financing statements must be obtained and must show that the Fannie Mae co-op share loan is in first-lien position. In those states in which co-op units are considered real property, perfection of the lien must comply with state law applicable to real estate.

The share loan must be a first-lien, except that, where custom dictates to the contrary, Fannie Mae will permit its lien to be subordinate to the co-op corporation’s lien against the tenant-stockholder’s shares for unpaid assessments that represents the pro rata share of the corporation’s payments for the blanket mortgage, current year’s real estate taxes, operating expenses or maintenance fees, and special assessments.

Note: The pro rata share of the project debt that is related to the co-op share loan cannot exceed 35% of the sum of the related pro rata share of the project debt and the appraised equity interest value of the shares. Lenders may use a higher ratio (not to exceed 40%) when there are fully documented compensating factors that justify using the higher ratio.

Fannie Mae will also permit its lien to be subordinate to any assignment of rents or maintenance expenses in any mortgage or deed of trust that is secured by the co-op project, or any Regulatory Agreement entered into by the co-op corporation and the Secretary of HUD as a condition for obtaining HUD mortgage insurance.

The co-op project must be in compliance with the requirements imposed by the holder of any prior financing for the project. If the blanket mortgage on a project includes a due-on-encumbrance clause and the project is located in a state in which share loans are considered to be an encumbrance on the project, the blanket lender must consent to the share loan financing. In the case of a conversion of an existing building, the blanket lender must agree to the use of the building as a co-op and, if it is feasible, agree—in the event of a default on the blanket mortgage—not to wipe out the shares of those tenant-stockholders who are current in the payment of their assessments or carrying charges.

Generally, the project documents should not permit the co-op corporation to restrict the sale, conveyance, or transfer of a unit owned by a lender, its successors, or assigns, nor to place any limits on the assignment of the proprietary lease or occupancy agreement to the lender, its successors, or assigns. This lease or agreement must be assumable by the lender if the tenant-stockholder defaults on the share loan. If the co-op’s organizational documents require that a tenant-stockholder be a natural person, they must permit the lender to select a non-corporate designee for any assignment of a proprietary lease or occupancy agreement that it acquires through foreclosure or acceptance of a deed in lieu of foreclosure. If the lender assumes the lease or agreement as the result of the tenant-stockholder’s default, the co-op corporation must allow the lender to attempt to sell its interest in the lease or agreement. However, if the lender is unable to effect a satisfactory sale within 60 days—either through its own efforts or with assistance from the co-op corporation—the co-op corporation may not prohibit the lender from subletting the unit.

The project documents may grant the co-op corporation the right to approve a lender’s sublessee or to offer an alternate sublessee that is satisfactory to the lender. However, the co-op corporation’s approval standards and procedures may not be unreasonably restrictive or in violation of applicable law, and the action must be completed within a reasonable time after the lender requests approval of a proposed sublessee.

The project documents must either require the co-op corporation to execute a separate agreement—such as a recognition agreement—or include provisions to recognize specific rights of the lender that finances the share loan (or those of its successors or assigns) and the co-op corporation’s responsibilities to that lender.

Co-op Corporation’s Responsibilities

The recognition agreement or other legal agreement (or the project’s legal documents) must include, among other things, the following responsibilities for the co-op corporation:

• The co-op corporation must evict a tenant-stockholder who has defaulted on their share loan and must terminate that tenant-stockholder’s lease, if the share loan holder requests it to do so.

• The co-op corporation must be legally bound to notify the lender of any of the following changes or occurrences:

  • any threatened or actual condemnation, eminent domain proceeding or acquisition, or any actual loss, whether or not covered by insurance, that affects any portion of the co-op project or unit;

  • failure to maintain compliance with co-operative corporation eligibility under IRS Code Section 216;

  • any 30-day delinquency by the co-op corporation in payments due under any blanket mortgage for real estate taxes, assessments, and charges imposed by a government entity or public utility, or under any ground lease;

  • any lapse or cancellation of any insurance coverages maintained by the co-op project;

  • any proposed action that requires the consent of a specified percentage of eligible share loan holders; and

  • any 90-day delinquency by the tenant-stockholder that is related to the payment of their monthly assessments or carrying charges.

• If the co-op project is subject to a ground lease, in the event of a condemnation or similar taking proceeding affecting any portion of the co-op project or the unit, the co-op corporation must protect the lender's financial interest.

The project documents must grant the lender financing a share loan the right to cure the tenant-stockholder’s defaults in their assessment payments or carrying charges and the right to review and approve the following actions before the co-op corporation can consent to them:

• any surrender, cancellation, modification, or assignment of any documents evidencing ownership, possession, and use of a unit;

• any sublease of a unit;

• any further or additional pledge or mortgage of any documents evidencing ownership, possession, and use of a unit;

• any action to change the form of ownership of the project; or

• the contraction, expansion, or termination of the co-op project.