HABITAT February 2009 Case No. 2-Behind the Legal Curtains The Case of the Reckless Russians By BILL MORRIS THIS IS A STORY ABOUT A RUSSIAN GANG THAT COULDN'T borrow straight. The gang was made up of dozens of people - a lawyer, an accountant, mortgage brokers, real estate appraisers, loan officers, and straw buyers - who put together about 1,000 fraudulent subprime mortgages and home equity loans in New York and New Jersey totaling some $200 million. They raked in millions from those mortgages and commission fees. Some gang members liked to play high-stakes dice in Atlantic City and roar around New York City in Bentleys. They had nicknames like "Lyosha," "Masha," "Buddha," and "Danik." They are now either behind bars, awaiting sentencing or awaiting trial. Among the gang's many victims was an elegant late-19th century condominium building on the Upper West Side of Manhattan. The gang pushed this 33-unit building to the brink of financial ruin, but the building was saved by a savvy lawyer and by residents who banded together and decided they were not going to be victimized by guys named "Buddha" and "Danik" who gambled away hundreds of thousands of somebody else's dollars at the craps tables in Atlantic City. This, then, is a story about a condo board that went straight for the Russian gang's jugular - and lived to tell the tale. SUSPICIOUS MINDS When 10 of the building's rent-controlled and rent-stabilized apartments were bought in quick succession in 2006, alarm bells started ringing immediately. "From day one we were suspicious because many of the 10 buyers used the same accountant," says the board's attorney, Steven Shore, a partner in Ganfer & Shore. ''The condo has the right of first refusal on any sale, if it can match the contracts. But they couldn't match the contracts so there wasn't anything they could do to stop the sale." The contracts themselves were another red flag. The buyers were paying wildly inflated prices for the 10 rent-controlled and rent-stabilized apartments, which had been owned by a single investor. "It was pretty clear from the get-go that something was rotten in Denmark," says Eleanor Lawson (not her real name), who has served on the condo's board of directors since 2004 and is now president. "We involved our lawyer right away." Although no one in the building knew it at the time, they were already victims of an elaborate scam orchestrated by a Brooklyn-based brokerage firm called AGA Capital. The firm was run by a Russian-born mortgage broker named Galina Zhigun, her son Garri Zhigun, and the office manager Maryann Furman. The gang's appraisers inflated the value of its 10 "target" apartments, then AGA Capital applied for subprime loans in the names of the gang's straw buyers, claiming that seven of the apartments were going to be used as a "primary residence" and three as "investment property" that would generate a total of $6,500 a month in rent. What AGA Capital failed to mention in the loan applications was that the apartments were occupied, they were either rent-controlled or rent-stabilized, and there was no way they could become the buyers' primary residences or generate anywhere close to $6,500 in rent. Soon after the loans were approved and the sales went through, the straw buyers stopped paying monthly maintenance charges. "When you stop getting maintenance payments for approximately one-third of the units in your building, that's a big problem," says Shore. The condo building's board is a mixture of professionals-Lawson, plus two doctors, an attorney, an interior designer, a union negotiator, and an entertainer. They realized they needed to act quickly, so they appointed a three-member legal subcommittee to work with Shore and his team. "There were two questions," says Lawson. "What do we need to do from a legal perspective to protect the building? And what can we do to go after the lost maintenance money?" When indictments against AGA Capital and its web of co-conspirators began to come in the spring of 2007, the board realized it was the victim of a vast, sophisticated criminal scheme. It was a "jaw-dropping" moment, according to Lawson. By now, the board realized that the lost income from maintenance was going to necessitate a special assessment, and it approved a 40 percent maintenance increase. Shore suggested the board had two options. It could pursue millions of dollars in damages in federal court, a slow process that might result in a judgment that was substantial but uncorrectable. Or it could go to civil court and try to win a quick judgment that would funnel rent on the 10 apartments away from the owners and directly into the building's coffers. At the legal subcommittee's suggestion, the board opted to follow Shore's advice and pursue the latter course. It worked. The building ended up collecting about $130,000 in rent, which covered a portion of the lost maintenance. It also covered legal fees. "It's not like the building is flush with cash because of the money we've collected," says Lawson. "But it's better than nothing." The principals of AGA Capital pleaded guilty to fraud charges in federal court in October 2008. Since then, one of the ten apartments has been sold, banks have foreclosed on three others (and will begin paying maintenance), and foreclosure proceedings are under way on the other six apartments. IT COULD HAPPEN TO YOU While this story has its sensational elements-Russian mobsters in Brooklyn! High rollers in Atlantic City! Speeding blue Bentleys on the Staten Island Expressway! – Shore believes that similar scenarios could befall other condo buildings in the city. "This was fraud," says Shore, "but with the current economic slowdown, I believe you're going to see more and more people foreclosing on condos and just walking away. It's already happening in other parts of the country. What this shows is what could happen with this type of economy. Instead of being Russian mobsters, it could have been guys who lost their jobs. That's why this story is so germane." Lawson agrees. "There was a significant increase in foreclosures even before the subprime crisis," she says. "So, I do think we're going to see more people having trouble making maintenance payments. My recommendation is for condo boards to be on top of those who are paying slower or who are unable to pay - on a monthly basis - and then make changes almost immediately. Levy a special assessment or take a portion of the reserve fund in order to keep the building sound. Quick, decisive discussion and action are vital." At Shore's suggestion, the board is now debating whether the condo should act more like a co-op in the future. Specifically, it is considering a more rigorous application procedure, requiring board approval of new apartment buyers, and demanding a security deposit. "We feel very victimized," Lawson says. "Clearly, a top priority for 2009 is making sure this doesn't happen again." H The Case of the Reckless Russians By STEVEN SHORE THE SALE OF MORTGAGE-BACKED DERIVATIVES and the lax lending standards that infected the housing market made it possible for unqualified buyers to obtain mortgages on properties. These loans were behind a fraudulent scheme in which over $200 million in bogus mortgages were obtained and the perpetrators literally were able to take the money and run. One of the victims of this scheme was a client of my firm. What was our strategy in this case? What did we do? While the overall scam included securing mortgages at inflated values based on overstated appraisals and other alleged wrongdoings, the portion that affected our client- a New York condominium - concerned a situation in which ten units occupied by rent-stabilized or rent-controlled tenants were purchased and the occupied units were then resold to fictitious and/or "straw-men" purchasers at significantly inflated values. Mortgages were then taken out on these units based on the inflated valuations and the mortgage proceeds were taken by the conspirators. The purported owners vanished and the condominium was faced with a situation in which no one was paying the common charges or the cost of repairs required in these units. The perpetrators were able to significantly inflate the values of the subject units by neglecting to advise the lending institutions that the units were not vacant and were being leased to rent-controlled and/or rent-stabilized tenants. The lenders apparently did not inspect the units (or else they would have found people living in them) and, as occupied units, the apartments had a value significantly less than what the units would have been worth had they been vacant. Unfortunately, because the mortgages had been secured through subprime facilities and then sold off, the identity of the holders of the interest in the mortgage could not be readily ascertained in all cases, and accordingly, the lenders did not promptly begin foreclosure proceedings. The result was that the condominium was faced with the prospect of a relatively long period of time during which it would not be able to collect common charges from the "bogus" unit-owners. Because we anticipated that it would take years for all the foreclosure proceedings to be started and then proceed to foreclosure, and because the condominium's lien on each unit was subordinate to the lenders' lien, the condo was faced with the prospect of never collecting its common charges. In addition, the condominium also had to deal with its obligation to repair dangerous conditions that existed in some of the units, as well as to deal with the federal criminal investigation that ultimately resulted from this scheme. Because our client was a condominium and the mortgages secured on the units had priority over any lien the condominium would have for unpaid common charges and/or unreimbursed repair costs and unpaid legal fees, the condominium was faced with a situation in which it would not only suffer a serious reduction in the collection of common charges, but at such time as foreclosures on the units were completed, any claims that it possessed would be wiped out. As these units represented a substantial percentage of the total number of units in the condominium, the loss of common charges on them and the incurring of costs to deal with problems in these units created a financial emergency for the association. Although the condominium association had an excellent claim for significant sums of money that would have been tripled under the Racketeer Influenced Corrupt Organizations (RICO) act – and would also have entitled the condo to recover its legal fees – we recommended that it not start a RICO action. Among other things, that would have taken time and would probably have resulted in the condominium's securing a substantial but non-collectable judgment. We anticipated that the authorities would institute criminal proceedings and freeze and ultimately take all of the wrongdoers' assets. Our concerns were ultimately proven justified when the federal authorities indicted many people in connection with this fraud and subsequently secured guilty pleas and control of their assets. Given our concerns that it would take years for all the foreclosures to come to fruition and the urgent cash flow needs of the association, we suggested an alternative strategy that would enable the condo to secure some cash flow during the time it was waiting on the foreclosures. We recommended that proceedings be instituted for unpaid common charges and legal fees in the civil court where judgments could quickly be secured. Once the condo had judgments, restraining notices could be served upon the tenants in the subject units to be followed by securing turnover orders directing the tenants to pay their rent directly to the condominium. As a further part of our strategy, once an initial judgment on each unit was satisfied we would go back into court and secure additional judgments and continue with such process until the subject unit had been foreclosed. As a result of this strategy the condominium was able to secure all of the rent that the tenants in the subject units owed to the conspirators and their "straw men." The money recovered was in the six figures and along with a special assessment enabled the condominium to meet the shortfall caused by these defaults. Because of this situation, we have advised a number of other condominiums on ways to better shield themselves in the future from situations of this nature. Among alternatives that we have discussed are bylaw changes to provide for more rigorous application procedures, approval of new purchasers, security deposits, and a mortgage for common charges. Steven Shore is a partner in Ganfer & Shore, a law firm specializing in co-ops and condos. Reprinted with permission of HABITAT MAGAZINE-www.habitatmag.com |
