Julie L. Melander, CRE, Director, Asset Management, of PEG Companies in Provo, Utah, has earned the 2020 James Felt Award for Creative Counseling from The Counselors of Real Estate®.  The award celebrates outstanding achievement and ingenuity in real estate counseling.

Through her work with a prior employer under a Special Servicing contract, Melander worked with a private equity fund which had acquired the mortgage on 11 commercial condominiums in a mixed-use condominium building—Park Place by the Lake—in Lake Forest, MN.  Completed in 2004, the development contains 12 residential units and 17 commercial units, all of which had been sold to third parties except for the 11 mortgaged units still owned by the original developer.  In 2015, the developer defaulted on the mortgage payments to the private equity fund.

According to Melander, the property and assignment presented several challenges:

1. The private equity fund preferred not to foreclose and take ownership of the collateral units due to environmental issues related to a leaking underground storage tank upgradient from the site;
2. Water damage to the building from a 2014 storm had an estimated remediation cost of $2 million;
3. Imminent litigation over management of the project between the condo association and the developer who had maintained control of the condo board until 2015 through ownership of the 11 mortgaged units plus two other units that had been released from the mortgage;
4. A engineering report evidencing construction defects.

“The private equity fund was fully funded,” said Melander.  “No additional funds could be easily advanced to remedy these problems with the property.  The mortgage holder had been counting on this asset for positive cash flow.  As the representative of the mortgage holder who had the largest block of economic interest in the property, I had to gain as much control over the real estate and the problem situation as possible. Because the mortgagee did not want to foreclose and own the property due to the perceived environmental risk, I had to petition the court to appoint a receiver, but the mortgagee wanted a receiver with the power to sell the collateral units.”

In Minnesota that required an agreement with the original developer with which MeIander negotiated for a settlement that required approval from her client to execute.  The court appointed a receiver in October 2015.  Melander worked with the receiver to assure the 11 commercial units were leased to generate income while each was on the market for sale.

When the condo association filed a claim for coverage of the water damage from the storm of 2015, the insurance company denied coverage due to their engineering report which determined construction defects were the cause of water damage to the property.

“With the denial of coverage, the condo board was at a standstill because it was still controlled by the original developer,” said Melander.  “The third-party condo owners grew increasingly angry at the lack of action and banded together, engaging an attorney and forming a litigation committee aimed at the development team.”

In Spring 2016, the condo board imposed a special assessment of $361,000 on all units to cover legal fees and additional engineering consultant expenses to pursue a construction defect claim. The collateral units were assessed $164,000.  In March 2017, the board implemented a second special assessment of nearly $2 million of which $900,000 was imposed on the collateral units.

“The receiver had paid the first assessment out of the operating accounts of the collateral units from rental income, but there were no funds to cover this second large amount,” recalled Melander.  “I informed the condo board the mortgagee was not responsible for the latter assessment and could foreclose on the units, but that wouldn’t solve the problem for anyone.  So the board, the receiver and I had to come up with another solution.”

Over the next year the principals considered alternative solutions, including bank financing for the repair work, structuring a line of credit to the board from Melander’s private equity fund client, selling the collateral units and diverting the proceeds to funding the mortgagee’s proportionate share of the repair costs, and escalating the construction defects litigation to pay for repairs from the proceeds of the lawsuit.

“During this time period, the condo board grew increasingly frustrated and, of the five original members, only two stayed through to shepherd this to the end,” said Melander.

Melander structured a settlement agreement with the condo board that provided for an escrow account to be funded with the owners’ contributions to the special assessment, as well as by an advance of funds from the private equity fund.  She retained a consultant to review the progress of construction and approve the contractor’s draw request in conjunction with the board’s review and approval before funds would be advanced from the escrow account.  “This required careful negotiation with the condo board which was wary of any further delay in completing the repair work.”

Melander negotiated with the board to provide the mortgagee with updates on the litigation strategy and potential settlement discussions in the construction defect lawsuit through ongoing communication with the board’s legal team.  The settlement agreement was executed and the escrow fully funded, allowing the board to sign the construction contract and proceed with the restoration and rehabilitation of the building in late Spring 2018.

“By early 2019, the construction project was nearly complete,” said Melander.  “The extremely risky job of going ‘behind the walls’ to repair construction defects was completed within 5% of the estimated budget, which was an amazing accomplishment.”

The construction defects lawsuit proceeded to mediation with several challenges occurring over the course of the year: (1) a “Two Harbors Agreement” that allowed the board to “step into the shoes” of the developer to pursue the lawsuit that was being litigated in the Minnesota Court of Appeals under another case.  If that lawsuit was overturned, it would mean the subject case would be dismissed; (2) one of the larger subcontractors had been given full immunity by the developer in 2012 that limited the total recoverable amount to two-thirds of the original claim; (3) another large subcontractor claimed immunity from a 2004 communication with the general contractor and a member of the development team that limited any claim to 20% of its contract; and (4) a statute of limitations argument.

While the project was delivered in 2004, these claims were filed in 2017. The defendants tried to get the case dismissed for that reason, but the judge’s ruling left this issue, as well as the subcontractor’s immunity claim, for a jury to decide.

“If the matter went to a jury trial, six out of seven jurors would have had to agree on the liability and the amount of each claim,” recalled Melander.  “So the parties agreed to mediation. The outcome was the recovery of approximately 40% of the claim—$742K—which was acceptable by all members of the condo board.  These people were not real estate executives or lawyers. They were retired doctors and professionals or local business owners who had endured living in a home with severe water intrusion issues, conflict among their neighbors over extended delays in the resolution, unfulfilled promises by the receiver to sell collateral and fund the mortgagee’s assessments, legal setbacks, and more.”

A longstanding member and secretary of the condo board who worked closely with Melander remarked, “I believe there is a high likelihood the building would not have been repaired and the commercial units not salable without the ‘back channel’ founded in trust and openness created with Julie.  I believe only she and I fully appreciated what was accomplished.”

“Although it was common for my employer to pursue legal remedies through the courts in a problem situation such as this, I felt strongly that the complexity of the problem and the involvement of multiple parties required that we sit down together and figure this out,“ said Melander.  “I found a like-minded individual in the secretary of the board, a retired physician. I worked to show him how his and the other owners’ interests aligned with those of the mortgagee—namely repairing the building as quickly as possible with as little cost and risk as possible and recovering as much as possible from third parties, while minimizing the cost and risk of doing so.  My challenge was to walk the line between the ‘tough’ boss and his approach to the problem and what I felt was the best route for all parties.

“The progress was agonizingly slow on several fronts over which we had limited control:  the lawyers and drafting of agreements; the engineers and contractors and nailing down contract scope and costs; and approvals from the ‘boss’ and the client.”

As the secretary of the condo board concluded, “To this day, I view this as a terrific tribute to Julie and her team that this was accomplished.  It was no less miraculous than pulling a rabbit out of a hat.”

The James Felt Award for Creative Counseling honors the memory of James “Jack” Felt, CRE, a prominent real estate pioneer, founding father of The Counselors of Real Estate, former chairman of the New York City Planning Commission, and a trustee on many well-known corporate and charitable boards.