Condominium associations in large numbers are adopting provisions that eliminate rental units and forbid absentee ownership. Here’s a look at (mostly unsuccessful) legal challenges to these restrictions and some of the ways owners have tried to get around them.

The American middle class has learned what astute investors knew years ago; investing in condominiums is a smart way to make money (1). The condo-buying trend began when condominiums first hit the real estate market in the ’70s.

However, in the late ’80s, a countertrend began – the effort to restrict leasing and rental (as opposed to sale) of units. Many condominium owners became concerned about the negative effects of high resident turnover and renters’ perceived lack of attention to the property. Resident owners also clashed with investor owners over the need for long-term or aesthetic capital improvements to the common elements – the former favored them, the latter did not.

As a result, condominium associations began amending their covenants to limit or even prohibit leasing. For the resident owner, the condominium remains a good investment. However, potential investor/landlord owners now face the risk that no-leasing amendments can be enacted and applied retroactively, forcing them to sell. For the large investor, the requirement to sell multiple units can result in unexpectedly large capital gains. Forcing large blocks of units on the market at the same time could also suppress prices.

The constitutionality of these no-renter covenant modifications has been challenged repeatedly since the mid-’70s. With rare exceptions, the right of condominium owners to modify their governing documents has been consistently upheld.

This article looks at the legal challenges to the constitutionality of rental restrictions. It also looks at how courts have responded to some of the creative “end runs” owners have used to try to get around these restrictions.

Court challenges to leasing restrictions

Nationally. One of the first cases nationwide to challenge rental restrictions was Kroop v Caravelle Condominium, Inc. (2). The Florida Court of Appeals held that the restriction in question was not invalid and unit owners were on notice that the unique form of ownership they purchased was subject to change through the amendment process and that they would be bound despite those changes (3). Florida decisions of the mid-’70s have been followed by those of other states arriving at similar conclusions (4).

It thus became well settled that a condominium association could amend the declaration to eliminate leasing. Needless to say, this could be a harsh reality for many owners without some exceptions. Condominium boards of directors began to consider less harsh measures for specific situations, including financial hardship and leasing to blood relatives.

Associations began considering whether existing investors could be grandfathered indefinitely; whether to grandfather certain existing tenants (particularly handicapped or elderly); whether the right to rent could be retained by owners who had first occupied their units for a specified period; and whether a certain percentage of units could be permitted to lease. In many instances, the association made exceptions to allow itself to rent units it had acquired through a right of first refusal. These considerations, as well as others, colored the different types of amendments being proffered to the owners. (For more about exceptions, see discussion below.)

Illinois. More than 34,000 condominium associations have been incorporated in Illinois alone (5). (This figure does not include townhome associations, homeowners’ associations of single-family homes, and cooperatives.) Not surprisingly, leasing-restriction challenges made their way into Illinois courts.

In 1995, the Illinois Appellate Court addressed leasing restrictions for the first time in Apple II Condominium Association v Worth Bank and Trust Co. (6). In this seminal case, the court held such amendments presumptively valid and enforceable.

In Apple II, a condominium association brought an action to enforce an owner occupancy amendment to its declaration of condominium ownership and to recover fines imposed against one of its members. The court held that (a) an Illinois condominium association may prohibit leasing of units either by board action or a vote of the entire association pursuant to the terms of the condominium declaration; (b) when such a restriction is passed by the association’s membership and made part of the condominium declaration, a reviewing court will presume the restriction is valid and uphold it unless it is arbitrary, against public policy, or violative of a fundamental constitutional right of the owners; and (c) the amendment was a valid exercise of the association’s power (7). An amendment properly adopted in accordance with the declaration’s amendment procedure is thus given a strong presumption of validity.

In 175 East Delaware Place Homeowners Association v Hinojosa (8), the first district significantly expanded the principle of the association’s right to amend its documents by including “board adopted” amendments (in this case, one that prohibited dogs). In Apple II, the first district held that an Illinois condominium association may prohibit leasing of units “by [either] board action” or by a vote of the owners, and then expanded this principle in Hinojosa by upholding the same principle for prohibiting dogs.

Board-adopted restrictions, however, are treated less deferentially by courts than those contained in the declaration or bylaws (9). They are a direct attack on what was once considered a vested property right, so a condominium board must proceed cautiously. What must they do to assure that their board-enacted restriction will be valid?

A rule adopted by the board requires written notice to all owners and can be adopted at an open board meeting after a meeting of owners (10), though it can be revoked by a subsequent board following the same procedure. Frequent shifts in leasing rules can result in problems for owners and affect unit market prices.

Clearly, the best way to restrict or eliminate leasing is for owners to support an amendment to the covenants rather than rely on a board amendment. For one thing, a validly adopted amendment must be recorded under the Illinois Condominium Property Act (11) and

thereby becomes public record. It could only be overturned or revoked by another valid amendment. Simply put, a rule must withstand much tougher scrutiny than a validly adopted amendment.

Under the principles of Apple II and Hinojosa, a rule to limit or restrict leasing rights must (a) be in the best interests of the association, (b) be nondiscriminatory, (c) be applied even handed-ly and not create a hardship, (d) not restrict any owner’s rights under the First Amendment or any other constitutional or public policy provision, (e) be binding on all present and future owners, (f) not be antagonistic to the legitimate objectives of the association, and (g) be intended to promote the health, happiness, and peace of mind of the owners.

While a board-adopted policy must meet these tests, an amendment to the declaration is presumed valid unless proven otherwise. Therefore, an association is always better off amending the covenants than relying upon board-adopted policies and then being subjected to a much tougher standard.

End runs: efforts to avoid leasing restrictions

Defining an “owner.” Leasing restrictions must be read together with covenants and declarations that define ownership. Most sets of covenants and declarations of condominium ownership contain a definition of an “owner” or “member,” which usually reads more or less as follows: “a person whose estates or interest individually or collectively aggregate fee simple absolute unit ownership of a unit.” The typical owner holds title in fee simple or in an Illinois land trust or living trust and is the individual beneficiary or with a spouse.

Hypothetically, what happens when a unit owner conveys a nominal interest (e.g., one percent) to a tenant to get around the restrictions of an owner/ occupant-only policy? Without specific guidelines or further restrictions, or possibly an additional amendment to the declaration defining an owner’s interest, the association will arguably have to accept a nominal owner as an “owner” for the purpose of occupancy.

If there is a lease between the majority owner and the minority owner, the lease would likely be prima facie evidence of a sham transaction.

Typically, declarations contain provisions outlining voting rights (e.g., only one person shall be entitled to vote vis a vis each unit). However, beneficiaries could still maintain the right to vote by agreement of the parties. In this situation, the board of directors would have to go beyond the four corners of a trust agreement to verify whether there is a legitimate relationship or merely a cover for a lease.

The validity of leasing restriction exceptions. When is a lease an arms-length transaction? Does a child occupying his or her parent’s condominium constitute a landlord/tenant relationship?

To address this scenario, many associations include a “blood relative exemption” to a leasing restriction amendment to the declaration so that blood relatives are not considered lessees. Typically, this exemption includes parents, children, and siblings. However, it could be crafted broadly to exempt “next of kin,” defined as all or a defined class of blood relatives or kinsman in existence who would take the owner’s personal property when he died (12).

What about a hardship situation? A financial crisis, a job change, or a health problem can sometimes force a unit owner to rent his or her unit to a third party for a limited period before retaking possession or selling it. Can a board of directors grant an exception to one unit owner over others?

Though we know of no Illinois court test, an amendment that includes such a hardship provision should pass court scrutiny as long as the exception is granted uniformly and fairly. Such an approach is consistent with the Apple II case.

The Florida Appellate Court has upheld an amendment that provided for an exception to a leasing restriction under special circumstances of hardship. In Seagate Condominium Association, Inc. v Duffy, the court held that the association’s leasing restriction was not unreasonably broad (13).

Moreover, can some owners be allowed to continue leasing while others are not, e.g., by grandfathering existing investor-owned units for rental while prohibiting new owners? Can tenants be grandfathered? What about requiring an owner to first occupy a unit for a specified period before allowing him/her to rent the unit? What about a quota allowing a specific percentage of unit owners to lease and, once that percentage is attained, putting owners on a waiting list? What about requiring an owner to occupy his unit for at least one year before being allowed to rent to discourage pure investors? These and other variations have yet to be tested.

End runs, part 2: installment contract sales

Background. Contract sales can be a valuable tool for selling property, especially in difficult economic times, or when the property won’t appraise to value or the buyers have a history of financial or credit problems. However, courts are sometimes faced with determining whether the contract purchaser is really an “owner” occupant or whether the contract sale is a sham to get around a no-leasing restriction. Court rulings have varied based on the specific facts of the sale, the nature of the transaction, and the intent of the parties and the association.

Section 18(b)(11) of the Illinois Condominium Property Act (14) outlines the voting rights of sellers and purchasers involved in an installment contract to purchase the unit. Typically, the buyer makes a small down payment and pays monthly towards the loan. The agreement frequently amortizes the payments on a 30-year schedule, although the full amount is due in a balloon payment after a shorter period, such as five years, with provisions for extensions. The seller retains legal title and will convey a deed to the buyer only after payment of the entire purchase price. A default by the purchaser results in loss of all interest in the property and forfeiture of all payments made to date.

The Illinois Condominium Property Act provides that the purchaser has the right to vote and attend meetings “unless the seller expressly retains in writing any or all of such rights.” Evidence of the sale “shall” be made available to the board. Although, a legitimate method of selling and buying real property through a “contract sale” can also open the door for a violation of association policy if an unscrupulous owner wants to avoid enforcement of a “no leasing” policy through a sham installment purchase contract.

Court rulings. In a Cook County case where identical sales contracts were executed by a defendant involving three condominium units, the defendant (contract seller) entered into articles of agreement with the occupants with identical nominal down payments equal to a typical security deposit amount. The defendant advertised his units as a “lease with an option to buy.” The monthly “installments” approximated the former rent payments the same occupants had paid while they had been tenants. Typically, articles of agreement provide for a short term of installment payments with a balloon payment after a few years. In these agreements, it was a five-year term with automatic five-year renewal periods for 30 years.

The trial court held, and the appellate court affirmed in an unpublished opinion, that the sales contracts were voidable because they were actually leases (15). The amendment to the declaration to restrict the leasing of units was thus valid and enforceable and the defendant’s installment agreements were rendered void. In most instances, the doctrine of equitable conversion will apply to give the contract purchaser some measure of equitable interest in the property above and beyond a mere possessory interest inherent in a leasehold (16).

Greenwood Park v Shah (17) grew out of a sale for which no deed was drawn up, no title commitment was ordered, no recording was made of the articles of agreement to reflect the purchasers’ interests, no liens could be placed on the property, and no assignment or transfer of the property was allowed without the defendant’s consent. The defendant also retained the right of eviction (through forcible entry and detainer (18)) for a default on payments, which allowed it to bypass enforcement under the Illinois Mortgage Foreclosure Law (19), the applicable statute for contract sales.

Further, the contract seller retained the existing mortgage and maintained the right to place additional mortgages on the property. The seller paid all insurance, real estate taxes and assessments owed to the association in order to sustain his income tax deductions.

In determining whether a contract purchase is an arms-length transaction, courts look among other things at who will pay the association assessments and property taxes on the unit. In most instances, the seller retains that right, fearing that a default by the purchaser could cause him to lose the property or incur penalties. In Shah, the seller paid all insurance, real estate taxes, and assessments owed to the association so he could retain his income tax deductions.

Based on the facts of the case, the court held that a then-adopted amendment to the declaration to restrict the occupancy of units to “owners only” was valid and enforceable, that the defendant’s installment agreements were void, and that there was no transfer of ownership by the defendant to the occupants. The agreements thus violated the declaration (20).

Voidable contracts. The Illinois Dwelling Unit Installment Contract Act, Section 2, provides that “any installment contract for the sale of a dwelling structure shall be voidable at the election of the buyer unless there is attached to the contract or incorporated therein a certificate of compliance [or the seller’s warranty that there are no code violations or, if there were violations, a list of them].” (21)

Many sellers who enter into installment sales are unaware that they must provide a buyer with a certificate of compliance.

In Ruva v Mente (22), the defendant admitted that he did not provide the contract purchasers with a certificate of compliance or attach one to the articles of agreement. As such, the installment contracts were voidable by the contract purchasers. The trial court granted summary judgment to the plaintiff on three other units owned by the defendant on this basis: occupancy by individuals unrelated to the defendant pursuant to voided installment contracts violated an amendment to the declaration.

Likewise, the same rationale applies even more forcefully where the installment purchase contracts are voidable. In that case, the court held that a voidable contract that remains executory for anywhere from five to 30 years does not transfer legal or equitable ownership of the subject properties sufficient to render the contract purchasers “owners” under the declaration. The purchasers’ legal interests are not vested, and they do not bring the kind of stability and interest in the subject properties as was contemplated by the association when it amended the declaration to limit occupancy of the units to owners.

What does the future hold?

In a tight real estate marketplace with limited rental property, restrictive condominium rental policies could come under attack as many former rental communities convert to condominium living and make even fewer rental properties available (23). Lack of affordable housing is reaching a “crisis” level in some parts of the country.

Conversely, in times of low mortgage rates and an active real estate buyers market, more potential tenants have the opportunity to become owners. In such a climate there is less likelihood of a legal challenge to a restrictive rental policy than during a housing crunch.

Ultimately, the needs of the market may dictate the continuing efficacy of such policies and amendments of leasing restrictions. Alternatively, it may legitimize the argument against “restraint on alienation.” Only time and economics will tell.

Jordan I. Shifrin is a founding principal of Kovitz Shifrin Nesbit. A graduate of the University of Illinois and The John Marshall Law School, he has been consulting with, advising, and representing condominium and homeowners associations and cooperatives since 1977. He thanks Vilia M. Dedinas and Rebecca J. Maxey for their assistance.

1. A recent national survey revealed that condominiums and townhomes are “appreciating in value at more than double the rate of conventional detached single family resale homes.” Kenneth Harney, Nation’s Housing, Washington Post (Aug 29, 2003), a copy of the article is available at http://www.athomecharlotte.com/cc/hotcondos.htm.
2. 323 So2d 307 (Fla D Ct App 1975).
3. Id at 309. In tandem with the Kroop decision, was Hidden Harbor Estates, Inc v Norman, 309 So2d 180 (Fla D Ct App 1975), where an association declaration was amended to limit the right to lease or rent units to no more than once during an owner’s tenure. The court held that such a restriction on ownership was not invalid as a restraint on alienation and not unreasonable.
4. See Seagate Condominium Association, Inc v Duffy, 330 So2d 484 (Fla D Ct App 1976) and Ritchey v Villa Nueva Condominium Association, 81 Cal App 3d 688, 146 Cal Rept 695 (1978).
5. Secretary of State, State of Illinois, Feb 2004.
6. 277 Ill App 3d 345, 659 NE2d 93 (1st D 1995).
7. Id at 352, 659 NE2d at 99.
8. 287 Ill App 3d 886, 679 NE2d 407 (1st D 1997).
9. Id at 892, 679 NE2d at 411.
10. 765 ILCS 605/18.4(h).
11. 765 ILCS 605/17.
12. Rodgers v Consolidated RR Corp, 136 Ill App 3d 191, 195, 482 NE2d 1080, 1084 (4th D 1985).
13. 330 So2d 484, 486-87 (Fla D Ct App 1976).
14. 765 ILCS 605/18(b)(11).
15. Greenwood Park v Shah, #01-01-2993 (1st D 2003) (non-published).
16. Ruva v Mente, 143 Ill 2d 257, 572 NE2d 888 (1991).
17. Shah (cited in note 15).
18. 735 ILCS 5/9-101 et seq.
19. 735 ILCS 5/15 et seq.
20. See also Ruva at 264, 572 NE2d at 891.
21. 765 ILCS 75/2.
22. Ruva (cited in note 16).
23. In a specially concurring opinion, Justice Quince of the Florida Supreme Court reasoned “[the] Legislature [should] seriously consider placing some restrictions on present and/or future condominium unit owner’s ability to alter rights of existing unit owners… [the restriction] has deprived these owners of a valuable right that existed at the time of purchase.” Woodside Village Condominium Association, Inc v Jahren, 806 So2d 452, (Fla Sup Ct 2002) (Quince concurring).

Originally published in the Illinois Bar Journal, February 2006. Reprinted with permission. Copyright by the Illinois State Bar Association.

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