Are Forced Condo Sales “Takings” Under the Arizona Constitution?

UPDATE: The Arizona Supreme Court ruled that the forced sale of the plaintiffs’ condominium did not violate the state constitution’s eminent domain provision. The court did vacate part of the lower court’s decision, finding that, under the operative contract, the full building should have been sold, instead of individual condos.

An Arizona couple is asking the state supreme court to block the investment firm that took over their condominium association from forcing them to sell their home.

The case, Cao v. PFP Dorsey, will determine under what circumstances a termination of ownership through forced sale can be considered a constitutional taking. It tees up a series of hard questions about the interplay between constitutions and private agreements — specifically the covenants and restrictions that bind the nearly one-third of Americans living in a homeowners’ association (or HOA), condominium association, or the like.

The dispute arose from a condominium complex in Tempe, Arizona. Construction on the complex wrapped up in 2007. Sales underperformed following the 2008 financial crisis, and only six units — of 96 total — sold as condos. One of those was purchased by Jie Cao and Haining Xia.

Like most condominium buildings, the complex was set up as a common-interest community where residents own individual units, co-own shared spaces with other residents, and agree to submit to the authority of both a governing board and a written declaration. Under the declaration, each unit owner was a member of an owners’ association, with each unit equating to one vote within the association. The declaration specified that the condominium ownership structure could be terminated if 90 percent of unit owners agreed. The declaration also referred to state regulations on condominium ownership, including Arizona’s Condominium Act. The act sets forth a minimum percentage of votes required for termination — 80 percent at the relevant time — and specifies how a sale of all condominium units should proceed after termination.

An investment firm (and corporate antecedent of PFP Dorsey) subsequently bought the remaining 90 units, giving it ownership of 94 percent of the units. In a press release, the company touted its plans to convert the complex into a “rental community” targeted to neighboring Arizona State University — in other words, PFP Dorsey planned to remain the owner and lease the remaining units, rather than selling them as condos.

After the firm’s purchase, the owners’ association called a meeting to discuss terminating the condominium agreement and selling all units to PFP Dorsey. Cao and Xia protested. But PFP Dorsey’s ownership of 94 percent of the votes let it terminate the condominium unilaterally under the declaration. Cao and Xia’s unit (along with the other five that didn’t belong to PFP Dorsey) were transferred to the firm.

According to the complaint, PFP Dorsey changed the locks on Cao and Xia’s home. The couple’s belongings were discarded or donated. Cao was later arrested for trespassing in the complex lobby.

Cao and Xia are not alone in having found themselves on the wrong end of a condo wind-down. In the typical pattern, an investor — like PFP Dorsey — buys units to gain control of voting in a condominium association and then turns units that would otherwise be in homeowners’ hands into more profitable rentals. Scholar Evan McKenzie tracks similar “deconversions” in Illinois, and The New York Times recently reported on a Florida condominium where the owners had “coexisted peacefully” with an investor who owned all but their unit in a condo complex. The condominium declaration required 100 percent of owners to vote for termination. But when the investor wanted to force a sale anyway, they used their condo board voting power to lower that threshold to 80 percent.

The crux of the couple’s claim in the Arizona case, however, is unique: they assert that the Arizona Condominium Act is a taking under both the state and federal constitutions because it enables or regulates the forced sale of a property. But, points out PFP Dorsey, even if Arizona condominium law was silent on termination, a duly elected condominium board could ostensibly bind an owner to sell if 80 percent of the neighbors so voted by simply changing the governing contract. That makes bringing the claim as a takings one a bit tricky, since the same outcome could result through ordinary contract and covenant law without the “unconstitutional” statute.

Faced with traditional judicial deference to condo and HOA covenants, Cao and Xia could have turned to bigger questions of public policy. Judges are extraordinarily deferential to condo and HOA covenants, but that deference does have limits: restrictions in common-interest communities may not be enforced if “arbitrary or in violation of public policy or some fundamental constitutional right.” What it means for a covenant to be against public policy is an evolving question that has come up in contexts ranging from solar panels to Confederate monuments. One could imagine an argument buttressed by constitutional principles that a covenant allowing other people to force you to sell your property rises to that level.

The concept of “public policy,” however, is primed for state constitutional challenges of its own. Legislatures quite frequently declare covenants against public policy when they update state law. For example, if a legislature were to authorize duplexes throughout a state, they might in the process suspend any contrary covenants restricting lots to single-family use. Some experts have evaluated whether these sorts of covenant invalidations are themselves takings of a property interest.

The lower court opinion in this case hints at another potential problem. A secondary question was which version of the condo law’s sale provisions applied: the 1986 version, which might have yielded a larger payout, or the later one from 2018. The legislature that changed the provisions in 2018 declared any covenants inconsistent with its change “void as a matter of public policy.” But the appellate court said it would be a violation of the state’s contract clause for the legislature to have eliminated Cao and Xia’s interests under the 1986 law in this way. In another recent case, a Montana district court similarly suggested that if a legislature tried to invalidate any restrictive covenants in the process of changing zoning rules, it would violate both the state and federal contracts clauses. In other words, further research is necessary to determine why and when a covenant is “against public policy.”

All in all, something about forced sales strikes many as unseemly. Whether the takings clause is the right vehicle for challenging them is another matter. Legislation may be a better path for closing the loop. As of late 2022, Arizona itself has prospectively increased its statutory floor for forced terminations to 95 percent, which would have prevented the forced sale in this case.

The process of condominium deconversion is an illustration of the increased interest of institutional investors in acquiring real estate to convert into rentals, a practice that may have wide-ranging social and economic consequences, for good or for ill. Many other states have termination laws that resemble Arizona’s. This complex case attracted an intriguing cast of amici on the plaintiffs’ side, including the Pacific Legal Foundation, responsible for bringing many of the biggest takings cases to the U.S. Supreme Court. That level of interest means it’s surely not the last litigation we will see involving the wind-up of condominiums and other forms of common-interest communities.

Maureen (Molly) E. Brady is the Louis D. Brandeis Professor of Law at Harvard Law School.