Community Association Bankruptcy 101
The National Bureau of Economic Research made the determination that the United States is in a recession – and has been since December of 2007. The current economic downturn has been caused, in part, by the nation’s housing downturn, which began in 2006. As a result, many Georgia community associations have noticed an increased number of homes being foreclosed upon and an increased number of bankruptcy filings. Many assume that a bankruptcy will completely eliminate an association’s ability to collect from that debtor. However, for a community association, bankruptcy is not always bad. This is because the debt owed to a community association is often a “secured” debt because the debtor’s delinquency is secured against the property by a lien. Such security will cause the association’s claim to be superior to creditors who hold an “unsecured” debt, such as credit card companies. The type of bankruptcy an owner has filed, and whether the association’s debt is secured or unsecured will determine whether funds can be recovered.
The most common types of bankruptcies that a community association will have to deal with are those filed under Chapter 7 and Chapter 13. And, while some may equate the number 7 as “lucky” and the number 13 as “unlucky,” the exact opposite holds true for community associations. Chapter 13 can often have a positive effect on a delinquent owner’s past-due balance, while a Chapter 7 will often result in a complete and total loss for the association. In an effort to end this article on a high note, let’s get the bad news out of the way first.
THE AUTOMATIC STAY
Beginning immediately when the petition is filed, the debtor is protected by the Automatic Stay (11 U.S.C. § 362(a)). Under the Bankruptcy Code, the debtor is granted certain protections from creditors. Common examples of prohibited actions by creditors are: (1) contacting the debtor to demand repayment for pre-petition debt and (2) taking any action whatsoever against the debtor to collect money owed before the bankruptcy petition was filed. Starting or continuing foreclosure actions, repossessions, wage deductions, filing liens against the debtor’s property, and towing vehicles owned by the debtor or the guests of the debtor are prohibited because such actions disrupt the “bankruptcy estate” which is protected by the Automatic Stay. Suspending the debtor’s right to use common property or deactivating gate access (or any similar sanction) for the debtor’s failure to pay pre-petition debt are also prohibited by the Automatic Stay. This is important to note, because a violation of the Automatic Stay by the Association or its agents is considered to be Contempt of the Bankruptcy Court, and any violation could subject the violator to sanctions including heavy fines and possible imprisonment. So, when an owner files bankruptcy, it is vital that the association ensure that notices and letters related to pre-petition debt are stopped. At this point, it is often advisable to separate the owner’s pre- and post-petition debt, so that a costly mistake is not made. Communications related to post-petition assessments can (and probably should) continue.
CHAPTER 7
Chapter 7 is a “liquidation” of the debt. In a Chapter 7, all of the bankrupt owner’s eligible assets are generally sold by the Trustee to pay secured claims. Any excess proceeds are distributed pro-rata to pay unsecured creditors. In most cases, however, the debtor has no assets to liquidate other than those which are already fully secured by a lien holder, such as that owner’s mortgage company. As a result, the debtor’s home (a secured asset) is usually surrendered to the mortgage company, which in most cases holds the most superior secured interest in the home. In a Chapter 7, the mortgage company will often proceed to collect its secured interest by “liquidating” the collateral. In other words, the home will often be foreclosed upon. Unfortunately, a foreclosure will extinguish the association’s lien, and as a result, the Association will become an unsecured creditor, and is unlikely to receive any funds from the bankruptcy.
Worse, the Chapter 7 debtor generally receives a “discharge” by the Bankruptcy Court four to six months after the case is filed. A discharge legally releases the debtor from any personal debt obligations (including assessments) that became due prior to the date that the bankruptcy petition was filed. Thus, any funds that were owed to the association that became due before the Chapter 7 was filed are now completely and forever uncollectable from that owner.
What about the assessments that came due after the case was filed? These amounts are not discharged, and remain the legal obligation of the owner. In fact, that owner will remain liable for these “post-petition” assessments until the home is eventually sold or foreclosed upon. It is up to the association whether it is worth it to proceed against the owner for these amounts. Generally, most owners who are foreclosed upon do not have the funds to pay the delinquency, and the cost of collection is prohibitively expensive.
Is there a silver lining to a Chapter 7? Perhaps. First, often an individual who files Chapter 7 has had trouble paying assessments to the association for some time. When that owner loses the home to foreclosure, the bank or a new owner will take possession, and if we’re lucky, the future assessments will be paid. Also, a Chapter 7 itself has no effect on the association’s lien. An argument can be made that even if a Chapter 7 debtor receives a discharge, the discharged debt can still be recovered satisfying the existing lien. Again, however, most homes are lost to foreclosure in a Chapter 7, and as a result, the association’s lien is lost too. With no lien and no personal liability, the association literally hits a dead end.
CHAPTER 13
A Chapter 13 bankruptcy is a reorganization of debt. When the debtor files a petition under Chapter 13, he submits to the Court a schedule of all of his debt, what his income is, any assets he may have, a list of his monthly expenses, and a proposal or plan as to how he will pay off the debt. This is called the Chapter 13 Plan. The Chapter 13 Trustee, the Judge, and the creditors will review the debtor’s Plan for repayment and evaluate its feasibility. A hearing is held to determine if the Plan will be confirmed by the Court. If confirmed, the debtor will pay a set amount to the Chapter 13 Trustee each month, and creditors receive checks for a pro rata share of that amount pursuant to the terms of the Chapter 13 Plan. The Plan must be completed within sixty (60) months or less. Secured creditors have priority over unsecured creditors; however, it may still take several years for the secured creditors to receive all pre-petition amounts due.
The good news? If the debtor is not giving up his home through the Chapter 13 Plan, the association’s lien will classify it as a secured creditor, and the association should be paid in full over the course of the bankruptcy. However, getting paid through a Chapter 13 is not automatic. It must be monitored, and certain documents must be filed by rigid deadlines set by the Bankruptcy Code. That is why it is vital that a Chapter 13 receive the association’s utmost attention. It is advisable to have your association’s legal counsel assist in this endeavor by evaluating the Chapter 13 Plan, and filing a “Proof of Claim” on behalf of the Association for pre-¬petition debt owed. The “Proof of Claim” should include all amounts owed to the association prior to the filing of the bankruptcy action, including any unpaid assessments, late fees, interest on the balance, any judgments, post judgment interest, costs of collection, and attorney’s fees incurred through and including the bankruptcy filing date. The “Proof of Claim” will serve as the basis for the payment “disbursements” that the Chapter 13 Trustee will eventually send to the association. Disbursements from the Trustee on secured claims usually begin within a few months after the confirmation of the Plan by the Court, but sometimes the Plan will not call for payments to begin to secured creditors for up to a year or more after the Plan is confirmed. Debtors’ attorneys often try to have their own attorney’s fees paid out immediately under a Chapter 13 Plan, and only then have secured creditors begin having their claims paid out years later. This often results in a Chapter 13 Plan where the association’s claim is not paid until several years after the Plan is confirmed. Under Chapter 13, a Plan may not be confirmed by the Court unless the secured creditors accept the Plan. This long-term, remote-paying “scheme” is another reason associations should have an attorney evaluate the Chapter 13 Plan. Another common issue with Chapter 13 Plans is the failure of the debtor to even list the association’s claim at all or in the correct section of the Chapter 13 Plan. Failing to object to the confirmation of a Chapter 13 Plan as proposed by a Debtor is deemed to be a waiver by a creditor of any future right to complain about the terms of the Plan.
Better news: the debtor has to follow the strict guidelines of the Bankruptcy Code while in bankruptcy. For the Association, the most important guideline is that the debtor may not incur any new debt while the bankruptcy action is pending. This means that the debtor is responsible for keeping current on payment of post-petition association fees. A debtor’s failure to pay post-petition debt will almost certainly have an adverse affect on the bankruptcy, and could possibly result in the entire bankruptcy being dismissed.
So, as long as the owner intends to keep the property, not only will a Chapter 13 clear up the owner’s debt with the Association in a court-monitored payment plan, the law is set up to ensure that the owner continues to pay his current and future assessments. An owner who successfully completes a Chapter 13 can be a member in good standing by the time it is done.
As you can see, a bankruptcy case can have several possible outcomes, not all of which are bad. If an owner files bankruptcy, feel free to contact us to find out what it could mean for your community.
Joseph C. Larkin, Esq.