The Effect of Bankruptcy on Assessment Collections

As far as lawsuits go, a suit for the collection of assessments, assuming that the accounting was done properly, is one of the strongest cases that a homeowners association can have. The association has case law and statutes on its side, making success extremely likely. Of course, true success for the association can only be measured by how much money is collected, and that largely depends on how much money the delinquent homeowner has and if the property has equity.

However, despite the likelihood of success, a bankruptcy can stop a lawsuit or collection dead in its tracks, causing the association serious financial hardship, which in turn is passed on to the other homeowners in the form of higher budgets and increased assessments.

Bankruptcy is supposed to be a debtor's last ditch remedy. It prevents a person from becoming destitute upon the filing of a petition with the bankruptcy court by automatically stopping all collection procedures. The petition triggers an automatic stay which prevents attorneys from proceeding with the lawsuit or obtaining the debtors assets. This gives the debtor some breathing room and allows the debtor to get back on his/her feet. Despite popular belief, it does not always mean that the association can not collect the delinquent assessments.

Generally speaking, when homeowners file bankruptcy they will file either a Chapter 7 or a Chapter 13 bankruptcy. There are other types of bankruptcy, such as a Chapter 11 reorganization which is available to business and individuals, or a Chapter 9, the kind that Orange County filed a few years back.

The Chapter 7 Bankruptcy:

The goal of a Chapter 7 bankruptcy is to combine and liquidate the debtors assets and use the assets to pay off the creditors. Unfortunately, there are rarely substantial assets, and therefore creditors do not always get paid. Often, where there are assets, the case will convert to a chapter 13 (which is discussed below) because the debtor has the ability to make payments to the creditors.

In addition, the debtor in a Chapter 7 is entitled to keep some of the assets because they are exempt from collection by law. The debtor's intention is to get all the debts discharged, thereby making it impossible to collect on them. However, if a lien has been filed and the property has not been foreclosed by the first mortgage holder, the association may still be able to collect its money by foreclosing on the property.

Whether the association can collect the assessments in a Chapter 7, largely depends on whether the assessments accrued before or after the debtor filed the petition for bankruptcy. The assessments which accrued prior to the date the petition was filed are called pre-petition assessments and those accruing after the filing are called post-petition assessments.

Pre-petition assessments may only be collected if 1) the association filed a lien; 2) the property has not been foreclosed; and 3) the bankruptcy court gives you permission. However, the assessments may only be collected by foreclosing on the lien, and not by pursuing a money judgment. The problem with this is that if there is equity in the property, the property usually will be foreclosed by the first mortgage holder. Therefore, the chances are good that the property has no equity and the association may not want to foreclose. However, if the debtor never paid assessments, sometimes it is better to take the loss on foreclosure and get an owner that will pay assessments in the future. This is something that must be determined on a case by case basis.

The law regarding post-petition debts changed in 1994 so that associations can now collect assessments, late charges and interest which accrued after the petition was filed if the association is a condominium or cooperative association and if the debtor either lives in the home or collects rent from someone who lives in the home. Often, many debtors and their attorneys are unaware of this fact, so a simple letter explaining their obligations generally does the trick.

The Chapter 13 Bankruptcy:

A Chapter 13 bankruptcy is designed for people who are in over the heads, but still have a regular income. For an association, the results are usually more favorable than a Chapter 7. The debtor designs a repayment plan, carried out by a court appointed bankruptcy trustee. The plan provides for payment of some or all of the debts.

The amount of the debt that is paid and the time period in which it is paid depends on whether or not the association had a recorded lien. If the association had a lien, it should be paid all of the assessments, late charges, interest, and attorney's fees and costs. If the association did not have a lien, the amount of payment largely depends on what the debtor can afford, and often that is absolutely nothing. Therefore, liens are very important and should be filed as soon as possible.

The amount of time that it will take to pay off the debts also depends on what the debtor can afford. It may take two years, or it may take five. Anything over three years requires the debtor to show good cause, and plans over five years will not be approved. Post-petition debts are still paid as they accumulate, however, occasionally, the plan will provide for payment through the trustee, rather than the debtor paying the association directly.

What can you do to help:

Often the attorneys handling a bankruptcy case lack information that can be obtained by management and homeowners. For example, in a Chapter 7, the attorneys will want to know whether the debtor's home is occupied. Normally board members already know this.

Additionally, the attorneys need to know if the debtor is hiding assets. For example, our office handled a case in which the debtor had received a large cash settlement for construction defects. All the board members were aware of this because they too had received settlements. However, the debtor neglected to inform the bankruptcy court of this matter. This is sometimes grounds for dismissal of the bankruptcy and is therefore crucial information.

Probably the most important thing that management or the board can do is to inform the attorney if they are aware that a bankruptcy has been filed. If an association has received notice of a bankruptcy and the attorney proceeds with the case, monetary sanctions may be imposed. Additionally, important deadlines may pass by without anyone realizing it.