Published in the ECHO Journal, December 2007
Collection of homeowner assessments is a constant issue for community associations. This problem becomes even more difficult when a homeowner files a bankruptcy. This article provides a cursory review of the ways in which a consumer bankruptcy can affect a community association’s efforts to collect delinquent assessments.
What is Bankruptcy?
The Bankruptcy Code[1] is a federal law that provides protection to individuals and corporate entities from the collection efforts by their creditors. It is designed to provide the debtor with shelter from creditors and eventual relief from debts that arose prior to the filing of the bankruptcy petition. Debt that is incurred prior to the filing of the bankruptcy petition is often referred to as “pre-petition debt.”
What Happens When an Individual Files Bankruptcy?
When an individual debtor files for protection under the Bankruptcy Code, one of the protections afforded to that individual is an automatic stay on all collection efforts by its creditors. (See 11 U.S.C. 362” [2] This means that all creditors, including community associations seeking to collect assessments, are precluded from pursuing that debtor or any of the debtor’s assets. All collection activity must stop immediately.
This is often very frustrating for the association creditor, as very often, the bankruptcy petition will be filed on the eve of a foreclosure sale and the community association is forced to cancel the sale until such time as the bankruptcy is concluded or the creditor successfully obtains relief from the automatic stay.
What Are the Different Types of Bankruptcies?
There are essentially three types of bankruptcies: Chapter 7, Chapter 13 and Chapter 11. This article focuses on the two types of consumer bankruptcies that often impact community association collection activities: Chapter 7 and Chapter 13.
CHAPTER 7
A Chapter 7 bankruptcy is often referred to as a “liquidation” whereby the debtor seeks an order from the Court “discharging” all of the debtor’s pre-petition debt. In exchange for obtaining the relief from these pre-petition debts, the debtor agrees to surrender all of its assets, if any, to the appointed Chapter 7 Trustee. The Trustee, in turn, distributes the assets of the bankruptcy estate to the various creditors. Those bankruptcies that impact community associations will most often have at least one asset, the debtor’s home.[3] Generally, a Chapter 7 bankruptcy can be concluded in as little as three months and rarely takes longer than a year to complete.
A debtor who successfully completes a Chapter 7 bankruptcy receives a discharge. The entry of the discharge order by the court terminates the automatic stay but, at the same time, it precludes any further attempts by creditors, including community associations, to collect on pre-petition debts.[4] The discharge order does not, however, prevent associations from pursuing any security interest they may have in the debtor’s real property.
For example, consider a debtor that is three months delinquent on his or her assessment payments at the time that the bankruptcy petition is filed. Consider further that this debtor also fails to make the three payments that became due after the filing of the bankruptcy but prior to the entry of the discharge order. This debtor is only personally liable for the three months of assessments which came due after the bankruptcy filing. However, assuming that the community association’s secured interest in the property is perfected prior to the date of the bankruptcy petition, the community association will be entitled to conduct its foreclosure based on all six months of delinquent assessments.[5]
Community associations should be careful in their pursuit of unpaid assessments that come due post-petition. The recordation of a lien or an assertion of a claim against the real property (an asset of the bankruptcy estate) prior to the entry of a discharge order, can be deemed a violation of the automatic stay. [See 11 U.S.C. Section 362(a)(2)(3) and (4)]
Unfortunately, California, unlike other states, does not recognize the community association’s secured lien as being “perfected” simply by virtue of the delinquency. In California, in order for a community association’s lien to be “perfected” certain time periods must expire and certain filing requirements, the specifics of which are not the subject of this article, must be met.
Accordingly, it is possible that a pre-petition assessment delinquency could be deemed unsecured and subject to the discharge order. This would mean that as long as the debtor is current on its post-petition assessments, the community association is precluded from foreclosing on the property even if there are unpaid pre-petition debts.
What Actions Can a Community Association Take to Protect its Interests in the Event of a Chapter 7 Bankruptcy?
Monitor the Bankruptcy
Community associations can avoid many of the pitfalls related to Chapter 7 bankruptcies simply by monitoring the case or instructing their collections agent to closely monitor the bankruptcy.[6] Community associations need to make sure that their claims are listed in the debtors’ schedule as “secured” by the property.
File a Proof of Claim
In most instances filing a proof of claim in a Chapter 7 will not be fruitful for the community association because, often, the debtor’s only asset is their home and the various mortgage lenders claims will likely extinguish the value of that asset. However, when there are other assets to be distributed by the Trustee, or where there is substantial equity in the debtor’s home, filing a proof of claim will often yield at least partial payment on the community association’s claim.
Seek a Reaffirmation Agreement
The Bankruptcy Code provides the debtor with an opportunity to reaffirm certain debts that might otherwise be discharged by the bankruptcy. Essentially, this is the debtor’s voluntary written agreement to exempt this debt from the discharge order and agreement to continue payment on the debt either according to the original agreement or according to some other agreed upon terms. A debtor’s desire to keep their home and avoid foreclosure is often an incentive for them to reaffirm their debts to community associations.
Seek Relief from the Automatic Stay
11 U.S.C. Section 362(d) entitles a creditor to obtain relief from the automatic stay for, among other things, “good cause.” In prior cases, good cause included things such as failure to make required post petition payments or failure to maintain insurance on the real property, thereby jeopardizing the interest of the secured creditors. If a debtor is unwilling to reaffirm the debt and/or the debtor is not making his or her post-petition payments, a community association that is concerned about waiting until the end of the bankruptcy to conduct its foreclosure may wish to employ the services of an attorney and have the attorney file a motion with the court for relief from stay. A community association may also wish to seek relief from the automatic stay to “perfect” its lien on the debtor’s home related to the pre-petition debts.
CHAPTER 13
In a Chapter 13 bankruptcy, the debtor is seeking to “reorganize” its debt in a way that allows the debtor to get back on pace with their normal monthly payments to its creditors.
In this type of a bankruptcy, the debtor will propose a reorganization plan. This plan will outline specifically how each of the pre-petition debts will be resolved. Often, a Chapter 13 plan will propose a payment schedule for those debts secured by collateral, such as the debtor’s home. Often the plan will provide for payment of the debtor’s unsecured debts at cents on the dollar or, in some instances, no payment at all.
This type of bankruptcy poses three unique concerns to community associations in addition to those discussed in relation to a Chapter 7 filing:
The community association’s first concern should be with regard to its treatment under the Chapter 13 plan. It is important that a community association do what it can to ensure that the debt owed to it is deemed to be “secured.” Often homeowners will either forget to list the assessment debt in the plan or they will list it as unsecured. Community associations should carefully monitor the terms of the proposed plan. Community associations should also monitor objections to the plan made by other creditors. In this regard a community association should also monitor whether that plan is approved (“confirmed”) by the bankruptcy court.
Assuming that the plan is confirmed and the bankruptcy court permits the debtor to proceed with the reorganization plan as proposed, the next problem the community association faces relates to the time in which it receives its payments. Chapter 13 plans can take up to five years to complete. As such, depending on the terms of the Chapter 13 plan, the community association may be waiting some time before it starts receiving any payments.
Like with a Chapter 7 filing, a bankruptcy trustee is appointed at the time of the Chapter 13 filing. However, the Chapter 7 Trustee will rarely be responsible for receiving a string of payments from the debtor and distributing them to the creditors. In a Chapter 13 context, unless the order confirming that debtor’s plan provides otherwise, the debtor is required to make its payments to the Chapter 13 Trustee who in turn distributes the payments to each of the creditors. [7]
The involvement of the Chapter 13 Trustee can often delay the payment of assessments further and can also lead to confusion regarding which payments or portions thereof are intended to be applied to “pre-petition” debt and what amount is to be applied to debt or assessments which accrue after the filing of the bankruptcy petition. It is very important that community associations have a detailed accounting of the payments received and how those payments were applied to the delinquent assessments.[8]
What Can Community Associations Do When the Plan does not Provide for their Secured Interest or When the Debtor Does Not Make the Chapter 13 Plan payments?
Objections to Chapter 13 Plan
In addition to Monitoring the Case, Filing a Proof of Claim (usually beneficial in Chapter 13 cases), and contemplating a Motion for Relief from the Automatic Stay, community associations faced with Chapter 13 bankruptcies should also contemplate filing objections to the debtor’s proposed plan. Grounds for objecting to the plan include the debtor’s failure to provide for the delinquent assessments as a secured claim and/or failure to provide for ongoing post-petition payments to the association. Community associations may also wish to object to the rate at which any delinquency is being repaid relative to payments made to the other creditors. The community association may also wish to object to any provision in the plan that would modify or extinguish the community association’s right to foreclose on the Property in the event of future delinquencies.
Conclusion
Community associations must be very careful when dealing with bankruptcies. The penalties for violating the automatic stay and/or the discharge order can be very severe. Accordingly, community associations faced with bankrupt debtors should immediately stop all collection activities and monitor the bankruptcy with the following questions in mind?
- Which chapter is the bankruptcy filed under—Chapter 7 or Chapter 13?
- What is the status of the case? Has the debtor received a discharge already?
- Is it worthwhile to file a proof of claim?
- Would the debtor entertain a reaffirmation agreement?
- If it is a Chapter 13, how does the reorganization plan treat the debt owed to the association? Does the Chapter 13 plan provide for the payment of ongoing post-petition assessments? If not, is an objection to the plan warranted?
- Is the debtor making its payments under the proposed plan?
- Is a motion for relief from the automatic stay warranted? Is a motion for relief from the automatic stay economically advisable?
- Is the debt substantial enough that enlisting the services of an attorney is justified?
This article is intended for informational purposes only and is not intended to provide legal advice. Each bankruptcy case is different and community associations should contact their attorneys for specific information regarding their specific situations.
[1] The Bankruptcy Reform Act of 1978, Title 11 of the United States Code, as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
[2] 11 U.S.C. Section 362 provides in part:
(a) Except as provided in subsection (b) of this section, a petition filed under section 301, 302 or 303 of this title, or an application filed under section 5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—
- the commencement or continuation, including the issuance or employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title;
- the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;
- any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;
- any act to create, perfect, or enforce any lien against property of the estate;
- any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;
- any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title…
[3] In some instances, a debtor will be allowed to exempt their home from the Chapter 7 bankruptcy estate by demonstrating that the value of the home does not exceed the secured liens against it.
[4] Prior to the amendment of 11 U.S.C. Section 523(a)(16) in 1994, a split in authority existed as to whether post-petition payments were also subject to the discharge order. One set of authorities dismissed the position that the obligation to pay assessments was a covenant that ran with the land and instead, found that the obligation to pay post petition assessments was contractual in nature. This set of authorities concluded that because the contract predated the bankruptcy, the entire obligation to pay, including post-petition assessments was discharged.
Although section 523 does not explicitly provide for homeowners association assessments, in many instances courts have relied on the legislative intent of the section in concluding that this section applies to assessments imposed by homeowners associations. See In re Rivera 256 B.R. 828 (M.D. FL 2000). The ninth circuit has not yet ruled on this issue.
[5] In most instances, the association will also be able to include late fees, interest and attorneys’ fees in this amount. 11 U.S.C. Section 506(b).
The terms “secured interest” and a “perfected lien” are used differently in this article. “Secured interest” refers only to a potential claim that a debt is secured by some collateral. The term “perfected lien” refers to instances where the creditor has taken all necessary steps to ensure that its lien is superior to and cannot be subordinated by any subsequent lien on the collateral (property).
[6] Bankruptcy filings can be tracked on the federal courts PACER system. In addition, many collection agencies will also monitor the bankruptcy as part of the services they provide in connection with the collection fees charged.
[7] The debtor’s failure to make payments according to the terms of a confirmed plan can also be good cause for granting relief from the automatic stay.
[8] Collection agencies will often perform this accounting for an association as part of their collection services.
Dan Angius is a founding partner at Angius & Terry LLP, an ECHO member law firm that specializes in community association transactional and construction defect law. He speaks at various ECHO seminars and writes for the ECHO Journal.