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BANKRUPTCY BASICS FOR COMMUNITY ASSOCIATION BOARDS OF DIRECTORS

Authored by Attorney Jeremy R. Moss; jmoss@vanblacklaw.com; 757-446-8522

Over the last decade, community associations (like other businesses) have been forced to navigate the “Great Recession” and continued recovery.  The “Great Recession” brought with it a significant increase in the number of personal bankruptcy filings across the country.  Even now, personal bankruptcy filings continue to impact communities and their ability to collect assessments.

It is a common thought that the filing of a bankruptcy petition eliminates a community association’s ability to collect past due assessments.  This is not always true.  But, a number of factors will impact a community associations ability to claim, and collect, debts in bankruptcy.

This brief overview is intended to provide community association boards of directors with a basic understanding of the impact a bankruptcy filing may have on the association’s ability to collect past-due assessments, along with important factors for a board to consider as they consider the appropriate course of action.

As always, the following is provided as general information.  Because of the complexity of bankruptcy law (and the law in general), association rights and responsibilities should be promptly reviewed by counsel for the association on a case-by-case basis.  The following cannot be substituted for legal advice.  

Common Types of Bankruptcies in Community Associations

The two most common types of bankruptcy filings faced by community associations are those filed under Chapter 7 and Chapter 13 of the Bankruptcy Code.

A Chapter 7 bankruptcy is a “liquidation” of assets in exchange for a discharge of debts and is the most common type of bankruptcy filing in the United States. 

When a Chapter 7 bankruptcy is filed, a Trustee (the “Chapter 7 Trustee”) is appointed.  This Chapter 7 Trustee is empowered to take control of all legal or equitable interests of the debtor in personal and real property held by the debtor at the time of the bankruptcy filing, liquidate or sell those interests and distribute the proceeds to secured creditors (with excess proceeds distributed to unsecured creditors on a pro-rata basis).  These interests are referred to the as the bankruptcy estate.

A Chapter 13 bankruptcy provides for an adjustment (really, a “reorganization”) of debts of an individual with regular income.  A Chapter 13 bankruptcy allows a debtor to keep property and pay debts over time, usually three to five years, through an approved plan.

An Owner has filed for Bankruptcy Protection, What Happens Now?

Bankruptcy cases are opened upon the filing of a bankruptcy petition by the debtor (or, in some cases, by creditors) in a bankruptcy court.

The filing of a bankruptcy petition immediately initiates the automatic stay.  The automatic stay is an injunction that automatically stops lawsuits, foreclosures, garnishments, and all collection activity against the debtor the moment a bankruptcy petition is filed, and remains in place until the bankruptcy case is either dismissed or the debtor is discharged.

Certain potential violations of the automatic stay by community associations are obvious - sending a letter to the debtor demanding repayment of a pre-petition debt, filing suit or continuing to pursue a judgment after a bankruptcy petition is filed (a bankruptcy search using the debtor’s name should be done before any suit is filed), or initiating a garnishment to collect a pre-petition debt.

Other violations are less obvious – initiating foreclosure actions, suspending the right to vote, suspending the right of the debtor to use facilities or services (e.g., pool, gate or elevator access) for non-payment of assessments, or taking actions against co-debtors (including spouses and other co-owners in a Chapter 13 bankruptcy). 

In a Chapter 13 bankruptcy, if a unit or lot is owned by multiple owners and is a delinquent in the payment of assessments, the automatic stay protects all co-debtors, even if only one files for bankruptcy protection.  These actions threaten portions of the bankruptcy estate, which are protected by the automatic stay.

Despite the automatic stay, assessments that accrue after the date the bankruptcy petition are filed (post-petition assessments) remain the legal obligation of the debtor and are not discharged in bankruptcy.

Within the first few weeks after the filing of a Chapter 7 bankruptcy, a notice of the commencement of case is sent to all creditors listed in the bankruptcy petition and schedules.  The recordation of a lien and commencement of a timely civil suit can both ensure inclusion in the list of creditors.

Within forty or fifty days (depending on the type of protection sought) of the filing of a bankruptcy petition, a creditor’s meeting (also called a 341 meeting) is held.  A 341 meeting is an out-of-court meeting that allows the debtor to be questioned under oath by creditors, a trustee, examiner, or the U.S. trustee about his/her financial affairs.

A community association board of directors should consider engaging association legal counsel to file a proof of claim (a form-based written statement and verifying documentation filed by a creditor that describes the reason the debtor owes the creditor money) any time an owner delinquent in the payment of assessments files for bankruptcy protection, unless the amount of assessments owed is very small.

If a community association fails to file a proof of claim, the association will be precluded from sharing in any distribution made to creditors as part of the bankruptcy case.  The proof of claim filed by an association will include all amounts owed to the association prior to (and including) the date the bankruptcy petition was filed, and should include all unpaid assessments, late fees, and interest, plus any court-awarded costs of collection, and court-awarded attorneys’ fees (unless the governing documents provide otherwise).

Even in a Chapter 7 bankruptcy, a portion of a community association claim may be secured (backed by a lien) and will have be paid before unsecured portions.  In a Chapter 13 bankruptcy, the proof of claim will be used to determine disbursements made by the Chapter 13 trustee.

Chapter 7 bankruptcies are addressed relatively quickly, with many debtors granted a discharge within six months of filing.  An experienced bankruptcy attorney can assist in determining whether the association should participate in a Chapter 7 bankruptcy beyond the filing of a proof of claim.

If a debtor, for example, indicates an intention to retain the unit or lot and the association previously recorded enforceable liens, the association can enforce its liens even after the bankruptcy case ends.  The association assessment lien, therefore, is a powerful tool in protecting the association from dischargeable personal debt in bankruptcy.

Chapter 13 bankruptcies are not addressed as quickly as those filed under Chapter 7 and may take several years (many last five years) to reach final resolution.  After a Chapter 13 bankruptcy is filed, the debtor files a plan – a detailed description of how the debtor proposes to pay creditors' claims over a fixed period of time.  The plan is also mailed to creditors (and is sometimes the first notice a creditor has a Chapter 13 filing).

In a Chapter 13 bankruptcy, the prior recordation of a lien is even more critical than in a Chapter 7 bankruptcy.  If unpaid assessments are secured by lien, those assessments will oftentimes be paid (over time).  There are instances, however, when the value of secured claims exceed the value of the collateral.  In those instances, the portion of secured claims that exceed the collateral will be considered unsecured.  This process of converting a secured claim to an unsecured claim is called lien stripping or cramming down.  Association bankruptcy counsel can assist in ensuring that assessment liens are treated as secured debts.

After a plan is approved, plan payments are made from the debtor to the Chapter 13 trustee.  Payments are then made from the Chapter 13 trustee to the creditors as provided in the approved plan.  Post-petition assessments (i.e., those that came due after the bankruptcy petition was filed) in a Chapter 13 plan must also be paid on time.

Associations must be able to track pre-petition and post-petition payments and ensure that payments are applied correctly.  Separate accounts should be established for pre-petition and post-petition debts to ensure proper tracking.

Conclusion

With these basics, community association boards of directors should have a basic understanding of the impact a bankruptcy filing may have on the association’s ability to collect past-due assessments, along with factors for a board to consider as they consider the appropriate course of action.

Because of the complexity of bankruptcy law (and the law in general), association rights and responsibilities should be promptly reviewed by counsel for the association on a case-by-case basis.

*Jeremy Moss is an attorney with Vandeventer Black LLP, with offices in Norfolk and Richmond, Virginia, Raleigh and Kitty Hawk, North Carolina, and Hamburg, Germany.

Jeremy is a member of the Virginia Bar Association Bankruptcy Section and in 2016 was listed among Virginia’s “Legal Elite” by Virginia Business Magazine in Bankruptcy and Creditor’s Rights and as a “Top Lawyer” by Coastal Virginia Magazine in Bankruptcy and Workout.

Jeremy is also the Chair of the Virginia Legislative Action Committee of Community Associations Institute, a fellow of the College of Community Association Lawyers, a member of the SEVA-CAI’s 2017 CA Day Committee, Secretary/Treasurer of the Virginia Bar Association Real Estate Section Council, and Chair of the Virginia State Bar Real Property Section Committee on Common Interest Communities.

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