Owners who, for whatever reason, become financially overextended and unable to pay their assessments sometimes file for bankruptcy. The delinquent owner becomes a debtor and the association a creditor. There are three types of bankruptcies that can affect community associations:

• Chapter 7 Bankruptcy. The owner liquidates his/her assets and pays pennies on the dollar for all outstanding debts. Their debts are then discharged and the association cannot pursue the person for any unpaid pre-petition debts. Exempt property may include cars, work-related tools and basic household furnishings. Not all Chapter 7 filings are valid and may be subject to challenge by the association. In such cases, the owner could be forced into a Chapter 13, which gives the association a better chance of recovering its delinquent assessments. In addition, associations can hold the owner personally responsible for post-petition assessments until ownership of the unit is transferred. In Re Kenneth Ames.

• Chapter 11 Bankruptcy. Used primarily by businesses to reorganize their debts but sometimes used by high net worth individuals. This impacts associations when units are owned by corporations or other forms of business entities. The business sells off its property to cover as much of the debt as possible.

• Chapter 13 Bankruptcy. Used by individuals to reorganize their debt. Debtors are allowed three to five years over which to pay their debts. The debtor retains ownership and possession of his/her property but must pay their post-petition assessments and also devote some portion of their income to repaying their pre-petition assessments. If the association's delinquent assessments were secured by a lien, it may be entitled to greater payment than unsecured creditors.

Automatic Stay Imposed. When debtors file for bankruptcy, by law an automatic stay is imposed. It means that all collection efforts by the association against the owner must immediately cease. While the automatic stay is in effect, the association cannot do any of the following:

• record a lien against the delinquent owner's property,

• foreclose on an existing lien,

• file a lawsuit against the owner (or threaten to sue),

• continue an existing lawsuit against the delinquent owner,

• suspend the owner's privileges,

• make any demands for unpaid fees, fines or assessments (whether by telephone, letters, emails or any other form of communication),

• garnish wages, or

• repossess vehicles.

Duration of Automatic Stay. The automatic stay continues in effect until one of the following occurs:

1. Relief from Stay. If the owner does not pay post-petition assessments to the association while continuing to own or occupy the unit, the association can seek permission to pursue post-petition assessments. This is done by means of a motion for relief from the automatic stay. If the court grant the motion, the association to take action to recover delinquent post-petition assessments.

2. Dismissal. Bankruptcy courts will an homeowner's petition if he/she fails to submit required information or documents to the court. When an owner's bankruptcy claim is dismissed, the association can re-start collection efforts on all delinquent assessments.

3. Discharge. A discharge occurs when the bankruptcy case has been completed and the delinquent owner's debts have been eliminated (Chapter 7) or reorganized (Chapter 13). Once the case is discharged, the association can pursue any unpaid post-petition assessments owed by the homeowner.

The duration of the automatic stay is also affected by multiple filings. If a delinquent owner had a bankruptcy case dismissed within the last year, the automatic stay lasts 30 days (unless extended by the court upon motion of the debtor). If the owner had more than one bankruptcy dismissed in the past year, the automatic stay does not go into effect at all (unless imposed by the court upon motion of the debtor).

Proof of Claim. Associations can protect their claims by filing a "Proof of Claim" with the bankruptcy court. Once an association learns of an owner's bankruptcy, it has a limited time to file a Proof of Claim with the Court. Claims filed after the deadline may be denied.

Post-Petition Assessments. Once an owner files a bankruptcy petition, his/her debts are divided into “pre-petition” debts (those incurred prior to the filing of the petition) and "post-petition" debts (those incurred after the filing). Only pre-petition debts are protected by a bankruptcy filing. Owners must remain current on all post-petition debts, including all regular and special assessments. That means the association can continue to send bills for all assessments, fees and fines that accrue after the bankruptcy filing.

Lien Secures HOA Claim. The board has a duty not only to manage the association, but to oversee the collection of assessments from owners. Assessments are necessary for the operation of the association. Without them, the board cannot pay insurance premiums, utility bills, employee salaries, maintain the property or contribute to reserves. To protect the association, boards must timely record liens against delinquent owners. A lien secures the association's claim with a "hard asset," the unit. If there is equity in the property, the association has priority over unsecured creditors and has a better chance of recovering its claim.

Pre-Petition Liens. A bankruptcy can erase an owner's personal obligation to pay pre-petition assessments to the association, thereby preventing the association from pursuing those debts against the owner. If that occurs, the board has no choice but to write off the amounts as bad debt. That is not the case if the board recorded a lien prior to the bankruptcy filing. Because assessment liens are recorded against the property, they are nondischargeable in bankruptcy. In re Whitten (Bankr D Mass 1996) 192 BR 15; King v. Cherrywood Residents Ass'n (In re King) (Bankr D Md 1997) 208 BR 376. This means an association could eventually collect the monies owed if and when the property is sold by the owner (provided the bank does not foreclose ahead of the association).

RECOMMENDATION: Boards should immediately cease all collection efforts against a delinquent owner and seek legal advice whenever that owner files for bankruptcy. For a list of companies specializing in collections for homeowner associations, see "Collections" in our Business Directory.