Owner Bankruptcy
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. Three types of bankruptcies can affect community associations:
- Chapter 7 Bankruptcy. The owner liquidates their 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 bankruptcy, 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. Businesses use it primarily to reorganize their debts, but sometimes it is 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 debt as possible.
- Chapter 13 Bankruptcy. Used by individuals to reorganize their debt. Debtors are allowed three to five years to pay their debts. The debtor retains ownership and possession of their property but must devote some portion of their income to repaying their pre-petition assessments. If a lien secures the association's delinquent assessments, it may be entitled to greater payment than unsecured creditors. Debtors who complete a Chapter 13 and earn a "discharge" may be freed from their personal obligation to pay post-petition dues but can still have their property liened and foreclosed on by the association if such payments are not made. (Goudelock v. Sixty-01 Assn.)
Automatic Stay Imposed. When debtors file for bankruptcy, an automatic stay is imposed by law. 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:
- 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 them using a motion for relief from the automatic stay. If the court grants the motion, the association can then take action to recover delinquent post-petition assessments.
- Dismissal. Bankruptcy courts will dismiss a homeowner's petition if he/she fails to submit the required information or documents to the court. When an owner's bankruptcy claim is dismissed, the association can restart collection efforts on all delinquent assessments.
- 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 the debtor's motion). If the owner had more than one bankruptcy dismissed in the past year, the automatic stay does not go into effect (unless imposed by the court upon the debtor's motion).
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, their debts are divided into “pre-petition” debts (those incurred before the filing of the petition) and "post-petition" debts (those incurred after the filing). Only pre-petition debts are protected by a bankruptcy filing. An owner who files for bankruptcy remains responsible for all post-petition dues and assessments unless there is a transfer in title. (In re Montalvo (Bankr MD Fl 2016) 546 BR 880.)
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 record liens against delinquent owners in a timely manner. 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. 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 before 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 owner sells the property (provided the bank does not foreclose ahead of the association).
Effect on Special Assessments. If an association failed to record a lien when an owner became delinquent, and if the entire assessment was levied at once rather than over time, the owner's responsibility for the debt could be completely discharged in bankruptcy. That means the association cannot pursue the owner for the unpaid debt. However, if the association recorded an assessment lien on the unit before the owner filed for bankruptcy, an anomaly occurs--the bankruptcy may eliminate the owner’s obligation to pay the association, but the lien remains valid. That's because the duty to pay assessments is both personal to the individual and separately attaches to the unit when a lien is recorded and is 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. As a result, the association can leave the lien in place until the debt is paid (provided the bank does not foreclose on the unit).
Association Bankruptcy
Chapter 7 Bankruptcy. A Chapter 7 bankruptcy by the association would not be granted. Under this particular filing, a company goes out of business and a trustee is appointed to sell the company's assets to pay off debts. Associations have no assets of any significance to sell, and the common areas cannot be sold. Moreover, an association cannot realistically go out of business--someone has to maintain the common areas and associations are created specifically for that purpose. Finally, the court can simply impose a special assessment to raise the funds necessary to pay the association's debts. (O'Toole v. Kingsbury Court.)
A community association has the legal ability and duty to pay its debts. It cannot discharge them in bankrutcy. Under the Oak Park Calabasas case, the Bankruptcy Court specifically describes the unique nature of California’s homeowners associations – they must continue to exist and pay debts, and can’t create an alter ego that is not liable for the debts. (In re Oak Park Calabasas Condominium Ass'n, 302 B.R. 665 (Bankr. C.D. Cal. 2003)
In general, chapter 7 results in the liquidation of non‑individual debtors since there are no exemptions to allow them to maintain assets or other property. In most cases this means that no debtor entity would remain from which ECC [the creditor] could collect. But a homeowner association is unique, since California law requires that it continue to exist and collect monies from the homeowners and that only a portion of those amounts are exempt from execution. Therefore a homeowner association would survive chapter 7 and so would its liabilities, including this judgment, which would continue to accrue interest at 10%.
The preceding paragraph was in the Oak Park Calabasas case ended with the following footnote:
Though McClellan v. Northridge Park Townhome Owners Assn., Inc., 89 Cal. App. 4th 746 (Cal. App. 2 Dist. 2001), review denied (2001), never deals with the necessity of a homeowners association – finding on the facts that the new entity was a mere continuation of the prior homeowners association – some entity must comply with the Davis‑Stirling Act and do all the same things as the original homeowners association. Since the HOA cannot be liquidated and it or its alter ego must continue to operate, there will be a source of repayment for creditors even after the trustee administers and distributes all assets of the estate. This leads to a different result than In re General Teamsters Warehousemen and Helpers Union, Local 890, 264 F.3d 869 (9th Cir 2001), where the future union dues was not seen as an asset because the union could later cease to exist.
Chapter 11 Bankruptcy. A Chapter 11 bankruptcy (reorganization) is possible if an association has debt and needs time to repay it. The federal bankruptcy court fashions a repayment plan which would likely include a special assessment against all owners to raise funds to pay those debts. It resolves debt issues but does not address the association's lack of management.
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