Homeowners associations are frequently confronted with a bankruptcy filing by a homeowner. A bankruptcy filing by a homeowner can have a significant impact on the homeowners association and it is vital that the association’s directors and managers understand how the bankruptcy filing affects the association and what the association should do to protect its interests when it becomes aware of a bankruptcy filing.
There are three basic types of bankruptcies that can affect a homeowners association: (1) a Chapter 7; (2) a Chapter 11; and (3) a Chapter 13. The “Chapter” in each of the different types of bankruptcy refers to the chapter in the United States Bankruptcy Code.
Chapter 7 Bankruptcy:
A Chapter 7 bankruptcy is commonly known as a “straight bankruptcy” and it involves a process whereby the debtor (the homeowner that files the bankruptcy) turns over all of his or her non-exempt assets to a trustee appointed by the court for liquidation and ultimate distribution to the debtor’s creditors pursuant to a system of priorities that is spelled out in the Bankruptcy Code. The law provides debtors with certain specified “exempt” assets that need not be turned over to the trustee for liquidation (i.e. homestead, a primary vehicle, work related tools, household furnishings and certain necessities). In a Chapter 7 bankruptcy proceeding, the debtor is able to discharge his or her debts (with some limited exceptions) so they can no longer be enforced against him or her.
Chapter 11 Bankruptcy:
A Chapter 11 bankruptcy is commonly referred to as a “reorganization” and it necessitates a business that continues to operate under the protection of the bankruptcy court. In most Chapter 11s the debtor remains in control of the business as “a debtor in possession,” although under certain circumstances, the court may take the control away from the debtor. In a Chapter 11, the debtor is required to present a plan of reorganization that must be confirmed by the court. This plan is the mechanism by which the debtor will ultimately pay a certain percentage of its pre-petition debts to creditors and become rehabilitated and emerge from the bankruptcy. Homeowners associations are not typically involved in Chapter 11 bankruptcies that are filed by homeowners. It is more likely that they are involved in Chapter 11 bankruptcies that are filed by businesses that they deal with.
Chapter 13 Bankruptcy:
A Chapter 13 bankruptcy is commonly known as a “wage earner’s plan.” In a Chapter 13, the debtor is required to present a “payment plan,” that must be confirmed by the court, and which proposes to pay the debtor’s creditors an amount that is more than they would otherwise receive in a Chapter 7 liquidation, over a period of 3 to 5 years. In a Chapter 13, the debtor retains its property and creditors are prevented from taking action to enforce their debts that existed as of the bankruptcy filing date. The debtor is liable for the payment of all debts that accrued after the filing date, in addition to the payments that are required under the confirmed Chapter 13 plan — which go towards satisfaction of the percentage of the pre-petition debts that are required to be paid under the Chapter 13 plan.
The Automatic Stay Created by the Bankruptcy Filing:
Regardless of the type of bankruptcy, upon the filing of the bankruptcy petition an “automatic stay” is imposed on all creditors of the debtor. This stay prohibits creditors from continuing with or starting any actions against the debtor or the debtor’s property in an effort to collect money or property. This includes efforts by homeowners associations to collect unpaid fees, fines or assessments that were owed as of the bankruptcy filing date. The automatic stay also prohibits such actions as suspending homeowner privileges, recording and/or foreclosing on liens, and the filing or continuation of lawsuits against the homeowner debtor. The automatic stay continues during the period of the bankruptcy, or until a creditor obtains relief from the stay based on various statutory grounds pursuant to a written motion that is filed with the court. Forms for seeking relief from a debtor’s bankruptcy stay are available on the website for the United States Bankruptcy Court. The proper completion and filing of such a motion should be done with the assistance of legal counsel that is experienced in bankruptcy law. Action that is taken against a debtor in violation of the automatic stay is subject to being set aside and can result in the imposition of damages against the creditor. Homeowners associations are forced to deal with many bankruptcies that are filed by owners just to get the benefits of the automatic stay in order to stop a lender or the association’s foreclosure proceeding that is pending against the debtors property. As a practical matter, in many Chapter 7 bankruptcy cases, within 6 to 12 months following the initial filing of the bankruptcy, the bankruptcy trustee will abandon the estate’s interest in the debtor’s residence because it has no value to the bankruptcy estate, the debtor will receive a discharge of his or her debts, and the automatic stay will be terminated.
Treatment of Debts Owed to the Homeowners Association:
If a homeowner files a petition under Chapter 7, 13, or 11 of the Bankruptcy Code and the homeowners association has not recorded a lien for any delinquent assessments, the association holds the same status as any other unsecured creditor and must file a proof of claim form in the bankruptcy proceeding to share in the distribution, if any, that is ultimately paid to creditors. If the assets in the bankruptcy estate are insufficient to pay all claims, the association’s debt is subject to being discharged and the association may not recover any portion of its debt. If, at the time of the bankruptcy filing, the association had a recorded lien on the debtor’s property for delinquent assessments, that lien places the association in the status of a secured creditor and, following receipt of a bankruptcy court order granting relief from the automatic stay (an action that must be affirmatively pursued by the association), the association may pursue its foreclosure remedies against the debtor’s property. A homeowners association that records a lien against a homeowner’s property becomes a secured creditor to the extent of that lien. Because validly secured debts do not get discharged in a debtor’s bankruptcy proceeding, associations should make it a practice to record liens when they have the opportunity to do so.
Filing a Proof of Claim:
In order to share in any distribution of the proceeds from the liquidation of a debtor’s estate, or receive payments pursuant to a reorganization or Chapter 13 plan, creditors must file a Proof of Claim in the bankruptcy case. The Proof of Claim form is a standard form document that is available on line from the United States Bankruptcy Court website. It is straight forward and can be completed by an association’s management personnel without the assistance of an attorney. There are strict time limitations for filing a Proof of Claim which are specified in notices that are sent to creditors by the bankruptcy court. The failure to timely file a Proof of Claim can result in the inability to share in distributions towards the pre-petition debts that are owed to the creditor. Homeowners associations that are owed debts (secured or unsecured) on the date that a bankruptcy is filed should always file a Proof of Claim unless the bankruptcy court notices direct otherwise. A court may notify creditors not to file a Proof of Claim in a “no asset” Chapter 7 bankruptcy because there will not be a distribution to creditors unless assets are subsequently discovered. In that event, the court will notify creditors to file a Proof of Claim.
Proper Representation in Bankruptcy Proceedings:
A homeowners association should never ignore notices that it receives regarding a bankruptcy that has been filed by a homeowner. Each bankruptcy case must be properly evaluated so that appropriate decisions on how to proceed can be made by a homeowners association’s board of directors. Because bankruptcy proceedings can get very complicated and there are many aspects of a bankruptcy that can have a detrimental impact on a homeowners association , it is important that experienced legal counsel be utilized by a homeowners association when confronted with the filing of a bankruptcy by a homeowner.
Additional information about bankruptcies is available on the website for the United States Bankruptcy Court.