Bankruptcy is a means by which a person seeks relief from debt. The bankruptcy laws come from a long tradition of allowing people debt forgiveness and,in certain circumstances, freedom from debt. The bankruptcy laws are federal and are found primarily in Title 11, Chapters 7 and 13 of the United States Code.
A bankruptcy does not necessarily mean an association cannot collect the past due assessments from the bankrupt owner. What you know about bankruptcies and how you react may make the difference between recovering and not recovering at least some of the debt.
There are several different types of bankruptcies. The two most commonly seen by community associations as it relates to its owners are Chapter 7 and Chapter 13.
A Chapter 7 bankruptcy is a liquidation proceeding. Under Chapter 7, the debtor will turn over all non-exempt assets to the bankruptcy trustee. The trustee will then liquidate (sell) all of the assets and use proceeds to pay the creditors. Frequently this does not happen because after removing the debtors exempt property, there is nothing left to liquidate. Typically, the end result of a Chapter 7 will be that the debtor’s debt is all wiped out. For an association this means that the debtor is no longer personally responsible for any “pre-petition debt”, anything owing as of the date the bankruptcy was filed. This is called “discharge” of debt. On average, Chapter 7 bankruptcies last about six months from the date of filing until the debtor receives a discharge.
So, how does an association get paid when an owner files a Chapter 7 bankruptcy? If a debtor keeps his/her home after the date of filing a Chapter 7 bankruptcy, he/she continues to be responsible for any assessments that become due after the bankruptcy is filed – this is known as “post-petition debt”. In addition, the statutory assessment lien for all assessments incurred before and after the bankruptcy will survive the Chapter 7. Thus, if the owner sells or refinances his/her home, the association will be paid in full through the lien. This also leaves open the option for the association to foreclose its lien.
In contrast, a Chapter 13 bankruptcy, sometimes known as a “wage earner” plan is a structured reorganization proceeding. Under Chapter 13, the debtor will repay some or all of his/her debts over a period of three to five years through the Trustee. The Trustee will distribute the funds according to a repayment plan approved by the bankruptcy court.
Creditors have a chance to review the plan and object to it or request that it be modified before the court approves it. Since the association has a lien on the property, if the debtor’s plan does not provide for full payment, plus interest and monthly assessments as they continue to come due, the association’s attorney can object to confirmation of the plan.
After the plan’s approval, the debtor performs the plan by paying a designated sum each month to the Chapter 13 Trustee, who will then distribute the money to creditors listed according to the terms of the plan. If the association filed its lien before the bankruptcy started, and is properly provided for in the plan, the association should get paid everything it is owed. Be patient! The money doesn’t come right away in a Chapter 13, as several creditors may be ahead of the association in line of priority.
Most bankruptcies are routine and follow a predictable path. Sometimes you are able to recover all or a portion of the debt owed to the association, and other times you are not, but its important to understand what is happening.
If you encounter a situation that you are unfamiliar with, you should seek legal assistance promptly.