With bankruptcy numbers still on the rise, questions continue to abound regarding the impact an owner filing for bankruptcy has on an association…especially when it comes to collection of assessments.

Bankruptcy is a means by which a person (which can be an individual, partnership or corporation) seeks relief from debt.  If a bankruptcy is successful, a person is no longer responsible under the law for the payment of pre-bankruptcy debt.  There are generally two types of bankruptcies that associations deal with; Chapter 7 and Chapter 13.

Chapter 7:  Liquidation.  The Chapter 7 bankruptcy is referred to in the Bankruptcy Code as being a ”liquidation.”  The idea is that the debtor’s assets are sold to pay the debtor’s debts (the money the debtor owes to creditors).  Sometimes that actually happens.  Most often it does not, because when the debtor’s exempt property is taken off the “bankruptcy table”, there is nothing left to liquidate (that is, to sell) to generate the money to pay the debt.  The end result is usually a debtor in a Chapter 7 bankruptcy wipes out all of the debtor’s debt and the creditors typically get nothing.

Chapter 13:  Wage Earner Plan.  The Chapter 13 bankruptcy is sometimes referred to as a wage earner plan or a repayment plan.  It gives the debtor who has a regular income the opportunity to pay his creditors.  Before Chapter 13 was added to the Bankruptcy Act, debtors who wanted to do that had to file under the very cumbersome Chapter 11.  The Chapter 13 bankruptcy is considerably more simple and user friendly.  It allows debtors to pay all of their creditors all of the money owed, some of the money owed, or none to some and some to others.

When a debtor files a bankruptcy, whether an association will be able to collect any money typically rests on:

  1. Whether the association is a secured creditor. A secured creditor is one who has a lien on property, such as a recorded notice of delinquent assessment.
  2. Whether the debtor continues to own the property in an association community.

One question that our attorneys hear frequently is: What happens when an owner decides to “surrender” their property in a bankruptcy?

In a bankruptcy, an owner can choose to surrender or give up the property to eliminate the debt. This is almost always the case in a Chapter 7 and is becoming more common in Chapter 13 as well. Surrendering the property means that the debtor is giving up the property to the bankruptcy estate and the association will lose its standing as a secured creditor. If this is the option they choose, the bank will initiate a public trustee foreclosure to begin the process of taking the property back. In the current real estate and economic climate, this process can take in excess of a year. In terms of assessment collection, this usually means that the association will not be included for repayment in the Chapter 13 bankruptcy plan and the debt will be eliminated in a Chapter 7, leaving the owner no longer personally responsible for any amounts that they owed prior to filing bankruptcy. Although this is, at times, very frustrating there is good news: federal bankruptcy law states that even if an owner intends to surrender their property to the bank they continue to be responsible for the HOA dues and fines that come due after the bankruptcy filing until the home is sold at the foreclosure sale and legal title to the property changes to the bank. Collecting these assessments can sometimes be challenging but at least the association is left with the option of pursuing the debt from the individual, should they decide that it would be prudent to do so.

The other option for a debtor is to “retain”, or keep the property. If this option is chosen, the association maintains its status as a secured creditor, the debtor accepts responsibility for the debt, and all of the money owed to the association as of the date of the bankruptcy filing will be included for repayment in the Chapter 13 plan. This is great news for the association, as it will be paid in full (albeit over the life of the plan, which is typically 5 years). The debtor will also continue to be responsible for keeping up with current assessments payments as they come due.

Some owners who file bankruptcy indicate that they will surrender the property, but then continue to live in the property while the bankruptcy is pending. Again, while this is potentially very frustrating to the association, remember that until legal title changes hands, owners also continue to be responsible for the upkeep of the property; mowing and watering the lawn, keeping weeds to a minimum and otherwise complying with the standards set out in the covenants. If the owner is not in compliance, the association may still use the covenant enforcement process, including the imposition of fines (although it may not take steps to collect the fines until the bankruptcy is finished).

If you encounter any situation which is strange to you (especially a threat of action by a debtor), you should seek prompt legal assistance.  There are many things which can occur in a bankruptcy that are clearly beyond the scope of this article.  If you have any questions about bankruptcy and owners who are surrendering property, please contact one of our attorney’s at 303.432.9999.

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