Good News: The Unit Owner Has Filed Bankruptcy

If you’re part of a homeowners association (HOA), planned community, condominium association or cooperative  — this article is for you. Community Association attorney Elliot H. Berton outlines what exactly happens when a resident files for bankruptcy, and how it affects next steps for your community’s board members.

By Elliot H. Berton, Esq.
Gawthrop Greenwood, PC

You have been chasing a chronically delinquent unit owner for unpaid assessments. Your attorneys have secured a Judgment in State Court, and the owner’s assets have been scheduled for a judicial sale. Then you receive notice that the owner has filed a bankruptcy petition. How frustrating…. Or is it?

Association Bankruptcy Protections

While it is true that a Bankruptcy case can slow the assessment collection process, it may also be a positive development for an association. The Debtor’s attorney usually urges Owners to take steps to save their home and arrange to pay assessments.

In addition, our friends at Community Associations Institute (CAI) have managed to persuade Congress to include a unique protection for Associations within the Bankruptcy Code. No matter what else may occur in a Bankruptcy, so long as the Owner is on the Unit deed, they are responsible to pay all assessments that come due after the Bankruptcy is filed.[1] This means that after the Bankruptcy case is over, the Owner can be sued in State courts for any unpaid post-Bankruptcy charges[2], which often motivates the Owner to pay assessments during the Bankruptcy. In many cases, an Owner who has not paid in years will begin to pay accruing assessments after filing Bankruptcy.

Significantly, the Association is a secured creditor[3] and thus has rights that unsecured creditors do not. With rare exceptions, the Association’s lien against the Unit will not be affected by the Bankruptcy (though there have been some cases where the lien has been modified).[4] But unless the Owner plans to abandon the Unit, in the vast majority of cases, the Association’s lien will be paid through a Chapter 13 Plan or by the Owner to avoid a potential post-Bankruptcy lien enforcement action.

Bankruptcy Filing Basics

Most Units are owned by individuals, and thus the Association will be pursuing recoveries in either a Chapter 7 (a “Liquidation”) or a Chapter 13 (an Individual “Adjustment of Income”) case. While these two types of Bankruptcy cases are different in important ways, there are key similarities.

First, all Bankruptcy cases are initiated by filing a Petition[5] which creates an automatic stay.[6] Second,  Chapter 7 and 13 cases have a Court appointed Trustee, whose job, in part, is to look out for the interests of creditors.[7] Third, the Unit Owner will almost always retain an attorney to file and then administer the Bankruptcy case. The lawyer’s fees are controlled by the Court,[8] which often means that the Debtor’s attorney will be reluctant to adopt a strategy that is unusual or expensive. Fourth, all Petitioners must file publicly accessible “Schedules,” which will list the Debtor’s assets, liabilities, current income, current expenses, and other financial disclosures.[9] Such disclosures can be very helpful if the Bankruptcy is dismissed and the Association is permitted to resume collection efforts in state courts.

The Bankruptcy Code tries to push individuals into filing a Chapter 13 case rather than Chapter 7 because a Chapter 13 case requires the Debtor to pay some or all of what they owe to creditors, whereas a Chapter 7 case does not have such a requirement.  To pursue a Chapter 7 case, filers whose income is above the median income in the region must submit a “means test” to the Court demonstrating that they qualify for a Chapter 7 proceeding. As a consequence, most often, an Association will be chasing the Owner in a Chapter 13 case.

Chapter 13 Plans and Association Strategy

In a Chapter 13 case, the Debtor must file a Plan.  The Plan summarizes which creditors will be paid and how much, over a period of up to five years.[10] The Debtor submits future earnings to the Court Trustee, almost always through monthly payments to the Trustee, and if the Plan is “confirmed” the Trustee will distribute that money to creditors.[11] The Plan we see most often provides for payment of the Association’s pre-Bankruptcy assessment delinquency via Trustee distributions while assessments that come due after the Bankruptcy case is filed are to be paid by the Debtor directly to the Association. If all goes according to Plan, through the combination of Trustee checks and Owner payments, by the end of the Chapter 13, all sums due to the Association are paid in full.

On the administrative side, many Association Managers prefer to split the assessment account so that post Bankruptcy assessments and the Owner’s direct payments can be easily tracked. If the Owner pays the post-Bankruptcy charges on time each month, then no late charges or interest will appear on the post-Bankruptcy account. All Trustee distributions will be credited to the pre-Bankruptcy account (that is the charges due on the date when the Bankruptcy was filed). As a general matter, late charges and interest ought not be assessed to the pre-Bankruptcy account while the case is pending.

If an Owner does not pay the post-Bankruptcy assessments, the Association may file a Motion seeking relief from the automatic stay.[12] In Chapter 13 cases, the Association’s Motion will often be resolved with a Court approved Stipulation requiring resumption of the post-Bankruptcy payments and include enforcement provisions that can be effectively utilized to keep the Debtor paying assessments as the case moves forward.  The Stipulation allows the Association’s lawyer to issue a simple demand letter for any future missed payments. If the Owner does not cure the payment default, the Association’s attorney can file an Affidavit and request an Order granting relief from the Stay. Often, filing the Affidavit leads to resumed payments.

If the Association is granted relief from the Stay, then it may take action in State Courts to enforce the assessment lien, which are proceedings leading to a Sheriff’s sale of the Unit. However, at least while the Bankruptcy case is pending, the Association may not use the state courts to go after the Owner’s other assets.

Chapter 7 Cases and Strategy

As explained above, the Bankruptcy Code attempts to push Owners into Chapter 13 cases. But some Owners lack sufficient income to present a Chapter 13 Plan. Other Debtors start out in Chapter 13 but fail, and instead of dismissal, the case is “converted” to Chapter 7. A Bankruptcy case filed under Chapter 7 does not last very long and results in a “discharge,” which eliminates the Owner’s personal obligation for assessments due when the case was first filed but leaves the Debtor liable for any unpaid assessments that came due after the filing. Except in the rare situation where the Debtor attempts to modify or restrict the Association’s rights, the statutory lien against the Unit for unpaid assessments will be unaffected. Many times the least expensive approach in a Chapter 7 case is to wait for the Bankruptcy to conclude, and then file a proceeding in State court to recover unpaid post-Bankruptcy charges or enforce the Association’s lien against the Unit for all unpaid assessments, including charges that were due prior to the Bankruptcy filing.

Elliot H. Berton is an attorney at Gawthrop Greenwood, PC where he assists hundreds of condominium and homeowners associations in an array of matters including assessment collections in Bankruptcy and State Courts. Drawing on his extensive experience representing banks, financial service companies and other creditors, he advises community association clients on negotiation and documentation of loans, service and other association contracts, assessment recoveries and other financial issues. Elliot also assists associations with enforcement of rules and covenants, transition from declarant control, operational issues, governing document amendments and interpretation, and defense litigation. For more information, contact Elliot at eberton@gawthrop.com or 610-889-0700.

[1] 11 USC §523(a)(16)

[2] Skytop Meadow Community Association, Inc. v. Paige, 177 A.3d 377(Pa. Cwlth. Ct. 2017)

[3] 68 Pa. C.S. §§3315; 5315

[4] In re Sligh, 542 BR 723 (Bkrtcy. E.D. Pa. 2015)

[5]  11 U.S.C. §301(a)

[6]  11 U.S.C. §§301(b), 362(a)

[7]  11 U.S.C. §§323, 701, 1302

[8]  11 U.S.C. §329

[9]  Bankruptcy Rule 1007(b)

[10] 11 U.S.C. §1322(a)(4)

[11] 11 U.S.C. §1322(a)(1)

[12] 11 U.S.C. §362(d).