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Association Strategies When an Owner Declares Bankruptcy

By Paul W. Windust, Esq.
Published: February 2019

It goes without saying that assessment collection is the lifeblood of management and operation of a community association. A crucial step in the collection process is the recording of an assessment lien at the earliest possible opportunity. This is especially true if the owner files a petition in bankruptcy.

The most common bankruptcy filings faced by a community association are petitions filed under chapter 7 and chapter 13 of the United States Bankruptcy Code. In a chapter 7 filing, the debtor's non-exempt assets are liquidated by a bankruptcy trustee and the proceeds are distributed to creditors. The debtor's objective in chapter 7 is to obtain a discharge of all unsecured debts. A discharged debt is not enforceable or collectible.

In a chapter 13 filing, the debtor proposes a repayment plan that must be approved by the Court. In a chapter 13 plan, the debtor is required to pay some or all pre-petition debts over the life of the plan, usually five years. If the debtor complies with the plan, he will receive a discharge of pre-petition debts. Under recent case law, a debtor can also discharge post-petition assessments in chapter 13.

The bankruptcy notice will set a deadline for filing proofs of claim. No proof of claim is required in a “no-asset” chapter 7 case. However, a proof of claim is required in a chapter 13 case. There are two types of claims; unsecured claims and secured claims. If the association timely recorded an assessment lien for unpaid assessments, then it may file a secured claim which gets better treatment under chapter 13.

An automatic stay arises when bankruptcy is filed and prevents further collection action. Even though the debtor files a bankruptcy petition, the debtor must pay post-petition assessments, which are assessments that come due after the date the petition is filed. If the debtor fails to pay post-petition assessments, the association may obtain relief from the automatic stay and enforce its assessment lien. Moreover, a lien filed pre-petition remains a claim on the debtor's real property despite the bankruptcy filing. The assessment lien will survive bankruptcy unless the debtor successfully moves the court to avoid the lien.

Post-petition assessments are not dischargeable in chapter 7. Pre-petition assessment obligations not secured by an assessment lien are considered unsecured debts and dischargeable. Therefore, it is important to record an assessment lien because while a discharge will release the debtor from the personal obligation to pay pre-petition assessments, it will not release the real property from the association's claim for pre-petition assessments.

It is for this reason that many debtors will attempt to avoid the association's assessment lien. Lien avoidance can be accomplished in chapter 13, not chapter 7. Lien avoidance occurs when the debtor attempts to reduce the association's secured claim to the present value of the collateral, usually the condominium unit or residence. If the condominium unit or residence has no equity to secure the assessment lien, it can be avoided. Many times, debtors will undervalue their units or residence to accomplish lien avoidance. Therefore, the association should review the debtor's bankruptcy schedules to ensure that the unit or residence is not undervalued.

A debtor can avoid an assessment lien by filing a motion in the bankruptcy court or by the terms of the proposed chapter 13 plan. The association should review the plan to determine how the debtor intends to deal with the assessment lien. A chapter 13 plan must pay the secured portion of the association's assessment lien. A debtor may be motivated to undervalue his or her unit or residence to reduce the apparent equity in the property and cause the association's lien to impair the debtor's exemptions.

In summary, an association should record its assessment lien as soon as possible to ensure favorable treatment in bankruptcy. The association must review the proposed plan to determine if the debtor intends to avoid the association's lien. If the assessment lien remains, it will survive bankruptcy and can be enforced by foreclosure after discharge. Further, the association should ensure that the debtor continues to pay assessments post-petition and then seek relief from the automatic stay if they are not paid. By staying diligent, an association can survive bankruptcy and increase the likelihood of assessment recovery.

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