The Effect of Bankruptcy on Community Association Assessments
By Lester A. Ottenheimer III, J.D. Bankruptcy filings in the United States have reached a record high. Included in those who seek protection or relief from the United States bankruptcy laws are homeowners who own condominium units. Condominium associations are composed of owners of property who share expenses for the benefit of the entire association. When a unit owner fails to pay his or her assessments, the remaining unit owners must then make up the difference.
Are assessments discharged in bankruptcy when a unit owner files a Chapter 7 bankruptcy or a Chapter 13 bankruptcy? This article will provide a guide and will explain the practical effect of bankruptcy on assessments and what homeowners associations can do to protect their community interests.
Homeowners associations are usually faced with two types of bankruptcy cases when attempting to collect assessments from their unit owners. Chapter 7 bankruptcy, which generally provides for a liquidation of all debt, requires the debtor give up all non-exempt assets to the creditors. The debtor then receives a discharge from all debts owing as of the date of the filing of the petition. A Chapter 13 bankruptcy establishes a process by which the debtor proposes a plan to pay off all or a portion of his debt over a period of years, typically three to five years. In order to file a Chapter 13, the debtor must have regular income, and upon completion of the payment plan, which is approved by the court and creditors, the debtor is discharged from all debts owing as of the date of the filing.
As a general rule, claims of homeowners associations are classified as secured claims or creditors. A secured creditor is defined as a person or entity that holds some special pecuniary interest for the payment of its debts, such as a mortgage or a lien on the debtor’s property. Typically, homeowners associations are secured creditors because they possess a lien for unpaid assessments against the debtor’s property as provided by law or have recorded a judgment lien on the property.
Being a secured creditor has more advantages than an unsecured creditor because, under the Bankruptcy Code, the discharge in bankruptcy does not automatically release the lien when the debtor is discharged from his personal liability for the debt.
Prior to 1994, the courts held that pursuant to the Bankruptcy Code, the debt for future assessments for any condominium or homeowner association member filing bankruptcy arises out of the original obligation to pay assessments and, therefore, the court had the power to discharge all future assessments, regardless of whether the unit owner continued to reside in the unit. In Re Rosteck, 899 F.2d. 694 (7th Circuit, 1990). However, the Bankruptcy Code was amended in 1994. A significant amendment was made to the Bankruptcy Code, which affected homeowners assessments in relation to their dischargeability.
Not all debts are dischargeable in bankruptcy. There are a number of exceptions to the general rule that a Chapter 7 bankruptcy discharges all of the debtor’s obligations. In 1994, Congress amended the United States Bankruptcy Code and specifically provided in Section 523(a)(16) that a discharge under Section 727 of the United States Bankruptcy Code does not discharge an individual debtor from any debt for a fee or assessment that becomes due and payable after the order for relief to a membership association with respect to the debtor’s interest in a dwelling unit that has condominium ownership or a share of a cooperative housing corporation, but only if such fee or assessment is payable for a period during which (A) the debtor physically occupied a dwelling unit in the condominium or cooperative project, or, (B) the debtor rented the dwelling unit to a tenant and received payments from the tenant for such period, but nothing in that paragraph shall except from discharge the debt of a debtor for a membership association fee or assessment for a period arising before the entry of the order for relief in a pending or subsequent bankruptcy case. Simply put, the Bankruptcy Code provides that if a unit owner is living in his condominium or if he is renting it and collecting rent, assessments arising after the filing of the bankruptcy petition are non-dischargeable. What Congress failed to provide for, however, was the non-dischargeability of pre-petition obligations, or assessments that arose and were due prior to the filing of the bankruptcy petition.
Upon the filing of a Chapter 7 or Chapter 13 bankruptcy, the United States Bankruptcy Code provides that an automatic stay is in effect which prohibits any creditor, including associations, from taking any action to collect the debt. This effectively means that the association can no longer send notices or attempt to collect any delinquent assessments. What, therefore, can the association do in order to protect its interests and ultimately collect on the obligations which are due the association, and which, as a result of nonpayment, the other unit owners in the association are forced to pay?
The association protects its claim by the filing of a Proof of Claim with the bankruptcy court. If the debtor does not remit timely, post-petition assessments while continuing to reside in the unit or while receiving rental income from the unit, the appropriate motion must be filed with the court seeking permission to attempt to collect the post-petition assessments, which pursuant to Section 523(a)(16) of the United States Bankruptcy Code are non-dischargeable. This is particularly true in a Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, care must be taken to ensure that the repayment plan includes timely payments to the association for pre-petition obligations and the debtor must remain current with his post-petition obligations. Like the Chapter 7 petition, if the post-petition assessment obligations are not paid, the association may apply to the court for appropriate relief in order to pursue the homeowner to collect post-petition assessments.
Reaffirmation agreements are other useful tools that the association can utilize in order to protect its interests and collect its obligations. A reaffirmation agreement is an agreement signed by the debtor with a creditor in which the debtor acknowledges that he wishes to continue to pay or reaffirm the obligation. If a reaffirmation agreement is signed by the debtor and is not rescinded within the requisite time period, and the debtor fails to make payments in accordance with the terms of the reaffirmation agreement, the association may commence litigation against the debtor, as if the debtor never filed a bankruptcy petition. Reaffirmation agreements are applicable only in Chapter 7 bankruptcies. The purpose of a reaffirmation agreement is for the homeowner to reaffirm the pre-petition obligation, which is other dischargeable. In the event the debtor does not wish to reaffirm the pre-petition obligation with the association, the association still has some protection in that its lien on the property in the sum of the unpaid assessments, fines, and other costs, remain with the property. When the property is sold, this obligation will be paid, or, if the association wishes to take a more aggressive position, it may foreclose its lien on the property.
When a debtor/owner seeks relief through the bankruptcy laws, by means of a Chapter 7 petition or a Chapter 13 petition under the United States Bankruptcy Code, a homeowner association has many options to protect its interests, as well as those of all of the unit owners.
However, the remedies available require the association and its counsel to act swiftly in order to protect those rights.
Lester A. Ottenheimer III is a partner with the law firm of Kovitz, Shifrin & Waitzman, located in Buffalo Grove, Illinois. He received his Undergraduate Degree from Indiana University (B.S. 1977 – School of Public and Environmental Affairs) and his Law Degree from Indiana University School of Law (J.D. 1980).
|