By: John L. Finkelmann
Wegner and Associates, P.C.
In the current economic climate, especially in Southeast Michigan, there has been a significant increase in the filing of individual consumer bankruptcies. According to the United States Bankruptcy Court, Eastern District of Michigan, over 35,000 individual Chapter 7 and Chapter 13 bankruptcies were filed between January and August 2009 alone. These startling numbers include a substantial number of Association Co-owners and Members. The question then becomes, how does the Association deal with these bankruptcies, and what possible impact could these bankruptcies have on the Associations themselves? It would be nearly impossible to discuss all of the specifics and details that are involved in a consumer bankruptcy case, and for the most part, would be unnecessary for the Association in its day-to-day operation. Therefore, this article will provide merely a quick and very general guide on what an Association should do, or not do, upon receiving notice of a co-owner/member bankruptcy. Furthermore, it will discuss what the Association can expect to happen in most cases as a result of that bankruptcy.
The Initial Reaction: The first item for consideration is what must an Association do and not do upon notification of a co-owner/member bankruptcy filing. The United States Bankruptcy Code creates an “automatic stay” upon the filing of a bankruptcy. Amongst many other protections, this stay prevents creditors such as an association from the enforcement of judgments, the placement of a lien on property, or any act to collect from a debtor (as the filing member is now known). Once an association is aware of the bankruptcy filing, the Association, its management company and attorneys should all refrain from contacting the debtor directly. Instead, all contact should be made through the Debtor’s bankruptcy attorney if he or she has retained one. This specifically applies towards situations where a member may have a delinquent balance with the Association. Quite simply, the Association cannot contact the debtor in any manner requesting that they pay their delinquency. This shield from creditors is one of the main protections provided by the bankruptcy stay.
Furthermore, any and all actions that had been commenced against the Debtor must cease and desist immediately. If for example, the Association had filed a lawsuit seeking a judgment, that case must be closed at the relevant court. Any collection activity upon a judgment already entered against a debtor must also cease. A foreclosure sale should be canceled as well. If an Association were to continue with any of these actions despite knowledge of the pending bankruptcy case, it could run afoul with the Bankruptcy Court. The debtor may inform the bankruptcy court of the Association’s disregard of the automatic stay and file a motion seeking the sanctioning of the Association. The Bankruptcy Judges are very serious about the enforcement of the Bankruptcy Code, and have a lot of discretion when it comes to levying sanctions against violators. The levying of sanctions on an Association for attempting to collect a debt in violation of the automatic stay could be quite serious and expensive indeed.
The Assessment Stage: The next step that an Association should take is assessing the co-owner/member’s bankruptcy case itself and determining what actions are necessary on the part of the Association, if any. It is strongly recommended that the Association contact its attorneys to evaluate the debtor’s bankruptcy and advise the association. The most common Chapters of bankruptcy filed by a co-owner are Chapter 7 and Chapter 13, with Chapter 7s being much more numerous.
The basic concept behind a Chapter 7 Bankruptcy is for the debtor to obtain a discharge of his or her debts and to liquidate their assets. The Chapter 7 Trustee is a professional assigned by the Bankruptcy Court to evaluate the debtor’s assets, liquidate any that are not exempt under the Code, and administer any proceeds that are recovered. A debtor typically intends to surrender their property such as a house or condominium to their creditors in a Chapter 7 Bankruptcy case.
In most Chapter 7 cases, the Bankruptcy Trustee will not locate any assets of the Debtor that have any residual value that has not been exempted. If there are some assets that have been located, the Trustee will notify the Debtor’s creditors that they should file a Proof of Claim. If that occurs, then the Association or its attorneys should prepare a Proof of Claim which identifies the outstanding amount due as of the date the debtor filed his or her bankruptcy case. In some cases, the Association may receive a percentage of its claim from the Trustee’s administration of the Bankruptcy Estate.
Whether there are any assets to recover or not, the Debtor will either receive an Order of Discharge or will be denied a discharge. Denial of a discharge does not happen very often, but if it does, then the Debtor will remain responsible for their debts after the bankruptcy case closes. Usually however, the Debtor does receive a discharge in their Chapter 7 Bankruptcy. The effect of the discharge is that those debts not exempt from the discharge order, are no longer collectable from the Debtor. In the case of Associations, the fees and assessments outstanding and due as of the date of the Bankruptcy filing will be deemed discharged, and the Association cannot pursue the Debtor personally for those amounts.
This discharge of assessments and fees is certainly of great interest to Associations. One interesting note regarding a Bankruptcy discharge and Association fees was specifically addressed in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The Act identifies a specific exemption to the Chapter 7 Discharge involving Condominium or Homeowner’s Associations. 11 U.S.C. 523(a)(16) specifically exempts from discharge a fee or assessment that becomes due after the order for relief as long as they maintain some ownership interest in the unit. In other words, they co-owner/member will remain responsible for the fees and assessments that come due after the date they filed their bankruptcy petition.
The other typical Chapter of Bankruptcy filed by individual co-owners/members is a Chapter 13. The basic concept behind a Chapter 13 filing is to reorganize one’s debts. Debtor’s will typically submit a Chapter 13 plan of reorganization whereby they set forth how they intend to pay back some of their debt over a 3 to 5 year period. If they intend on continuing to reside and own in the unit with Association membership, any delinquency at the time of the bankruptcy filing will be considered the arrearage claim which will be paid out over a number of years. The continuing monthly or quarterly assessment levied after the bankruptcy filing should be paid on a timely basis going forward.
Again, it is recommended that the Association involve its legal counsel in order to both review the proposed bankruptcy plan and prepare a proof of claim to file on behalf of the Association. As a result of a Chapter 13 plan lasting between 3 and 5 years typically, the question often arises as to what to do when an assessment is increased or if there is an additional or special assessment that is levied. In the Eastern District of Michigan, a creditor with such a situation must file a Statement of Increase in a Periodic Payment in order to have the account paid properly during the Chapter 13 Bankruptcy. Again, the Association’s counsel should be familiar with preparing and filing such a document with the Bankruptcy Court. Should the Association fail to file this notification, then it will lose its ability to collect the difference between the increased amount and the established assessment figure.
A discharge in a Chapter 13 case in the Eastern District of Michigan also has a different effect than that of a Chapter 7 Discharge. In a Chapter 13 Bankruptcy, a discharge has the effect of discharging all of the assessments and fees that were levied up until the discharge has actually been entered. Thus, the personal liability of the Debtor for more than 3 or 5 years worth of assessments could be eliminated. If a Proof of Claim and periodic increase statements were diligently filed on behalf of the Association however, then those amounts should have already been paid and there should be little to worry about.
Options in the Aftermath: The final step for the Association in dealing with member bankruptcies is to determine what are its options after the bankruptcy case is done. If the debtor's bankruptcy case was dismissed without a discharge being entered by the Court, then any debt to the association still remains outstanding and traditional collection methods may be used. However, if there was a discharge order entered in the bankruptcy case, then the Association must be careful in how it acts moving forward.
After a Chapter 7 Bankruptcy Discharge is entered, the Association may still attempt its usual collection actions against the co-owner/member for those assessments that were levied upon his or her account after the date they had filed their bankruptcy. For example, if they had filed a Chapter 7 Bankruptcy case on February 20th, 2009, the debtor will still be responsible for the assessments from March 2009 onwards even if they obtain a discharge. The options could include filing a lawsuit against the delinquent co-owners/members for those post-bankruptcy amounts, or placing a lien on the property and possibly foreclosing.
If the Association had placed a lien on the property prior to the filing of the Chapter 7 Bankruptcy case, the Association may still foreclose based upon that lien. Although a debtor's personal liability for the pre-bankruptcy filing delinquency has been discharged, a Chapter 7 Bankruptcy discharge does not erase a lien against property. The Association must be careful however that this foreclosure action is not considered an effort to collect the discharged amounts from the debtor personally. This could be considered a violation of the Bankruptcy Court's discharge order and again subject the Association to possible sanctions. If the delinquent member wants to redeem the property from the foreclosure however, they can voluntarily do that.
One note of interest however is that it appears that there is an unresolved dispute whether an Association can recover its legal fees after a Chapter 7 Discharge in any lawsuit it files against a co-owner/member. I have not located a case on point, but there exists arguments on both sides, and this is a risk that an Association may want to consider before pursuing the recently discharged co-owner.
After a Chapter 13 bankruptcy case, all of the delinquent assessments and fees are considered to have been caught up with an Association, so the co-owner/member essentially starts over. The Association can take its usual collection actions for any delinquency that happens for future assessments.