By Laurie S. Poole, Esq. & Jennifer Todd (originally published in Summer 2001)

The most commonly asked questions by association boards of directors when a homeowner files bankruptcy are (1) what is the difference between Chapter 7 and Chapter 13 bankruptcy cases and (2) how is our association affected. The differences between the two filings are generally easy to describe. While we would love for there not to be an effect to the Association when a homeowner files bankruptcy, this is not the case.

When a homeowner files Chapter 7 bankruptcy, the intent of the bankruptcy is to wipe out all debts owing prior to the filing date of the bankruptcy. In theory, this gives the owner a “fresh start” with a debt free life. The Chapter 7 trustee, assigned by the court, will sell the owner’s assets in order to pay the creditors. However, in the majority of Chapter 7 cases, there are not sufficient assets to sell and the creditors often do not get paid. When the bankruptcy has been finalized the court will then discharge the debtor from all debts owing prior to the date of the bankruptcy filing (known as “pre-petition” debts). Thus, upon discharge of a Chapter 7 case, the owner is no longer personally liable to the association for pre-petition unpaid assessments or judgments and the association may have to “write off” that debt.

Associations may ask, what recourse do we have upon the discharge of a Chapter 7 bankruptcy case? If, prior to the owner filing bankruptcy, the association had recorded a lien against the owner’s real estate, then the association is a secured creditor and may still be able to foreclose on the real property after discharge of a Chapter 7 case. Additionally, while the owner is no longer personally liable for “pre-petition” delinquent assessments, bankruptcy law currently provides that if the owner either lives in the unit, or receives rental income from the unit after the bankruptcy is filed, that owner is still responsible for paying all assessments that accrued after the date the bankruptcy case was filed (known as “post-petition” debts). There is current legislation which may change this exception so that the Association will be able to collect post-petition debts on the sole basis of ownership, as opposed to relying on rental income or residency.

The filing of a Chapter 7 bankruptcy remains on an owner’s credit report for a period of approximately seven years. Additionally, upon discharge of the owner’s debts under the Chapter 7 case, the debtor is legally precluded from filing another Chapter 7 bankruptcy case for seven years. However, debtors are entitled to file a Chapter 13 case within that seven year time period.

Unlike Chapter 7, when a homeowner files Chapter 13 bankruptcy, the intent is to pay all or part of the pre-petition debts over a period of time. The homeowner submits a “plan” to the bankruptcy trustee outlining the amount that they wish to pay each month. The trustee then distributes a portion of the monthly payment to each one of the debtor’s creditors. Usually, secured creditors are paid first. If the Association has a lien recorded against the property, the Association then has a secured interest in the bankruptcy and is more likely to be paid. At the end of the plan, if there is any money remaining, the unsecured creditors will then be paid. The court follows the same discharge and dismiss rules as in the Chapter 7 bankruptcy.

In a Chapter 13 bankruptcy, associations have more of a chance of being paid pre-petition amounts owing. The presence of a lien on the property increases this chance. It is important,therefore, for associations to follow assessment collection policies without fail.

Whether a homeowner files Chapter 7 bankruptcy or Chapter 13 bankruptcy, associations may not pursue collection of the pre and/or post-petition assessments until the bankruptcy is discharged or dismissed. This is called the “automatic stay” rule. Basically, once the bankruptcy is filed, all creditors are automatically “stayed” (stopped) from pursuing collection. The only way to collect against a home over which the association has a lien during the course of the bankruptcy is to request permission from the Court to set aside the automatic stay and allow the association to pursue the debt through foreclosure.

Bankruptcy has its positives and negatives. While it allows an individual to have a “fresh start,” often associations pay the price by writing off bad debt. Obviously there is no way to prevent an owner from filing for protection under the bankruptcy laws. By actively pursuing collection of unpaid assessments and judiciously following your association’s collection policy, however, you can lessen the risk of losing money in bankruptcy and lessen the amount of money the association may be forced to write off. Bankruptcy does consist of complex laws. Associations should always consult with legal counsel regarding pursuing delinquent assessments from owners who have filed bankruptcy.