With the downturn in the economy, many New Jersey residents are strapped for cash. A possible reprieve for some people is to file for bankruptcy protection. In the past, many unit owners with equity in their units would simply file for Chapter 13 bankruptcy protection. Chapter 13 protection would allow the debtor to pay their secured debt in-full and their unsecured debt pro rata through a three to five year bankruptcy plan, while keeping current their monthly obligations. For condominium, homeowners, and co-operative associations (“Associations”), a successful Chapter 13 proceeding would lead to payment in-full, overtime of their pre-petition secured condominium lien, a pro rata payment of any unsecured claim and being kept current with the Association’s monthly assessments.
Many Debtors Now Filing for Chapter 7 Bankruptcy Protection
However, now many units are “underwater” – meaning that the value of the home is less than the mortgages and liens on the property. Instead of filing for Chapter 13 protection and attempting to re-pay debts overtime, many debtors are beginning to file for a Chapter 7 bankruptcy liquidation. In some cases, Chapter 7 debtors have simply ceased paying any post-petition monthly assessments. When this happens, Associations are left asking:
- Who’s liable for the post-petition assessments?
- Will we be paid all secured pre-petition assessments?
- How does the debtor’s discharge effect the Association?
- Can we proceed with foreclosure efforts?
Following is a brief overview on the Associations’ rights and remedies when a unit owner files for Chapter 7 bankruptcy protection.
The Chapter 7 Discharge
When a debtor files for Chapter 7 bankruptcy protection, they are seeking a discharge of all pre-petition obligations. Generally, the Chapter 7 discharge releases a debtor from personal liability for pre-petition debts and prevents the creditors from pursuit of those debts against the individual debtor. For Associations, this means that it cannot pursue the individual debtor for the any of its pre-petition claims. Associations can, however, pursue claims secured by collateral, such as Association lien claims. Valid Association liens pass through bankruptcy unaffected, while unsecured pre-petition Association claims are discharged and only paid pro rata if the Trustee finds assets to sell.
Unit Is Property of the Estate at Beginning of Chapter 7 Proceeding
Like a Chapter 13 bankruptcy proceeding, all of the debtor’s property, including interest in the unit, is placed into the bankruptcy estate (the “Estate”). Bankruptcy Code Section 541 defines property (“Property”) very broadly as all legal and equitable interests of the debtor. Included as Property of the Estate is the unit. Acts against the Property of the Estate are prohibited by Section 362 of the Bankruptcy Code (the “Automatic Stay”) and sanctionable. For Associations, just like in a Chapter 13 bankruptcy proceeding, this means all actions, including collection efforts, such as filing lien claims, foreclosure, seeking judgment and/or wage executions, must cease until otherwise allowed by the court.
Chapter 7 Trustee Determines Whether to Abandon or Sell the Unit
Overseeing this Estate, in a Chapter 7 Bankruptcy, is a Chapter 7 trustee (the “Trustee”). It is the Trustee’s job to liquidate the non-exempt Property of the Estate for the benefit of creditors, including the Association. However, in this economy, many units have little or no equity because either the value of the unit fell or the debtors leveraged all the equity.
To determine if equity exists, the Trustee will perform an equity analysis of the unit. Generally, the Trustee takes the value of the unit and subtracts all mortgages, liens, exemptions and costs of sale. As a rule of thumb, if there is less than $10,000 in equity remaining after the equity analysis, then the Trustee will abandon the unit. If there is equity in the unit, the Trustee can sell it to pay secured creditors in-full and make a pro rata distribution to unsecured creditors.
More often, the Trustee will abandon the unit because little or no equity exists. When abandonment occurs, the unit is removed from the Estate and placed back in control of the debtor. Any mortgages or liens, such as an Association lien, that were valid prior to the bankruptcy filing remain intact. By abandoning the unit, the protections of the Bankruptcy Code cease and the unit may be pursued by the Association.
Mere Ownership in Unit Obligates Debtor to Pay Post-Petition Assessments
A statutory exception to discharge is the debtor’s obligations to pay post-petition assessments. So long as the debtor has a mere ownership interest in the unit, the debtor is liable for post-petition assessments. The debtor’s liability was clarified by statute in October 2005 when Congress amended Bankruptcy Code Section 523(a)(16):
(a) A discharge under section 727,…does not discharge an individual debt for any debt –
(16) 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 unit that has condominium ownership, in a share of a cooperative corporation, or in a homeowners association, for as long as the debtor or the trustee has a legal, equitable or possessory ownership interest in such unit, such corporation or lot.
(See 11 USC 523(a)(16), Emph added).
Prior to the 2005 amendments, post-petition assessments due to an association were non-dischargeable, so long as the debtor physically occupied the unit or rented the unit. See prior 11 USC § 523(a)(16), pursuant to the Bankruptcy Reform Act of 1994. See also, Matter of Mattera, 203 B.R. 565, 572 (Bankr.D.N.J. 1997) (chapter 13 debtor’s non-occupancy of an association unit permitted her to discharge post-petition obligations due to the association). The 2005 amendments eliminated these two provisions entirely and added language that mere ownership creates the non-dischargeability of the post-petition assessments.
Association’s Rights to Enforce its Obligations
Until the unit is either sold or abandoned, it remains under the protections of the Automatic Stay. Bankruptcy Courts in New Jersey will permit an Association relief from the Automatic Stay to pursue its interest in the unit, only (i.e lien claim and or foreclosure), if the debtor has not paid approximately three months of post-petition assessments.
From a strategic and cost standpoint, the Association must make the decision to either expend money and file a motion for relief from the Automatic Stay or wait for the Trustee to abandon the unit. Although the motion will provide certainty and allow the Association to pursue the unit, the costs may be prohibitive and may not be collectible within the foreclosure action. Further, Trustees rarely abandon the unit within 90 days of the filing. Often, the Trustee must confirm the reasonableness of the value of the unit through an appraisal. This could take six months or more. With all these factors, it is vital to have effective communications between the Association’s bankruptcy attorney and the Trustee. These communications can provide the Association information that needs to make the best decision to enforce its rights.
With the increase in Chapter 7 filings, Associations must not only be vigilant to protect their interests, but also strategic in how to protect themselves. Although the bankruptcy process is complex, thoughtful and sound legal advice at the beginning of a bankruptcy case can help address many thorny issues that Associations regularly face as a creditor in a bankruptcy proceeding.
For more information on an Association’s rights in bankruptcy, please contact Thomas Onder at Stark & Stark in the Creditor’ Rights Group at (609) 219-7458 or tonder@Stark-Stark.com.