A recent New Jersey Bankruptcy Court decision issued by The Honorable Raymond T. Lyons, In re Robinson, Jr., Case No. 11-26981 (March 2, 2012) concluded that in certain circumstances, condominium liens secured under N.J.S.A. 46:8B-21(b), cannot be stripped off or crammed down through a debtor’s Chapter 13 plan of reorganization in bankruptcy.

This holding is significant to condominium associations because generally, under Bankruptcy Code 11 U.S.C. §1322(b)(2), a debtor may strip off (remove) or cramdown (reduce the amount) junior liens that are not secured by equity in the debtor’s principal residence. Under this section of the Bankruptcy Code, a debtor has the ability to remove or reduce a properly recorded junior lien from being secured by their principal residence and reclassify the lien as wholly or partially unsecured.

However, this same section of the Bankruptcy Code limits a debtor’s plan of reorganization from modifying the rights of holders of secured claims secured by the debtor’s principal residence.  11 U.C.S. §1322(b).

How do these two provisions of section 1322(b) affect condominium liens and where do such liens fall into the mix?  This recent decision makes it clear that certain condominium liens may not be stripped off or crammed down.  This means that the condominium association retains its security interest in the property (the lien rides through the bankruptcy and remains when the bankruptcy is closed and a discharged entered) unless the association’s secured claim is paid in full through the Chapter 13 Plan.

So under what circumstances are condominium association claims protected from this type of treatment by a debtor?  Under the Condominium Act N.J.S.A. 46:8B-21(b), a properly recorded assessment lien grants the association a limited six (6) month priority over recorded mortgages. Under this Act, the association has priority (is first in line) over the first mortgage holder for up to six (6) months of delinquent assessments.

If the condominium association has a lien that is properly recorded and that is secured only by the debtor’s principal residence, the Bankruptcy Court concluded that the debtor cannot strip off the association’s lien. The reason for this is that a partially secured junior lien holder, i.e., the association, retains its lien under the case law construing 11 U.C.S. §1322(b). The six-month priority granted by New Jersey statutory law provides an association a secured interest ahead of a first mortgage holder for six (6) months of assessments.  The Court reasoned that because the association’s lien was partially secured by the debtor’s principle residence, it is “impermissible” for the debtor to modify the association’s rights under the Bankruptcy Code.

Notably, this restriction of Section 1322 (b) only applies to the debtor’s “principal residence.”  If an association’s lien is secured by a debtor’s second home or by a vacation home, the debtor may have the ability to cramdown and/or strip off the lien.

This is a significant holding because in this economy many condominium unit owners are “under water”. Therefore, without the six-month first priority security interest provided by New Jersey law, a debtor would have the ability to strip off or cramdown an association’s lien under 11 U.C.S. §1322(b).

With the increase in bankruptcy filings, associations must not only be vigilant to protect their interests, but also strategic in how to protect themselves. This holding is important because it reinforces the strategy of filing and recording condominium lien claims as arrearages accrue.  A properly filed and recorded lien claim will grant an association this protection.  Whereas, an association’s failure to timely file and record a lien claim may leave it without a perfected security interest in the property. 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.