Like any other business, community associations are often faced with delinquent owners seeking bankruptcy protection. In fact, as of May 2018, over 9,800 bankruptcies have been filed in Virginia alone.  As such, community associations should be aware of the implications of being an unwilling bankruptcy creditor.

Types of Bankruptcies

The two most common types of bankruptcy that impact community associations are a Chapter 7 and a Chapter 13.

Chapter 7:  Liquidation

The Chapter 7 bankruptcy is commonly referred to as the liquidating bankruptcy and is what most people think of when they hear the term “bankruptcy.” The idea behind a Chapter 7 is that the court assigns a third-party (a trustee) to review the debtor’s assets and exemptions and sell any non-exempt assets to pay the debtor’s debts. Unfortunately, Most of the time, that doesn’t actually happen. Most chapter 7 cases are “no-asset” cases, meaning there are no un-exempt assets for the trustees to sell. In a rare “asset” chapter 7 cases, the trustee will notice creditors by sending a letter asking for creditors to file “proofs of claim.” A proof of claim is a standard form that a creditor fills out listing the amount and type of debt. A proof of claim must also have “proof” attached detailing the basis of the debt. The trustee then classifies the types of debt and pays those debts based on their classification or priority until the funds are depleted. The end result is a chapter 7 discharge which wipes away all qualifying unsecured debt incurred prior to the debtor filing bankruptcy.  However, there are debts that survive a chapter 7 discharge including secured debt, priority debt, and non-dischargeable debt. The easy way for community associations to prevent loss of assessments to a chapter 7 discharge is to speak with an attorney as soon as an owner is 30 days delinquent.

Chapter 13:  Wage Earner Plan

The Chapter 13 bankruptcy is sometimes referred to as a “wage earner plan.”  It gives a debtor, with a regular source of income, the opportunity to pay a portion of his or her debts and avoid the harsh reality of liquidation. A Chapter 13 bankruptcy is more complex (and more expensive) than filing a Chapter 7 bankruptcy.  It allows debtors to pay catch up on late payments on secured debt such as mortgages, assessments, and car notes. It also allows the debtor to pay a small percentage to unsecured creditors, most of the time pennies on the dollar. The benefit to the debtor is that the catch-up payments are spread over a period of 36-60 months, and, more often than not, they get to keep their property.

The Automatic Stay

The automatic stay provided by 11 U.S.C. § 362(a)(4) is arguably one of the most important provisions in the area of collections law, and one which every community association should take seriously. The automatic stay prevents any creditor from taking action to collect a debt against a debtor in bankruptcy. It applies in most bankruptcy cases and is considered sacrosanct.  Associations should be careful not attempt to collect any debt that is included in a bankruptcy without seeking legal counsel first. Collection attempts can include sending statements or perfecting a lien against property of the debtor’s estate once a bankruptcy petition has been filed. This stay provision, however, has several exceptions, and allows certain creditors to perfect their liens after a bankruptcy has been filed. Among these exceptions in Virginia, is the ability of Condominium and Homeowners Associations to file a lien after a bankruptcy has been filed for assessments incurred prior to the bankruptcy filing. In fact, perfecting a lien under Virginia’s Condominium Act or Property Owners’ Association Act does not violate the automatic stay; however,  it is important to consult with an attorney experienced in both bankruptcy and community associations law before proceeding with any collection attempts. Violating the automatic stay can have severe consequences for creditors and careful consideration should always be given to collection efforts when a bankruptcy is involved.

When Should I Call a Lawyer?

• If the debtor files a Chapter 13 or a Chapter 11 bankruptcy
• If a debtor files a Chapter 7 case and the trustee notifies you that it is an asset case
• If a debtor files a bankruptcy and the association has failed to perfect its lien before the bankruptcy was filed.
• If an owner is 30 days late on association dues
• If you have a question about when you can collect on assessments included in a bankruptcy.