Bankruptcy Reforms Welcome and Well Timed for Community Associations

Published on: December 19, 2009

When Congress enacted the Bankruptcy reform law four years ago, condominium industry executives predicted accurately that it would provide essential relief for community associations.  But no one predicted just how timely and welcome that relief would be.  The reforms, in tandem with the statutory super lien, have unquestionably helped to insulate Massachusetts communities from the worst effects of what is probably the steepest economic downturn most have confronted.

The sweeping overhaul of the bankruptcy rules mandated by the Bankruptcy Abuse Prevention and Consumer Protection Act generally made it harder for consumers to erase their debts and strengthened the hand of creditors trying to collect the money owed them.  The key change for community associations was the adoption of language clarifying their right to collect fees from condominium owners after they have filed for bankruptcy protection.

A bankruptcy filing triggers an automatic stay barring further collection efforts.  Minor changes in the bankruptcy rules adopted in 1994 had specified that condominium owners would continue to be liable for post-petition association fees as long as they occupied the residence or rented it to tenants.  Some courts interpreted that language to mean that associations could not collect from owners who moved out of their units and left them vacant.  The 2005 bankruptcy reforms closed that loophole by affirming that owners would be responsible for post-petition fees as long as they owned the unit, regardless of whether they occupied or rented it.

As a practical matter, the odds of actually collecting post-petition payments from owners are pretty slim.  Most people file for bankruptcy protection because of a severe financial crisis that makes it impossible for them to meet their obligations.  The association’s right to pursue owners personally is most likely to come into play in a situation where the owner is responsible for damage to other units or common areas –for example, a leak caused by the owner’s failure to heat a vacant unit.  In this case, the association could, and probably should, try to collect directly from the owner, although there is certainly no guarantee the collection effort will be successful.   The super lien, which targets the property, not the owner, ensures that the association will be able to collect up to six months of delinquent common area payments plus penalties and attorneys’ fees when the unit is sold.

Working Well

From the perspective of community associations, the bankruptcy reforms have worked well, which is fortunate because bankruptcy filings have soared here and elsewhere as the nation’s recession has lingered and deepened.   To pursue a post-petition collection action, associations must seek judicial relief – a legal formality, but, we’ve found, not a particularly arduous one in Massachusetts, where bankruptcy judges understand both community associations and the bankruptcy reforms targeting them.  A recent change in the Massachusetts bankruptcy rules has added a step to the process, however.  Under the revised rules, at least seven days before filing a motion for relief from the automatic stay we must confer with the debtor’s counsel to see if we can negotiate an agreement to handle the post-petition payments, and we must submit an affidavit describing those efforts.  This doesn’t alter the outcome for community associations — our requests for relief from automatic stays are usually granted quickly — but it does prolong the process by at least a week.

While bankruptcy judges typically understand condominiums and the laws governing them, the same cannot always be said for opposing counsel.  Attorneys who are not familiar with the special treatment of community associations in the bankruptcy legislation will often accuse boards of illegally violating the automatic stay by demanding payment after a bankruptcy filing.  We have spent considerably more time than we anticipated explaining the interaction between the bankruptcy reforms and the condominium statute to attorneys who do not specialize in these areas.

Doing it Themselves

One development many of us did anticipate when the bankruptcy reforms were enacted is that more consumers would represent themselves in bankruptcy court – a consequence of higher legal fees resulting from changes that have increased both the complexity of the bankruptcy process and the liability risks incurred by bankruptcy attorneys.

The increase in the number of pro se bankruptcy filers hasn’t altered the outcome of the proceedings, but it has prolonged them.  Bankruptcy judges tend to be sympathetic to pro se filers ¾ within limits ¾ and will give them as much leeway as possible.  We’ve found one thing do-it-yourself petitioners have in common is, they never seem to get their mail and so don’t receive notice of hearings and filing deadlines.  We’ve responded by having the bankruptcy-related notices we issue on behalf of our association clients served by sheriffs, so there is no question about whether the notices have been delivered and received.

One somewhat quirky byproduct of the bankruptcy reforms has been an increase in the number of condominium owners surrendering their property voluntarily through a Chapter 13 debt-restructuring plan.  Debtors who opted for the Chapter 13 filing in the past usually planed to hang onto their homes.  But the bankruptcy reforms have made it more difficult for consumers to qualify for the Chapter 7 debt-elimination process.  Many of these debtors, who expect to lose their homes, are being forced to file under Chapter 13 instead.

Debtors who intend to surrender their homes will typically state that intention when they file; condominium owners who are current on their common area payments at that time will often stop making them. We have to explain to these owners that stating their intention to surrender the property does not end their ownership; those obligations continue until the owners actually transfer their deed to the lender holding the mortgage or to a buyer.

If owners are current on their association payments, many boards assume incorrectly that they do not have to respond to a bankruptcy filing.  In fact, boards should view the filing as a red flag, signaling potential problems ahead for the association.  Owners who seek bankruptcy protection are in financial trouble, to say the least; if they haven’t fallen behind in their common area payments, they clearly are at risk of doing so.  For that reason, associations should contact legal counsel immediately after receiving notice of a bankruptcy filing, even if the owner is only one month behind, or isn’t behind at all.

The new Massachusetts bankruptcy rules described earlier heighten the need for a quick response to a bankruptcy filing.  The concern is that the bank could seek judicial relief from the stay and then immediately schedule a foreclosure sale.  If the association has not prioritized its lien, it could be precluded from doing so and lose the ability to collect any of the delinquent common area payments.

Boards should also be alert to “short sale” transactions, in which owners seek to avoid foreclosure by persuading the bank to accept less than the amount owed on the mortgage in order to facilitate the sale of the property.  Lenders in these transactions will typically set a minimum amount they are willing to accept – a bottom line that often does not include unpaid association fees, which the association is asked to forego.  In most cases, there is no reason for the board to agree, because the super lien ensures their right to collect the money owed the association before the lender gets its share of the sale proceeds.

But sometimes associations may be willing to bend, as one of our clients did recently, agreeing to forego one month of dues payments and waive penalties and late fees to avoid blocking the sale.  In this case, the association was anxious to get a new owner in place and determined that the amount to be collected was close enough to the balance due to justify the compromise.

Communication Helps

Our biggest problem with short sales is that   the owners involved are so focused on the demands of their lenders they fail to notify the board until after the negations are complete – at which point, we have to point out that the agreement does not cover  the owners’ delinquent association payments.   If we get advance notice, on the other hand, we can record the association’s priority lien but delay action to enforce it.  This protects the association’s interests while allowing time to complete the short sale, and potentially saving the owner some of the legal costs of the lien enforcement action.

The communication road should run in both directions.  Associations and struggling owners both stand to benefit if boards reach out to delinquent owners before beginning the collection process, to see if a repayment plan is possible.  This option is more likely to be feasible, if at all, before owners have fallen hugely and possibly hopelessly behind.

But board members sometimes take delinquencies personally, accusing owners of “living here for free” at the expense of those who are making their payments.  In fact, most owners become delinquent not because they want to, but because they have fallen on hard times.  The board’s outreach efforts may be rebuffed, but they are almost always worthwhile.  I’ve heard many owners say after the fact, “I never heard anything from the board.  I really wish they’d contacted me before turning this over to their attorney.”  A board’s first obligation is to protect the association.  Trustees can’t solve owners’ financial problems, but they can and should treat their struggling neighbors humanely.  Owners may not be able to avoid foreclosure and bankruptcy,   but the board can help them leave with as much dignity as possible.