COURT HOLDS CONDOMINIUMS MAY FILE BANKRUPTCY

Published on: April 10, 2018

Recently, the Bankruptcy Appellate Panel for the First Circuit (which includes Puerto Rico) decided that a condominium association is a “person” eligible to file bankruptcy. While the court did not permit the bankruptcy to go forward due to fraud, the decision is significant for condominium associations that are saddled with debt.

The court’s reasoning follows:

“[W]e conclude the bankruptcy court committed legal error when it applied a narrow, exclusive interpretation of the term ‘person’ set forth in §101(41) in determining that the Asociación [de Titulares de Condominio Castillo] was not eligible to be a debtor under §109. However, the bankruptcy court also dismissed the petition on an alternative ground — the lack of a legitimate bankruptcy purpose for the filing. …

“Section 101(41) provides that ‘[t]he term ‘person’ includes individual, partnership, and corporation[.]’ 11 U.S.C. §101(41) (emphasis added). The bankruptcy court interpreted §101(41) to mean that only those entities specifically identified in §101(41) — individuals, partnerships, and corporations — are ‘persons’ under the Bankruptcy Code that are eligible for bankruptcy relief. And, the court concluded, because the Asociación was not an individual, partnership, or corporation, it was ineligible to be a debtor.

“The First Circuit has not expressly addressed whether a condominium association constitutes a ‘person’ under §101(41) or whether it may be a debtor under §109(a). …

“Here, although the Asociación did not fall into any of the per se definitions of a person under §101(41), this was not dispositive on the issue of its eligibility to be a debtor under the Bankruptcy Code. The court should have considered whether the legal characteristics of the Asociación were sufficiently analogous to those of a partnership or corporation as to constitute a ‘person’ under the Bankruptcy Code. …

“Based on the foregoing, we conclude the bankruptcy court committed legal error when applying a narrow, exclusive reading of §101(41), without any supporting legal authority, to determine the Asociación was not a ‘person’ and, therefore, was ineligible to be a debtor. …

“… HUD asserted that the ‘sole reason’ the Asociación formed a new homeowners’ association ‘was to purposely deprive’ the Asociación of its income from ownership dues, in order to ‘fabricate an insolvency’ so that it could file for bankruptcy and ‘attempt to free itself’ of the judgments against it. According to HUD, this scheme was ‘tantamount to fraud.’ The bankruptcy court considered the Asociación’s pre- and post-filing conduct and examined why the Asociación filed for bankruptcy protection, determining, as a ground for dismissal, that the Asociación filed the petition solely to avoid efforts by judgment creditors to execute on their judgments, rather than as a ‘tool to handle its debts’ or to obtain a discharge — i.e., for lack of a legitimate bankruptcy purpose. …

“Here, there is no hope of discharge or a fresh start, because the Asociación is not an individual and, therefore, is not eligible for a discharge. … Moreover, there is no prospect of a fair and orderly liquidation of assets for creditors. It is undisputed that there are no significant assets to marshal or liquidate, and the Asociación admits it did not file the chapter 7 in order to maximize value for creditors; rather it filed the chapter 7 petition to avoid payment to certain judgment creditors while paying all of its other creditors through a new homeowners’ association, using income from homeowners’ dues. Given the little property it has, the Asociación does not need a bankruptcy forum to liquidate and distribute its assets or wind down its affairs. ‘Without any conceivable benefit to the debtor or creditors, a bankruptcy loses its raison d’etre.’ …

“Based on the foregoing, we conclude that the bankruptcy court did not commit legal or factual error in concluding that there was no legitimate bankruptcy purpose to be served and dismissing the chapter 7 petition for cause under §707(a). …”

In Re: Asociación de Titulares de Condominio Castillo (Lawyers Weekly No. 03-001-18) (28 pages) (Harwood, J.) Appealed from the U.S. Bankruptcy Court for the District of Puerto Rico (BAP No. PR 17-009) (Feb. 8, 2018).

For any questions regarding this article, please contact Ed Allcock at eallcock@meeb.com.

For a copy of the Decision [click here].