Bankruptcy 101 - Chapter 7 vs. Chapter 13

I recently read a magazine article about the capital crime of fraudulent bankruptcy in England. This crime was committed when a debtor intentionally concealed assets from creditors during a bankruptcy. John Senior of York, the last person known to have been executed pursuant to this law, was convicted and executed for fraudulent bankruptcy in 1813. The law was amended to eliminate the death penalty for this crime in 1820. Washington condominium and homeowners associations have been dealing with more owner bankruptcies lately, and as a result it is helpful for board members to be familiar with the two major types of bankruptcy they may encounter.

Under Chapter 7 bankruptcy, a trustee takes possession of all of the debtor's non-exempt property, liquidates it for cash, and uses the proceeds to pay creditors according to the priorities of the bankruptcy code. There are frequently not sufficient assets to satisfy obligations to creditors. The trustee then usually abandons the property to the creditors. Associations may begin an action against delinquent units at that time if they have obtained relief from the stay or the bankruptcy has been dismissed. Associations will often receive no payments from owners or trustees during Chapter 7 bankruptcies.

Under Chapter 13 bankruptcy, debtors with regular incomes repay debts over a three to five year period according to a court-approved plan. This can result in associations eventually receiving payment for all delinquent assessments. After the court approves a plan and an owner begins submitting funds, an association should receive periodic payments to be applied towards pre-petition assessments. The association should also receive payments from the debtor for post-petition assessments.

Bankruptcies may result in negative consequences for associations, but they are not complete safe havens for delinquent owners. It is true that discharges relieve owners of the personal obligation to pay delinquent pre-petition assessments. Associations can not file personal lawsuits against owners seeking garnishment of wages or funds to pay discharged pre-petition assessments. However, associations can pursue foreclosure of their liens for the entire amount they are owed if they have obtained relief from the stay or the bankruptcy has been dismissed.

Bankruptcy Basics - Filing a Proof of Claim

The rate of bankruptcy filings in Washington has accelerated recently. As noted last month in the Seattle Times, more than 7,000 people statewide declared bankruptcy in the first quarter of 2009, up 50 percent from a year ago. If a condominium or homeowners association receives a notice that one of its owners has filed for bankruptcy, taking quick action can minimize the damage that bankruptcy may inflict on the association’s budget.

A “proof of claim” is a document that creditors file in bankruptcy cases to provide notice that the debtor owes them a specified amount of money. Notices of bankruptcy filings sometimes state that there is no need for a creditor to file a proof of claim at that time. However, some bankruptcy judges have informally indicated to attorneys that practice in this area that a creditor should always file a proof of claim after receiving a notice of bankruptcy because the bankruptcy may be converted to another type that requires a proof of claim. Associations should not rely on delinquent owners to name them as creditors. If an owner does not list an association as a creditor and an association does not file a proof of claim, that association could lose the right to collect delinquent assessments once the bankruptcy has been concluded.

A proof of claim usually must be filed no later than 90 days after the date set for the meeting of the creditors. When filing a proof of claim, an association should list all delinquent assessments, late fees, interest charges, and collection-related attorney fees owed by the owner on the date the bankruptcy petition was filed. Assessments that become due after the bankruptcy petition is filed must be paid during the bankruptcy. If those post-petition assessments are not paid, an association may seek relief from the bankruptcy court, which could include payment of those amounts from the bankruptcy estate (if there are available funds) or permission to commence a collection action against the owner. In light of restrictions imposed by bankruptcy law, community associations should not attempt to collect delinquent assessments from owners that have filed for bankruptcy unless a court has authorized them to do so.

Submitting a proof of claim will often not be sufficient to protect an association’s interests after an owner has filed for bankruptcy. The association or its attorney may need to take additional actions to ensure that the association receives the funds that it is entitled to under the bankruptcy code. The proof of claim is important because it allows those steps to be taken if necessary.