Community Associations Should Brace for a Rise in Homeowner Bankruptcy Filings in the Wake of COVID-19

Florida is home to the largest number of community associations in the United States, with approximately 50,000 homeowners and condominium associations state-wide. In 2019, 752,160 personal bankruptcy cases were filed in the U.S. Now, bracing for the unprecedented and drastic economic impact COVID-19 is serving us, it is anticipated that a significant number of owners of properties in these community associations will seek bankruptcy relief. This newly altered financial landscape will force community associations, their boards and management to be prepared to successfully navigate through this uncertain economic future and the wave of bankruptcy filings expected in the coming months. Associations should avoid the belief that bankruptcy is doomsday; to the contrary, associations have rights in bankruptcy and the ability to pursue those rights and maximize the recovery under the circumstances of a homeowner parked in bankruptcy court.

There are three different forms of bankruptcy relief a community association should expect from one of its homeowners: i) Chapter 7-the liquidation form of bankruptcy where an owner is either current (or quickly cures a pre-bankruptcy deficiency in line with an acceptable out-of-court payment agreement to the association) with their maintenance assessments and intends to retain their unit, or will surrender the unit in the event the homeowner is delinquent with their maintenance and cannot otherwise bring their account current in order to save their property from foreclosure; ii) Chapter 13—a repayment program designed for individuals to save their property from foreclosure by curing arrearages to associations and lenders over a 3-5 year period; and iii) Chapter 11-better known for corporate reorganizations, but also available to individuals with more assets and debt requiring a more sophisticated restructuring than a Chapter 13, but similarly utilized to cure arrears due an association to stave off a foreclosure. Cases filed under Chapter 7 or 13 are more common to be filed by a property owner in a community association, but certainly, a Chapter 11 case will be filed on occasion. This article will focus on Chapters 7 and 13 bankruptcies.

When a homeowner files bankruptcy, he or she must provide notice of the filing to the association and all other creditors. Presuming the homeowner lists the association as a creditor correctly, the clerk of the bankruptcy will issue a ‘Notice of Commencement’ of the bankruptcy case, which outlines the important hearing dates and deadlines related to the particular case. Due to the myriad of deadlines involved in a bankruptcy case, which deadlines impact the rights of the association, it is paramount that the association provides the notice of the bankruptcy filing to its counsel. Association counsel should file a notice of appearance in the bankruptcy case so the association is served with all filings by interested parties, some filings which may have an impact on the association or the subject real property, such as a bank seeking relief to foreclose.

Howa homeowner will seek to treat their association in bankruptcy court will depend on whether the case was filed under Chapter 7 or 13. Florida Statutes governing community associations (Chapter 718 for condominium associations, and Chapter 720 for homeowners’ associations) grant associations lien rights against the owner’s property to ensure payment of assessments. Generally, association lien rights are in second priority position against the owner’s property to the first mortgage, only. Bankruptcy does not alter the lien priority position of an association, and associations must protect and preserve their rights in a unit owner bankruptcy.

Chapter 7

A property owner in Chapter 7 must state their intention with the unit-either retain and pay all assessments connected to the property or surrender the unit and allow the association (and mortgagees) to foreclose on its in rem rights against the property. Retention of the property forces the owner to pay all assessments and remain current with the association, notwithstanding the bankruptcy filing. For the most part, retention by a homeowner does not alter “business as usual” between an owner and association. The bankruptcy code provides that post-bankruptcy maintenance assessments are non-dischargeable. Thus, an owner who retains their property must continue to pay maintenance in the normal course of business. On the other hand, ‘surrender’ does not serve to transfer title but is a signal that the owner is ‘giving up’ and will allow the association to foreclose its lien in state court. When an owner surrenders the property and obtains a discharge in Chapter 7, the discharge releases the owner from all monetary obligations due to the Association prior to the bankruptcy filing.

In Chapter 7, an association’s lien generally survives the bankruptcy-while the individual liability for pre-bankruptcy assessments is included in the Chapter 7 discharge. The association may foreclose its lien against the property once the automatic stay imposed when the bankruptcy is filed is terminated. Immediately upon the filing of a bankruptcy petition, an “automatic stay” is imposed under the bankruptcy code which enjoins all creditors from pursuing collections against the debtor and his or her assets, unless and until the stay is lifted. When the Chapter 7 case is filed, an association may file a motion for relief from the automatic stay to pursue its lien rights against the delinquent homeowner or may wait until the owner obtains a discharge at which time the automatic stay is terminated on its own. If a Chapter 7 case proceeds in a reasonable period without a hiccup, then the discharge will be entered in approximately 3.5 months after filing the case.

In sum, a homeowner in Chapter 7 has two basic options-keep their unit and pay the association in the regular course or give up the unit by way of a foreclosure. The former allows the association to receive all assessments due to the property; the latter allows an owner to be relieved from the outstanding balance on the owner’s account with the association.

Chapter 13

Chapter 13 creates more complicated scenarios for an association. The Chapter 13 process mandates the filing of a repayment plan by the homeowner which sets forth his or her treatment of the association over a 36-60 month period: i) cure the arrears in full and pay the ongoing assessments during the life of the repayment plan; ii) “strip off” the pre-bankruptcy arrears if the owner can prove to the court that the property has no equity and is worth less than the balance due to the first mortgage lender and pay only the post-bankruptcy, ongoing maintenance assessments; iii) pay the association directly outside of the bankruptcy repayment plan; or, iii) surrender the property as described above. Importantly, the association must file a proof of claim, which is a statement of the amount of indebtedness from the owner as of the bankruptcy filing date. The court sets a proof of claim filing deadline, so the association must be mindful of this deadline and confer with its counsel to prepare and file the claim on its behalf.

As a creditor, the association has the right to object to the plan and challenge the owner’s proposed treatment of its claim. For instance, the owner’s plan may not provide for the correct amount of arrears or the proper ongoing, post-bankruptcy monthly maintenance payment. In the event the association does not file a proof of claim or otherwise object to the inaccurate treatment of its claim, then the association will be bound by those incorrect figures in the event the court confirms the plan.

The most critical analysis for an association in a homeowner Chapter 13 case is when the plan calls for a “strip off” of the association’s lien of the pre-bankruptcy arrears. With a homestead property, if the owner is able to evidence to the court that the property at issue has no equity after the first mortgage balance, then the owner will be able to avoid the entire amount of the pre-bankruptcy indebtedness and remain liable for the post-bankruptcy assessments, only. Notably, the association has the right to challenge this action and the valuation of the unit and must act timely in doing so as there is a deadline imposed to respond to the lien strip action. If the property is the owner’s homestead, then all that is necessary for the association to overcome the lien strip is to show that the unit has just $1.00 of equity. If the court determines there is any amount of equity, then the owner will be forced to pay the full pre-bankruptcy arrears through the Chapter 13 plan. Should the valuation issue fall in favor of the owner and the lien strip is approved by the court, the owner must complete the Chapter 13 plan and receive a discharge for the arrears to be formally avoided. Further, and importantly, under Florida law and the decisions of our local bankruptcy judges in the Southern District of Florida, should the owner successfully achieve a lien strip against an association in a Chapter 13 case and sell his or her property following the issuance of the owner’s Chapter 13 discharge, then the buyer is liable for the arrears that were avoided in the bankruptcy case. Subsequent owners are responsible for those unpaid assessments. While this can become complicated and technical, it is essential for the association to employ its counsel to advise it of the association’s rights in this regard.

Some additional Chapter 13 points: first, often during the 3-5 year Chapter 13 repayment plan period, the monthly assessment will change. The association is required to file a notice of payment change every time the payment amount changes within 21 days of the payment change, or it will waive its right to collect the increased amount. Second, if an owner files a motion to deem the association current at the end of the repayment plan and the association does not respond, the owner’s account will be deemed current even if the post-bankruptcy maintenance payments were not made in the correct amount. Again, these are important features in a Chapter 13 case that require the association to confer with experienced bankruptcy counsel.

In closing, the most important point that can be made is that the association has rights as a creditor in bankruptcy court and should pursue those rights to maintain its best available recovery in a bankruptcy setting. The association must act prudently and timely in responding to an owner’s bankruptcy filing to preserve any rights the association may hold.