Bankruptcy Basics for Condominiums

Bankruptcy Basics for Condominiums

During the COVID-19 pandemic, both the federal government and the Commonwealth of Massachusetts imposed foreclosure and eviction moratoriums. Due to these moratoriums, consumer bankruptcy filings fell dramatically as the urgency to protect assets, especially residential property, was no longer an immediate concern. Once the moratoriums ended, there was concern that a tsunami of bankruptcy filings would overwhelm both the courts and bankruptcy counsel as it was believed that banks would immediately race to foreclose on the backlog of thousands of delinquent mortgage loans. While the tsunami did not happen, bankruptcy filings are starting to trend upwards in 2022. It is important for both condominium trustees and property managers to have a basic understanding of the effect of bankruptcy on condominium lien enforcement actions and condominium accounting.

After a debtor receives a discharge from the Bankruptcy Court, affected creditors may no longer pursue the debtor to collect debts which arose prior to the bankruptcy filing.

Chapter Basics

When an individual files bankruptcy, an automatic stay immediately goes into effect whereby all legal actions against the debtor are stopped, or “stayed” from proceeding during the course of the bankruptcy. A Chapter 7 bankruptcy involves the liquidation of the debtor’s assets in order to pay for accrued debt due and owing as of the date of the filing, and is usually filed when the debtor has a large amount of unsecured debt and is surrendering real estate. The ultimate goal of a Chapter 7 bankruptcy is to obtain a discharge, which frees the debtor from personal liability from certain debt such as credit cards, medical bills and utility bills, all of which are dischargeable under the bankruptcy. After a debtor receives a discharge from the Bankruptcy Court, affected creditors may no longer pursue the debtor to collect debts which arose prior to the bankruptcy filing.

A Chapter 13 bankruptcy is a reorganization attempt whereby a debtor with a regular monthly income intends to repay debt owed as of the date of the filing over a set period of time not to exceed sixty months (5 years). A Chapter 13 is most often filed in order to retain real estate and is commonly used by homeowners to stop a foreclosure sale. The debtor files a Chapter 13 Plan which lists the debts the debtor intends to pay through the Plan and explains how he intends to pay these debts over the life of the Plan. If a debtor files a five-year Plan, then the debtor pays 1/60th of all determined and accepted pre-petition arrearages each month to the bankruptcy trustee. The bankruptcy trustee in turn distributes the monthly pre-petition payments directly to each creditor. Condominium trust counsel should file a Proof of Claim with the Bankruptcy Court which details the amount of arrearages the debtor owes as of the date of the filing and which will need to be repaid over the course of the Plan. If a Chapter 13 Plan is successfully completed, the debtor receives a discharge from the debt he has repaid.

Effect of Bankruptcy on Condominium Common Expenses

Condominium common expenses constitute a statutory lien and by definition, are a secured debt. Secured debt generally survives a bankruptcy filing, but a debtor may be released from personal liability for a portion of the debt. The amount of debt one owes to any and all creditors on the date of the bankruptcy filing are referred to as the pre-petition arrearages. Under a Chapter 7 bankruptcy, a debtor may be discharged as to his personal liability for pre-petition common expense arrearages owing to a condominium trust. However, as a secured debt, the pre-petition arrearages constitute a lien on the unit and are not a personal liability, and therefore the condominium trust, after obtaining the consent of the Bankruptcy Court or closure of the bankruptcy case, may still commence a lien enforcement action for payment of the pre-petition arrearages. A debtor who wishes to retain possession of his condominium unit will certainly seek to make payment of the pre-petition arrearages in order to avoid a lien foreclosure sale.

Post-petition arrearages are debts that arise after the date of the bankruptcy filing. Under Section 523(a)(16) of the Bankruptcy Code, a debtor who resides in a condominium unit, or who leases a unit and receives rental income, is obligated to pay all subsequently assessed condominium common expenses as they become due and owing. Consequently, after the filing of a Chapter 7 or a Chapter 13 Bankruptcy, the debtor who wishes to retain condominium property is obligated to pay the ongoing common expenses.

Motion for Relief From Stay

The proper method for commencing legal action for failure to pay post-petition common expenses or for bankruptcy cases where the unit is being surrendered, is to file a Motion for Relief from Stay with the Bankruptcy Court. This Motion certifies to the Court that the debtor has failed to submit the post-petition common expenses as required under the Bankruptcy Code and that the condominium trust seeks relief from the bankruptcy stay in order to pursue the debtor in state court. Once a Motion for Relief is filed, a debtor will often pay the post-petition arrearages to reinstate their account and avoid additional legal action. If the debtor does not pay the outstanding post-petition arrearages, and the Court allows the Motion for Relief from Stay, then the condominium trust is free to pursue the debtor in state court by filing a lien enforcement action and obtain a judgment and order to foreclose.

Posting of Payments During a Bankruptcy

It cannot be stressed strongly enough the great care that must be taken in posting payments after a debtor has filed bankruptcy. In a Chapter 13, one must segregate out the pre-petition arrearages on a debtor unit owner’s account and treat the debtor as current as of the date of the bankruptcy filing. Any payment made by the debtor after the bankruptcy filing must not be applied to the pre-petition arrearages, but only to the post-petition arrearages as they become due and owing. For example, if a debtor owes common expenses for January through June, and files for bankruptcy protection on June 15th, the debtor would be responsible for payment of the post-petition common expenses commencing July 1st. If the debtor makes the July common expense payment, the condominium trust must apply the payment to July, not to the oldest open balance on the account, which would be January. The same would apply if a debtor is delinquent in payment of post-petition arrearages – again if the debtor files bankruptcy on June 15th, but fails to submit the first post-petition payment until September, the payment must be applied to the oldest outstanding post-petition arrearage, which would be July. Bankruptcy does not prevent a condominium trust from assessing late charges, fines or supplemental assessments that are incurred post-petition.

What I often encounter in lien enforcement actions is that once a debtor files bankruptcy the condominium trust or management company fails to flag the account as bankrupt and continues to apply any post-petition payments as they would if a bankruptcy had not been filed. Then the condominium trust reports to legal counsel that the debtor is delinquent on payments and requests legal action, or perhaps sends a late notice letter directly to the debtor regarding their outstanding balance. Upon review of the ledger, it is then discovered that the debtor has, in fact, been making post-petition payments, but that they have been misapplied. It is understood that not every computer bookkeeping program is set up to segregate out the pre- and post-petition arrearages. Sometimes this needs to be performed manually in order to maintain the books correctly. A little due diligence at the time of the bankruptcy filing will save many manpower hours later when an account needs to be reconciled and numerous payments reposted. Further, if after notice of a bankruptcy filing, a condominium trust continues to apply the post-petition payments as they had been doing prior to the bankruptcy filing it could be sanctioned by the Bankruptcy Court for violating the automatic stay in the form of fines and legal fees.

Post-filing Communications

Communication with a debtor after a bankruptcy filing must also be carefully monitored, regardless of whether such communications are written or oral. A bankruptcy filing imposes a stay whereby creditors may not continue any legal or collection action. Debtors are represented by counsel, and to avoid any potential accusations of stay violations, any communication pertaining to payments and accounting should be directed through both parties’ counsel. Monthly invoices or trust collection statements should only list the amount of the current monthly common expense fee due and owing, should not state the total arrearages due and owing, and should never contain a demand for payment. It is also improper for a condominium trust to verbally request payment from the debtor, or to announce to other unit owners that the debtor owes outstanding condominium common expenses or has filed for bankruptcy protection. While the filing of a bankruptcy is a matter of public record, such actions by a creditor may be construed by a bankruptcy judge as an attempt to coerce or intimidate the debtor into making payment. Such conduct is a violation of the bankruptcy stay and again may expose the condominium trust to fines, penalties and other sanctions from the Bankruptcy Court.

Another area where bankruptcy comes into play is when a condominium has rules and regulations for use of recreational and/or common areas, which are directly tied into a unit owner’s status as to payment of condominium fees, such as for pool use, or the use of a clubhouse, or gym and other recreational facilities. Just because a unit owner has filed for bankruptcy and has pre-petition arrearages, does not mean that the unit owner may be denied access to these facilities, especially if they are making the post-petition payments. Even if a debtor is delinquent on post-petition common expenses, a condominium trust would be well advised not to deny access or the exercise of rights unless and until relief from the Bankruptcy Court has been obtained. Otherwise, the condominium trust again risks being held liable to the debtor for violation of the bankruptcy stay and subject to charges for harassment, embarrassment and emotional distress caused by the condominium trust’s denial of the debtor’s rights as a unit owner.

Bankruptcy can be complicated with no two cases being exactly the same. This article is intended merely as an overview of the subject. The condominium trust or property manager should always immediately advise legal counsel when they learn of a unit owner filing. Further, when in doubt about how to proceed in any situation during the course of a bankruptcy, the condominium trust should first speak with legal counsel before taking any action that could later be construed as a violation of the bankruptcy stay.

Laura Brandow Condo Law Blog

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Laura Brandow