What’s the Deal With Bankruptcy Chapters?

Chapter 13? Chapter 7? What’s the deal with bankruptcy chapters? I’m glad you asked! The Bankruptcy Code is found in Section 11 of the United States Code. Under Section 11, there are various chapters that describe different types of bankruptcies. There are various chapters that won’t really come into play (Chapter 9, Chapter 12, Chapter 15, and Chapter 11 will very rarely deal with association debt).

Chapters 13 and 7, however, regularly include association debt. What does that mean for the association? What is the difference?

First, in both bankruptcy chapters, the association debt is a secured debt because it is a debt that attaches to collateral – the home. In bankruptcy, unsecured debts such as most credit cards and medical bills for example, are discharged by the court and made unenforceable against the person who seeks bankruptcy relief. Because the association debt is secured, it is enforceable against both the home owner personally and against the home itself by way of foreclosure. Each chapter of bankruptcy deals with secured debts in a different way.

Chapter 7 bankruptcy is very cut-and-dried: all secured debts must be paid or the collateral that secures them (the home) must be surrendered to creditors. In a Chapter 7, there is no opportunity to pay the debt back over time. It is either paid in full or discharged and the home is surrendered. The home owner must file what’s called a Statement of Intention. Once a Statement of Intention has been filed indicating whether the owner will pay the association in a lump sum or surrender the home, association attorneys can rely on that statement. One very positive effect of having a Statement of Intention saying an owner will surrender the home is that an owner probably can’t file any defenses in an association foreclosure once they have declared to the bankruptcy court that they are abandoning the home. Because Chapter 7 bankruptcy only addresses debts that are owed on the date of filing, monthly assessments that come due after the case is filed are still owed to the association and cannot be discharged through Chapter 7.

Chapter 13 bankruptcy, as discussed in a previous newsletter, is a complex scheme for reducing, repaying, and/or eliminating the debt of the owner. Similar to the Statement of Intention in a Chapter 7, a Chapter 13 Bankruptcy Plan includes an outline of which debts will be fully paid, which will be reduced, and which will be eliminated. The Plan may or may not include payments of ongoing assessments which come due after filing. Also like the Statement of Intention, if the Plan indicates that the home will be surrendered, the owner has almost certainly waived the right to foreclosure defenses.

There are two other important points regarding bankruptcies. While a bankruptcy is pending, the association cannot use non-judicial means of enforcement (restricting access to the owner’s gate, restricting use of the pool, suspending voting rights, fines, etc.) are forbidden. However, at least one bankruptcy court in Florida has found that an owner who is in bankruptcy can be blocked from serving on the board. It’s important to discuss the implications of bankruptcy and what actions are appropriate for the association to take with your collection attorney and/or general counsel.