August 14, 2009

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.