A recent federal court decision highlights the importance of an association’s manager or board contacting the association’s attorney whenever a homeowner files for bankruptcy protection. When an individual files for chapter 13 bankruptcy protection, she is allowed to repay her debts over a period of up to five years through a court-approved payment plan, and her creditors are barred from attempting to collect on those debts unless first granted permission by the bankruptcy court. The plan is administered by the bankruptcy trustee, an official who collects money from the individual in bankruptcy (known as the “debtor”) and pays the creditors. In order to be included in the chapter 13 payment plan, a creditor, such as an association, must file a legal document with the bankruptcy court known as a “proof of claim.” The proof of claim sets forth the amount the debtor owed to the creditor as of the date she filed for bankruptcy protection (the “pre-petition debt”). Unless the debtor successfully objects to the proof of claim (i.e., convinces the court of some legal reason why the money is not owed or should not be paid through the bankruptcy), the creditor should be included in the plan and receive payments toward the pre-petition debt.

Because unpaid assessments are a lien on a homeowner’s unit in favor of the association, an assessment obligation is a “secured” debt (The lien on the unit “secures” the obligation.). The Federal Rules of Bankruptcy Procedure provide a deadline for when a proof of claim must be filed if a creditor wishes to be included in a chapter 13 plan. However, while it is well accepted that “unsecured” debts such as credit card debt will not be paid through the plan unless the creditor files a proof of claim by the deadline, there has been some confusion over whether this deadline applies to creditors, such as associations, holding secured claims.

The federal Seventh Circuit Court of Appeals, whose jurisdiction includes Illinois, settled this confusion in May 2015 with its decision in In re Pajian. For the first time, the Seventh Circuit clarified the proof of claim deadline established by the Rules of Bankruptcy Procedure applies to both unsecured and secured creditors. If a secured creditor does not file its proof of claim by the deadline, it may not be included in the chapter 13 plan and will not receive payments from the bankruptcy trustee.

The upshot of Pajian for associations is managers and board members, in order to ensure the association receives payments to which it is entitled, must notify the association’s attorney immediately upon receiving notice that a homeowner has filed for bankruptcy protection. The notice typically mailed to creditors by the bankruptcy court includes the proof of claim filing deadline. Given the ruling in Pajian, the proof of claim must be filed by this deadline in order for the association to receive payments through the plan. While a secured debt, even if not included in the plan, survives a discharge in a chapter 13 bankruptcy, collecting that debt five years down the road can be a much more cumbersome process when all that could have been required was filing a form with the bankruptcy court. Therefore, when the association’s manager or board becomes aware of a bankruptcy, notify the association’s attorney so she may, if necessary, file a proof of claim.

Collection of Pre-Bankruptcy Association Assessments . . . It Can be Done

When a homeowner in an association files for chapter 7 federal bankruptcy protection, bankruptcy law triggers certain rights and responsibilities for that homeowner and the association as they relate to that homeowner’s responsibility to stay current on his assessment account. One of the outcomes of a successful chapter 7 bankruptcy is the person who filed for bankruptcy (known as the “debtor”) receives a discharge, meaning he is no longer personally responsible for most debts he owed as of the date he originally filed for bankruptcy protection (“pre-petition debts”). Does this mean an association must write-off any assessments a homeowner owed when he filed for bankruptcy? Fortunately for associations, state and federal law allows an association a procedure to enforce the pre-petition assessment obligation following the conclusion of a chapter 7 bankruptcy.

While a homeowner who has completed a chapter 7 bankruptcy is no longer personally responsible for pre-petition assessments, the association still maintains its lien for unpaid assessments in the property because a bankruptcy discharge does not remove those lien rights. As such, even though the homeowner is no longer obligated for the assessments, the property itself still “owes” it. This idea is similar to a mortgage; if an owner does not make his mortgage payments, the bank has the option of forcing a sale of the home because the property itself owes the money in a legal sense. In Illinois, an association can enforce its lien by seeking an in rem judgment (a judgment against the property only, not against the homeowner) in a Forcible Entry and Detainer action, also known as an eviction. If the association obtains an in rem judgment for unpaid pre-petition assessments, the Illinois Forcible Entry and Detainer Act when combined with federal bankruptcy law allows the association to evict the occupants of a unit unless the entire assessment arrearage, including the pre-petition balance is paid.

Because an in rem judgment can be a powerful collection tool, an association should not immediately write-off an assessment balance when it receives a chapter 7 bankruptcy notice. That being said, the association must very carefully follow the steps to obtaining an in rem judgment for pre-petition assessments because any attempt to collect a pre-petition debt from the homeowner personally could be a violation of federal law and subject the association to severe penalties. Above all, the association should keep separate account statements for the pre-petition and post-petition (assessments that accrued after the homeowner filed for bankruptcy) balances and should send invoices for only the post-petition account to the homeowner. Therefore, if the board or property manager receives notice that a homeowner has filed for bankruptcy protection, please contact our office so we can help the association avoid violations of federal bankruptcy law while also ensuring the association can collect the maximum amount of assessments to which it is legally entitled.

An Association must be aware that once it receives notice that one of its owners has filed for bankruptcy protection, and as long as the bankruptcy case is pending, no further attempts to collect any unpaid assessments may be commenced without first obtaining the approval of the bankruptcy court. This preclusion from collection during a bankruptcy case is commonly known as the automatic stay.

There are two types of bankruptcy cases that individuals may file. The first is a Chapter 7 bankruptcy. In a Chapter 7 bankruptcy, an individual is asking the court to “liquidate” all of his or her assets and discharge any remaining financial obligations as of the date the bankruptcy case is filed. An individual who is only seeking to “reorganize” his or her debts files a Chapter 13 bankruptcy. In a Chapter 7 bankruptcy, there is not much for an association to do to protect its interests. If the court determines that an individual in Chapter 7 bankruptcy is entitled to protection from his or her creditors, a discharge order will be entered. What is the effect of the discharge order on an individual owner’s assessment account with the association? All assessments that were due and owing as of the date the owner filed for bankruptcy protection may not be personally collected from the owner. However, the owner is obligated to make all payments for assessments that become due and owing after the bankruptcy filing date. For example, if an owner files for Chapter 7 bankruptcy protection on June 10th, all amounts owed through June 10th may not be personally collected from the owner if a discharge order is ultimately entered. However, all amounts that are levied on the account commencing on June 11th and forward may be collected from the owner, even if the owner obtains a bankruptcy discharge. BUT, these amounts may only be collected from the owner after the bankruptcy case is closed, unless the association has filed a motion for relief from the automatic stay with the bankruptcy court. If a relief stay motion is filed and granted, it allows the association to continue with collection of the post-petition assessments while the bankruptcy case remains pending.

Chapter 13 bankruptcies differ in that the individual filing bankruptcy is looking to reorganize his or her debts, not be completely absolved of them. In a Chapter 13 bankruptcy, an individual will set forth a proposed plan for repayment of his or her debts. Since an association’s right to receive assessment payments are secured by a lien against each individual owner’s home/property/unit, associations can receive 100% of the amounts owed to it at the time an individual owner files for Chapter 13 bankruptcy protection. There are, however, certain steps that an association must take in order to ensure that it is paid all of these amounts. Before these steps are described, associations must understand that regardless of whether an owner files for Chapter 7 or Chapter 13 bankruptcy protection, and if the owner obtains a discharge of his or her obligations, the discharge only eliminates the owner’s personal obligation to pay the delinquent assessments. Since the obligation to pay assessments is both the personal obligation of the owner and an obligation that runs with the underlying real estate, the association still has a valid lien for the unpaid assessments that were discharged in bankruptcy. The association may still collect the assessments discharged in bankruptcy, but it will need to be careful in doing so. Any association seeking to recover pre-petition assessments should consult with its attorneys to determine the appropriate method of collection.

As for the actions to be taken by associations in an owner’s bankruptcy case, the most common first step is the filing of a proof of claim. The proof of claim sets forth the amount owed to the association as of the bankruptcy filing date in addition to establishing that the association maintains a secured interest in the owner’s real estate. After filing the proof of claim, the association must make sure that the owner’s plan for repayment of his or her debts includes the association’s claim, in the full amount, and as a secured claim. If the association’s claim is not properly accounted for in the plan, the association may not receive all payments to which it is entitled and it should therefore consider filing an objection to the plan. Once the bankruptcy court confirms the owner’s plan, the association can expect to begin receiving monthly or periodic payments from the bankruptcy trustee toward the arrearage. The payments are typically spread out over a period of three to five years.