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Yes, bankruptcy courts can strip away your lien, but not always

BY PETER S. SACHS – THE ASSOCIATION BARRISTER

So your community association has placed a lien upon a property for unpaid assessments, initiated foreclosure proceedings, obtained a foreclosure judgment and scheduled a foreclosure sale of the property to pay the delinquent balance. Then, on the eve of the sale, the delinquent owner notifies the court that the sale must be canceled because he has just filed bankruptcy. Soon thereafter, the owner files a bankruptcy plan and an accompanying motion indicating that he wishes to keep his home while repaying none (or almost none) of the past due assessments owed to the association. Thus, the ball is then placed in your court to choose between objecting to the owner’s bankruptcy plan and motion or allowing the association’s secured interest in the home to be stripped away.

Hopefully this is not a scenario that is familiar to your association. Since the housing market downturn, communities have more frequently been faced with this bankruptcy dilemma. Fortunately, case law and the Bankruptcy Code provide guidance on what circumstances must exist for a delinquent owner to strip away an association’s lien or other secured interest. Communities are encouraged to consult with their attorneys when owners file bankruptcies so that claims can be timely filed and, when available, legal strategies to oppose the debtor can be employed.

Provisions in the Bankruptcy Code allow Chapter 11 and Chapter 13 debtors to strip away a community association’s secured interest in past due assessments if, and only if, the association’s interest is junior to a secured senior interest, like a first mortgage. Value of the home also has to be less than the indebtedness owed to the holder of the senior interest. Often obtaining an appraisal or broker’s price opinion is helpful in assessing the merits of the debtor’s valuation argument.

Case law tells us that if there is any value at all above the indebtedness owed to the senior interest holders, then an association’s secured interest may not be stripped away. Also, other circumstances include:

  • The home is owned by other persons who are not also co-debtors in the bankruptcy
  • The debtor filed bankruptcy under Chapter 7
  • The debtor’s bankruptcy plan does not include provisions to pay upcoming assessments
  • The debtor has behaved in bad faith
  • The debtor’s plan cannot be confirmed

This is by no means an exhaustive list.

If the court denies the owner’s motion, his bankruptcy plan will most likely need to be modified to either pay back the balance owed to the association or surrender the home, which will allow state court foreclosure proceedings to resume. Alternatively, if the court grants the motion to strip away the lien, the association’s claim will be reclassified as unsecured and the lien will be extinguished. It is important to note that the bankruptcy court does not protect owners from their obligations to pay assessments that come due after bankruptcy is filed. Associations are encouraged to consult with their attorneys to make sure that these “post-petition” assessments are paid.

The interests of condominium associations and homeowners’ associations are treated almost identically by the bankruptcy courts. However, clubs whose membership dues and other expenses are not secured by a lien against property are most likely unsecured creditors and are therefore not subject to having a secured interest stripped. Bankruptcy matters are not always intuitive, and associations are encouraged to ask questions and obtain legal advice.

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Peter S. Sachs is the managing director with Sachs Sax Caplan in Boca Raton, Fla.

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