In the current economic conditions that are affecting most community associations in South Florida, as well as in much of the Country, delinquent assessments have resulted in a higher volume of collection activity by associations than in more traditional times. As a consequence of these factors, associations are finding themselves involved in the bankruptcy court with greater frequency.
In more normal times, a bankruptcy proceeding might delay the collection process, but associations, as secured creditors, would typically be able to recover a significant portion of the unpaid obligations, if not the entire amount. This could occur by the delinquent owner filing in Chapter 13 of the Bankruptcy Code, which results in a repayment plan over an extended period of time, such as 60 months. Alternatively, associations could file a motion for relief from the automatic stay against state actions imposed by the Bankruptcy Code during the pendency of the bankruptcy case, which asks the bankruptcy court to allow the association to proceed with its own foreclosure in the state court.
Recently, we are observing a disturbing trend affecting the interests of associations, which is available to debtors in bankruptcy, referred to as “lien stripping”. This process will apply in a Chapter 13 case when the property is “upside down” relative to the value of the property, with what are considered senior secured claims to the association lien against the property. Typically, this refers to the first mortgage being of an amount that exceeds the fair market value of the property, leaving no equity available for a junior secured interest, such as the association. In this event, upon the request of the delinquent owner, and upon him or her providing adequate proof that there is no equity in the property to support the lien of the association, that lien is removed by the Bankruptcy court (i.e., stripped). This results in leaving the association as an unsecured creditor of the delinquent owner in the bankruptcy proceeding, which will likely lead to little if any recovery for claims that pre-date the filing of the bankruptcy. The owner is able to retain the property within the community without the obligation to pay any arrearage. The owner is only responsible for the assessments that came due after the bankruptcy was filed.
Unfortunately, under present bankruptcy laws, as interpreted by the various bankruptcy courts around the Country, there is little defense for an association against lien stripping. When this occurs, which is happening with greater frequency, the association will have to be prepared for lack of recovery options. While this situation is occurring now due to the steep decline in the property values, over time, the values should again begin to rise, with the anticipation that ultimately some equity will develop in the properties. Once that occurs, the availability of the remedy of lien stripping will be eliminated.