American Bankruptcy Institute Report Calls for Fixing Hardships Flowing from Nondischargeability of Condo and HOA Assessments
In some jurisdictions in the United States, joining a condominium association is easy and swift, but exiting the association may be nearly impossible.
In April 2019, the FINAL REPORT OF THE ABI COMMISSION ON CONSUMER BANKRUPTCY (FINAL REPORT) was published. A copy of the report can be downloaded at http://consumercommission.abi.org/commission-report. This lengthy report (218 pages, not including appendices) recommends certain improvements to consumer aspects of the U.S. Bankruptcy Code (11 U.S.C. §101, et seq.). It is the product of a project begun by Chicago’s now-retired Bankruptcy Judge, Eugene R. Wedoff, when he became president of the American Bankruptcy Institute in 2016. The commission recommends certain legislative changes but also suggests improvements that can be made by rules changes or through interpretive changes when possible, rather than legislative action. FINAL REPORT, p. viii.
The report begins by noting the slow progress of bankruptcy law. For example, the report’s Forward explains that the current Code was enacted more than 40 years ago and the last major amendments to the Code, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Pub.L. No. 109-8, 119 Stat. 23, were enacted 14 years ago. During this time, U.S. population grew by 46 percent, mortgage debt grew 238 percent, and consumer credit grew 256 percent. FINAL REPORT, p. vii. In inflation-adjusted dollars, the 1978 median home price was $218,000 ($58,300 in 1978 dollars); in 2018, the median home price was $325,000. Id.
What does any of this have to do with condominium law? For insolvent consumers suffering the misfortune of owning an underwater condominium (or a home in a homeowners’ association), current bankruptcy law not only provides them with limited relief but may commit them to years of inescapable debt (or perhaps precipitate a flight to a new land to assume a new identity).
Discharge and Dischargeability in Bankruptcy Law
For our purposes, we begin with a superficial introduction to applicable consumer bankruptcy law. Article 1, §8, Clause 4, of the U.S. Constitution authorizes Congress to create a uniform system of federal bankruptcy law. Consumers will almost always file for relief under either Chapter 7 or Chapter 13 of the Code.
In Chapter 7 cases, the debtor keeps exempt property, as defined under either state law or federal bankruptcy law, depending on the jurisdiction, and the rest of his or her property becomes property of the Chapter 7 bankruptcy estate, which is administered by a Chapter 7 trustee for the benefit of creditors. The debtor’s objective under Chapter 7 is a “fresh start” through the ultimate relief of discharging debts incurred through to the date of filing for bankruptcy relief. 11 U.S.C. §727.
The date a debtor voluntarily files a petition for bankruptcy relief in either Chapters 7 or 13 cases is described the “petition date” or “order for relief.” The voluntary petition itself is an order for relief.
In Chapter 13 cases, the court ultimately confirms a plan to pay a portion of the debtor’s income each month for three to five years to a Chapter 13 trustee who administers the plan for the benefit of creditors who receive a certain percentage of their claims. Upon satisfaction of the plan payments, the Chapter 13 debtor receives a discharge under §1328(a) of the Code. If the debtor suffers extraordinary circumstances during the plan, he or she may obtain a hardship discharge under §1328(b), although eligibility for a hardship discharge is a difficult standard to meet.
A basic principle to remember is that the bankruptcy discharges the debt of the individual debtor but does not discharge a lien securing the debt. For example, a debtor may obtain a discharge of home mortgage debt, but the mortgage lien still remains attached to the property. Consequently, a debtor may continue to pay a monthly mortgage debt for years after it is discharged as the debtor’s personal obligation, and the lender takes no action to foreclose the mortgage. Upon default years later, the lender may foreclose the mortgage but is enjoined by §727 of the Code from seeking a personal deficiency judgment against the debtor.
Section 523 of the Code provides many exceptions from discharge. These exceptions include, for example, almost all public and private student loan debt, certain tax obligations, loans obtained through fraud, and support obligations arising from divorce. Under some of the numerous §523 exceptions, the creditor must bring an adversary proceeding during the bankruptcy case before a bar date so that the bankruptcy court can adjudicate the dischargeability of the debt. Under other exceptions, the question of dischargeability may be determined in either federal or state court after the bankruptcy cases is closed and the dischargeability bar date has no effect.
Nondischargeability of Condominium and HOA Assessments
As every condominium association attorney well knows, the entire association suffers when a unit owner stops paying assessments. The other condominium unit owners are left to carry the burden for the nonpaying debtors. When lenders stall in taking action to foreclose units (as has often happened in the past ten years and still happens, especially with reverse mortgages or units underwater), the results against the association and the debtor’s neighbors can be devastating.
On the other hand, most bankruptcy debtors are not in bankruptcy court as a result of indifferent or reckless money management or spending. Many, if not most, debtors are in their current situation because of events beyond their control, such as job loss and unemployment, illness or death of a family member, or simple economic inabilities to meet contemporary living costs based on wages available. For some, bankruptcy is just one of the incidents of living in the “Other America.”
The report uses the phrase “HOA fees” to refer to the range of assessments and fees that may flow from ownership of a unit or home in a condominium, homeowners association, or common interest community, or stock in a cooperative. The report observes that for bankruptcy purposes, there are two views for understanding a homeowner’s obligation to pay HOA fees. FINAL REPORT, p. 18.
In the early 1990s, bankruptcy courts were reaching different results depending on whether the court saw the debtor’s obligation to pay HOA fees as prepetition contract debt that could be discharged along with other prepetition debt (which was the Seventh Circuit view) or as obligations flowing from covenants running with the land where each month’s HOA fees were a new obligation arising from the covenant. The former view led to determinations that debtors could discharge postpetition HOA fees; the latter view led to the conclusion that postpetition HOA fees are nondischargeable. FINAL REPORT, p. 18. The report cites Ariane Holtschlag, Assessing § 523(a)(16), Am.Bankr.Inst.J. 16 (June 2012), for further discussion from the split of authorities arising from these two views.
Under the Bankruptcy Reform Act of 1994, Pub.L. No. 103-394, 108 Stat. 4106, Congress adopted §523(a)(16), which left the debtor able to discharge prepetition HOA fees, as prior to the amendment, but made postpetition HOA fees nondischargeable for the period during which the debtor “physically occupied” or rented the unit. The report refers to this resolution as “a middle-ground approach.” FINAL REPORT, p. 18.
In 2005, with the adoption of BAPCPA, the requirement that the debtor continue to occupy the unit or home was eliminated under §523(a)(16). As the exception to bankruptcy discharge now reads, all debtors are liable for postpetition HOA fees regardless of whether they reside in or rent the unit or property, or even if they abandon it, as long as they have any ownership or an interest in the unit or property.
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt —
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(16) for a fee or assessment that becomes due and payable after the order for relief to a membership association with respect to the debtor’s interest in a unit that has condominium ownership, in a share of a cooperative corporation, or a lot in a homeowners association, for as long as the debtor or the trustee has a legal, equitable, or possessory ownership interest in such unit, such corporation, or such lot, but nothing in this paragraph shall except from discharge the debt of a debtor for a membership association fee or assessment for a period arising before entry of the order for relief in a pending or subsequent bankruptcy case. 11 U.S.C §523(a)(16).
While this result may have given some members of Congress warm and fuzzy feelings that they were prioritizing associations against defaulting debtors, any experienced association attorney knows the difficulty of collecting debts from people who simply do not have money or the means of obtaining money.
The Report’s Recommendations
The report identified a couple of problems arising from the statute. The first is the “zombie property,” which creates a financial hardship for a good-faith debtor trying to get fresh start and willing to abandon or turnover the unit or property to a mortgage unwilling to accept it. FINAL REPORT, p. 19. The report describes a more extreme example in which a debtor owned a condominium in Nashville that was flooded to the ceiling in 2010. The debtor filed for bankruptcy and sought to surrender the unit, but the lender refused to accept it or foreclose its lien. The debtor was left facing unending obligations for postpetition HOA fees and potential cleanup fees because the bank refused to take action. Id., citing Pigg v. BAC Home Loan Servicing, LP (In re Pigg), 453 B.R. 728, 733 – 734 (Bankr. M.D.Tenn. 2011). To avoid the injustices occasioned by §523(a)(16) and the lack of action by the lender, the Pigg court fashioned a forced sale of the unit through the bankruptcy. For an excellent comment discussing Pigg and other problems arising from §523(a)(16), see Jeffrey S. Adams, 30 Emory Bankr.Dev.J. 347 (2014).
In the report, the ABI commission recommends that a debtor be allowed to discharge postpetition HOA fees if the debtor has stated an intention to surrender the property and does not possess, occupy, rent, or otherwise use the unit or property. FINAL REPORT, pp. 19 – 20. One of the debtor’s bankruptcy schedules filed with the court must include a statement of intention as to what the debtor intends to do with secured property. The report’s recommendation is a legislative change that would essentially revert §523(a)(16) to its language prior to BAPCPA in 2005. (Over the years there have been a multitude of studies, reports, and articles all pointing to the miserable failure of Congress to achieve its stated objectives through BAPCPA. The growing phenomenon of nondischargeable student loan debt, which is also addressed in the report, is one of BAPCPA’s offspring.)
The report also recommends, in the alternative to Congressional action, that at least the courts adopt the Ninth Circuit’s position with regard to a conflict among the courts arising from a legislative hole left by the Bankruptcy Reform Act of 1994. Looking at the beginning of §523 of the Code, you may observe that the exceptions to dischargeability of the debts under §523 do not include any reference to discharges obtained by successful completion of Chapter 13 plans under §1328(a). The hardship discharge under §1328(b) is included but not the subparagraph for a discharge. This is why some bankruptcy practitioners refer to completion of a successful Chapter 13 plan as the “super-discharge.”
The Ninth Circuit has held that a discharge obtained under §1328(a) includes all postpetition HOA fees. The Ninth Circuit’s reasoning, as presented by the report, is that “[t]he section 523(a)(16) discharge exception is only meaningful if, in its absence, postpetiton HOA fees would be dischargeable. The adoption of §523(a)(16) in 1994 reflected Congress’s judgment that HOA fees are — in the absence of an exception — a dischargeable debt arising from a prepetition contract.” FINAL REPORT, p. 20. The report recommends that all bankruptcy courts follow the Ninth Circuits reading of §523(a)(16) with regard to dischargeability of HOA fees through Chapter 13 plans.
Because Congress chose to give a priority to associations over consumers through BAPCPA in 2005, it created unnecessary hardship for some bankrupt debtors. The reality is that telling a person who does not have sufficient money that he or she must continue to pay a recurring debt each month — when that person derives no benefit from the debt — is an unrealistic solution to a problem. The American Bankruptcy Institute has called for Congress to fix this problem by reverting to the statutory exception to discharge available prior to the adoption of BAPCPA. Alternatively, courts may remedy some of the hardship created here by adopting an approach taken by the Ninth Circuit.
For more information about condominium law, see CONDOMINIUM LAW (ILLINOIS) — 2016 EDITION. Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.