Bankruptcy Issues: Automatic Stay

Date: January 5, 2017

By: David W. Gaffey, Esq.

A resident filing for bankruptcy can have a serious impact on the financial outlook of a community association.  The financial impact on a community association can go well beyond lost dues, however.  A fundamental purpose of the Bankruptcy Code (11 U.S.C. § 101 et seq.) is to give a person in bankruptcy (a “debtor”) a “fresh start.”  To advance this purpose, the code imposes restrictions on creditors, including community associations, once a resident files for bankruptcy.  One of these restrictions is found in Section 362 of the Bankruptcy Code, which imposes an “automatic stay” upon the filing of a bankruptcy case that prohibits certain actions against a debtor in order to give the debtor time to reorganize its financial affairs.  The scope of the automatic stay is extremely broad.  It forbids:

  1. The commencement or continuation of any lawsuit or administrative proceeding against the debtor that could have been filed prior to the bankruptcy case, or to recover a claim against the debtor that arose prior to the bankruptcy case.
  2. The enforcement against the debtor or property of the bankruptcy estate of a judgment obtained prior to the bankruptcy case.
  3. Any act to obtain possession or exercise control over property of the bankruptcy estate.
  4. Any act to create, perfect, or enforce a lien against property of the bankruptcy estate.
  5. Any act to create, perfect, or enforce against property of the debtor any lien that secures a claim that arose prior to the bankruptcy case.
  6. Any act to collect, assess, or recover a claim against the debtor that arose prior to the bankruptcy case. 

Courts interpret the scope of these prohibitions very liberally against creditors; an arguable violation often will be decided in the Debtor's favor. 

As a result, community associations must alter their collection practices with respect to debtors.  First and foremost, a community association may not file a lawsuit against a debtor to collect any amounts owed prior to the day the bankruptcy case is filed.  Second, a community association may not continue any pending lawsuit seeking payment of amounts owed prior to the bankruptcy filing.  Any pending lawsuits must either be stayed for the pendency of the bankruptcy case or dismissed.   Third, a community association may not garnish a debtor's wages or bank accounts.  Any garnishments existing as of the bankruptcy filing must be dismissed, and any amounts seized after the filing date must be returned to the Debtor.  Fourth, a community association may not revoke any privileges, such as pool or parking privileges, due to a failure to pay amounts owed prior to the bankruptcy filing.  All privileges previously suspended must immediately be restored.  One bankruptcy court in the Eastern District of Virginia has also held that an association may not suspend privileges for failure to pay post-filing amounts.  Under this court's analysis, privileges are part of the “bundle of rights” protected by the automatic stay and cannot be taken away, even for a failure to pay post-bankruptcy debts, without court approval.  Finally, a community association may not encourage its other residents to pressure a debtor into paying its pre-bankruptcy debts, such as by including a debtor on a public delinquency list.  In one notable case, a court found that a community had violated the automatic stay by encouraging its residents to shun a debtor and exclude the debtor from social activities until the debtor paid its outstanding debts. 

In a bankruptcy case under chapter 13 of the Bankruptcy Code, which deals with personal reorganizations, a community association also may not take any of the actions described above against any person that owes the debt along with the debtor, such as a spouse, guarantor, or co-obligor.  Therefore, if multiple owners own a property and are delinquent on assessments, but only one owner has filed for bankruptcy, the community association must not take any action against any of that property's owners during the pendency of the bankruptcy case. 

In chapters 7 and 11, however, there is no general prohibition against collecting pre-bankruptcy debts from any party (other than the debtor) that is also liable on the debt.  Therefore, a chapter 7 or 11 bankruptcy filing by one co-owner does not prevent a community association from attempting to collect unpaid assessments from another co-owner of the property.

Community associations must pay close attention to these rules.  A violation of the automatic stay can result in serious consequences to a community association.  Liability for violating the automatic stay exists as soon as an association learns that a debtor has filed for bankruptcy, regardless of whether the community association knows of the existence of the automatic stay or understands the implications of the bankruptcy filing.  At the very minimum, a community association that violates the automatic stay will be required to compensate the debtor for any actual damages suffered as a result of the violation.  If an association improperly suspends a debtor's parking privileges, for example, it will be required to compensate the debtor for the cost of an alternate parking garage until the suspension is lifted.  If the violation of the stay was intentional, where the community association knew or should have known of the automatic stay and acted anyway, a debtor can be awarded punitive damages as well.  Depending on the severity of the violation, this can add thousands of dollars of additional expense.  If a violation has already occurred, it should be corrected immediately to minimize the extent of any damages suffered by the Debtor.   

Given the significant consequences for violating the automatic stay, community associations should inform their counsel immediately upon becoming aware that a resident has an active bankruptcy case.  Knowledgeable bankruptcy counsel can help community associations to avoid unintentional violations, and help to resolve any existing violations, before the issue escalates to the point that an association suffers further financial harm.