Can a Condo or HOA File for Bankruptcy? A Primer.

Bankruptcy!  We all tend to view bankruptcy as the bottom of the well–the worst possible financial outcome for any business or person.  But how many of us know what bankruptcy really means, and can a condo or HOA declare itself bankrupt?

Years ago, the idea of a shared ownership community filing for bankruptcy was nearly unheard of–now, it’s become an almost regular occurrence.  As an SOC is essentially a taxing authority, so the idea that they would be unable to pay their bills wasn’t really a prominent concern.  But as the market, and the economy, has regressed, more and more communities are unable to pay their bills at a maintenance level that can be supported by owners.  An increasing percentage of condos and HOAs are finding themselves scrambling for options, with the ghost of bankruptcy looming overhead.

First, a basic question–what is bankruptcy?  Bankruptcy is a legal process whereby an individual or business files for protection from paying some or all of its debts with a federal bankruptcy court, who then determines which debts get paid, how much, and when.  Basically, it’s a surrender.  The business or individual, overloaded with debt that it cannot repay, asks the court to step in and help it pay its bills.  It’s really that simple.

There are two types of bankruptcy–liquidation and reorganization.  You’ve probably heard them referred to as Chapter 7 and Chapter 13, but there are other types as well.  A Chapter 7 bankruptcy, a liquidation, occurs when the business is really in dire straits, and the court needs to sell off some of the company assets to pay off debtors.  A Chapter 13 bankruptcy, which is one of several types of reorganizations, requires that the individual or business has at least some source of income that would allow it to pay off its debts over time.  The debtor proposes a repayment plan to the court of how it intends to pay off its debt over a period of 3 to 5 years.  Basically, it’s a court-ordered renegotiation of all of the debt held by a business.

Now of course, bankruptcy is a pretty extreme measure, and it’s not looked upon favorably by lenders.  But sometimes bankruptcy is the only option that would allow a business to survive financially under the weight of overwhelming debt.  So the question becomes, is it ever appropriate for an SOC to file for bankruptcy protection, and what happens to the association’s assets?

First, an SOC cannot file for Chapter 7, liquidation bankruptcy.  They can, however, file for a reorganization, usually using Chapter 11 (similar to Chapter 13, but it has a higher debt ceiling).  The intent of the bankruptcy is to get an automatic stay on all debts while the association formulates a reorganization plan that will allow it to recover financially.

That said, bankruptcy is not a silver bullet.  For one thing, as it involves lawyers and courts, it is expensive to the association–easily mid-5 figures for a full process.  I know that’s a bit counter-intuitive, but the purpose of a bankruptcy of this type isn’t to simply swipe a wand and say “poof, you owe no money!”  It’s a genuine business reorganization.  As part of this process, there are new debts (legal fees and court costs) that will need to be paid.

Now, filing for bankruptcy puts a hundred different eyes on the board of directors that is running the association.  The court and all creditors will be closely watching every single act and expenditure to determine whether they are reasonable and fall within the reorganization plan.  The association will need to provide regular operating reports to the court to prove that it can carry itself forward, and any evidence of improper actions would subject the association to the control of a trustee appointed by the court.

If the bankruptcy goes smoothly, the association can come out of protection in as little as a year, and be back on its way to a healthier financial future.

So if you hear that your association is considering bankruptcy, don’t panic–it doesn’t mean that the entire world has been lost.  There is a light at the end of the tunnel, but remember that tunnel can be long and expensive.  So don’t jump into such a decision lightly, but understand that it exists to help associations who really are in dire straights and have no other financial options.

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One Response to Can a Condo or HOA File for Bankruptcy? A Primer.

  1. Pingback: » What Could Happen if Your Active Adult Community Went Bankrupt? Topretirements

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