To answer that question, we first need to talk about the different types of bankruptcy that owners typically file: Chapter 7 and Chapter 13. A Chapter 7 bankruptcy generally takes about 3-6 months and is often referred to as a “liquidation bankruptcy” where an owner’s nonexempt property is sold and the proceeds are distributed to creditors. A Chapter 13 bankruptcy is a different process—this type of bankruptcy is often referred to as a “reorganization bankruptcy” and often takes about 3-5 years to complete.

It may be easiest to think of a Chapter 13 bankruptcy as a 3-5 year payment plan bankruptcy. For a Chapter 7 bankruptcy, the United States Supreme Court recently decided a case relating to a debtor’s ability to void a second mortgage’s lien on a property. Since associations often find themselves in the junior lien holder position, we wanted to provide you with an update on the Court’s decision. In Bank of America, N.A. v. Caulkett, et al, the U.S. Supreme Court held that a debtor may not void a junior mortgage lien when the debt owed on the senior mortgage lien exceeds the current value of the property (this is often referred to as a lien that is “underwater”)1. If you are interested in reading the full opinion (it’s fairly short and includes more sarcasm than typical for a U.S. Supreme Court opinion), you can read the opinion here: Bank of America, N.A., v. Caulkett, et al.

So, what does that mean for associations? The practical outcome for associations is that an owner that files a Chapter 7 bankruptcy will likely not be able to void or remove the association’s lien even if the owner’s home is underwater. This is important for associations because an owner’s bankruptcy often prevents associations from pursuing the owner for past-due assessments that were due before the filing of the bankruptcy (that’s the case when an owner receives a discharge in the bankruptcy). This U.S. Supreme Court decision means that even if the association cannot pursue an individual personally, the association will likely be able to maintain its lien on the property through the pendency of the bankruptcy (however, whether the association will be able to collect on that lien will be a topic for another weekly email). The outcome, though, may be different in a Chapter 13 bankruptcy, so if you encounter a Chapter 13 bankruptcy, keep an eye out for owners attempting to remove the association’s lien.

1 Although there are some exceptions and the junior lien does have to qualify as an “allowed secured claim”, the Court’s decision provides guidance in the situation where an association’s lien is partially or wholly underwater.