Trevor G. Pinkerton, Escaping the Death Spiral of Dues and Debt: Bankruptcy and Condominium Association Debtors

• Publication year: 2011

ESCAPING THE DEATH SPIRAL OF DUES AND DEBT: BANKRUPTCY AND CONDOMINIUM ASSOCIATION DEBTORS

INTRODUCTION

In the current financial crisis, condominium associations face rising numbers of delinquent member dues, increased assessments, soaring foreclosure rates, and crushing association debt. This parade of horribles creates a circular "death spiral" of dues and debt, where high delinquency in dues payment leads to increased assessments, which produces even more delinquencies. Filing for bankruptcy, particularly under chapter 11, could present collapsing condominium associations with a means to weather the economic storm.

Condominiums and condominium associations are integral pieces of the American residential landscape. Each new condominium is accompanied by a condominium association, and every condominium association holds significant power over its individual unit owners.¹The condominium association provides the members with a forum for condominium governance. Through this forum, unit owners can reap the benefits of collective action, such as maintenance of common areas and improvement of the condominium facilities. In order to preserve these benefits, the condominium association can exercise various powers to ensure member compliance. These powers include collecting dues, levying assessments for special purposes, and foreclosing on unit owners who do not comply.

Despite the condominium association's collective action benefits and corresponding enforcement powers, the current mortgage, financial, and credit crises place condominium associations in a precarious position. Falling housing prices, slowdowns in nearly every sector of the economy, and sweeping job losses all increase the likelihood that condominium association dues will go unpaid. When this happens, the association loses its only real source of income.²It is then forced to cover the losses through increased assessments and the foreclosure of non-paying units. Both the heightened assessments and foreclosures are likely to further lower already depressed condominium prices and scare off the few potential buyers in the market. New homeowners do not want to enter a condominium regime where heavy assessments and foreclosures are commonplace.³As dues dwindle, assessments increase, and debts pile up, associations could begin looking to the last refuge of the sinking debtor, bankruptcy.⁴While bankruptcy liquidation under chapter 7 is not the answer, chapter 11 reorganization allows the association a temporary reprieve from creditors. Chapter 7 is not ideal because condominium associations and their members cannot escape liability without suffering serious consequences, such as the potential loss of units through increased assessments.⁵On the other hand, chapter 11 reorganization, with the aid of the automatic stay, allows the association to keep its creditors at bay, free from the threat of conversion into chapter 7.⁶Chapter 11 also gives the association time to try to confirm a reorganization plan or rework their finances to free themselves from debt.

Chapter 7 is a dangerous option for condominium associations because it wrests control of the association away from the members.⁷It also allows the trustee to levy large assessments against the unit owners, which likely will increases foreclosures,⁸and could force the association to confront the uncertainty of dissolving the association and holding the common elements as tenants in common. Chapter 11 reorganization is the better bankruptcy option

Id. for condominium associations facing crushing debt and dwindling revenue from dues and assessments. It permits the condominium association to take advantage of bankruptcy's automatic stay; it likely allows the association's members to stay in control of the debtor condominium association during bankruptcy as debtor-in-possession ("DIP"); it gives the DIP the ability to reject or assume executory contracts; and most importantly, it protects the association from having the case converted to a chapter 7 liquidation by parties in interest or by the court because courts will likely find that the association is not a "moneyed, business, or commercial corporation."⁹

This Comment will examine the possible intersections between bankruptcy law and condominium law where a condominium association is a bankruptcy debtor. First, it will demonstrate how the current mortgage/credit crisis has placed condominium associations under severe financial strain. Second, the Comment will show how a condominium association, as distinct from the individual unit owners, could find itself in bankruptcy. Third, the Comment will examine how the bankruptcy of a condominium association might play out in a chapter 7 liquidation or a chapter 11 reorganization. Finally, this Comment will suggest that a chapter 11 bankruptcy proceeding could provide a condominium association debtor with better survival options than a chapter 7 proceeding.

I. SHORT SUMMARY OF CONDOMINIUM ASSOCIATIONS

Before examining the issues attendant to a condominium association in bankruptcy, it is necessary to outline briefly the basic elements of the condominium. First, this section will explain the legal structures that underlie condominiums, including: the creation of condominiums, their governing documents, and their ownership structures. Second, this section will examine the association powers most applicable to bankruptcy and debt collection, including assessment and foreclosure. Finally, this section will address termination of the condominium.

A. Background Legal Structures, Governing Documents, and Ownership

Structures

Condominium law is an amalgamation of several different legal structures that include: servitudes, tenancy in common, corporate business law, and non- profit corporations.¹⁰However, condominium law employs three primary relationships between background legal structures and governing documents. First, the individual unit ownership and creation of the condominium legal structure rests on the legal doctrine of tenancy in common and the relevant state's condominium act. Second, the condominium is created through recordation of the condominium declaration, which relies on the legal doctrines of covenants, conditions, and restrictions ("CC&Rs"). Third, the condominium association is the entity through which joint action between unit owners is achieved, and it is mainly founded on corporate law.

State statutes and the condominium documents, namely the declaration, articles of incorporation, and association bylaws, govern the creation and operation of the condominium.¹¹Generally, condominiums are completely creatures of statute.¹²In addition to underlying common law ideas of tenancy in common and servitudes, unit owners' interests are founded on the relevant state's condominium act.¹³The validity of a condominium in each state is dependent upon recording the various documents in conformity with that jurisdiction's condominium statute.¹⁴Each state has its own version of a condominium statute,¹⁵with special requirements for compliance.¹⁶

In the condominium, the individual owners each own their unit and a share of the common areas as tenants in common.¹⁷This combines the "advantages of property ownership with the savings available from spreading the costs of common facilities and services across the community."¹⁸Condominiums are a tool designed to satisfy a specific need; they provide people with the ability to own an apartment without owning the entire building. Condominiums offer permanence and the ability to grow equity in a piece of property.¹⁹They accomplish this through the ownership of individual units combined with fractional ownership of common areas.²⁰The obligation of common area maintenance is established and protected by covenants requiring mutual financial support found in the condominium declaration.²¹

The condominium is created through the recordation of the condominium declaration and its CC&Rs in accordance with the jurisdiction's condominium act.²²Generally, the condominium declaration must allocate to each unit a fraction or percentage of the undivided interest in the common elements.²³

Condominium declarations, put in place by the developer, use easements and covenants to "create burdens and benefits that run with the land for an indefinite and potentially unlimited period of time, giving permanence to the arrangements."²⁴These servitudes, which are enforceable between present and future owners, allow the condominium to survive because they provide the obligations compelling joint action between units.²⁵Also, in furtherance of the goals of permanence and collective action, statutes generally do not permit partitioning of the common areas or separation of the condominium units from their share of the common elements.²⁶

The condominium declaration and its CC&Rs are closely related to the condominium association because the association is the vehicle through which the CC&Rs are enforced. The association is generally contemplated by the condominium's governing documents and thus, is present from the inception of the condominium regime.²⁷In most jurisdictions, the condominium association itself is incorporated under state law either as a for-profit or a not- for-profit entity.²⁸The condominium association is controlled by a board of directors or other governing body who have broad authority to manage the association in accordance with the bylaws.²⁹The condominium association is a legal entity separate from the member unit owners, "just as a corporation is distinct from its shareholders."³⁰

Although the condominium association is a separate legal entity from the owners, the exact nature of the condominium association's assets presents interesting problems. Generally, the common areas are held by the unit owners as tenants in common, rather than by the association.³¹As the court in White v.

Cox stated, "[i]n a formal sense, therefore, the condominium owners are tenants in common of the common areas...