March 2010 – With nearly $1 million in debt, a $112,000 per month 99-year lease for its pool and some parking spaces, and at least 100 unit owners delinquent on association fees, the Maison Grande condo association in Miami Beach filed for bankruptcy in July 2009, according to the Daily Business Review.

The 270-unit Legacy Park subdivision homeowners association in Davenport, Fla., also filed for bankruptcy protection in June 2009, according to The association faced a bill of more than $100,000 to its cable company and $253,824.14 in unpaid assessments.

In February 2008, the View West Condo Association in Kendall, Fla., also filed for bankruptcy protection because of unit owner delinquencies and because Z Roofing filed a lien against the association for more than $100,000 in repairs.

Could your association be headed down the same path? If your association has been beaten up by the economic downturn and there seems to be little hope of ever getting back onto solid financial footing, bankruptcy is something your board can consider. Here’s what you need to know about how bankruptcy might affect your association.

Not Your Father’s Bankruptcy

Most people think of bankruptcy in the context of individuals who are in over their heads financially. Those struggling souls file for bankruptcy protection to rid themselves of the burden of their debt in exchange for turning over their home and other possessions so they can be sold to repay creditors.

But bankruptcy is also available for businesses, including nonprofits like homeowners and condo associations. Like individual debtors, when businesses file for bankruptcy, they can seek a liquidation of all their assets, which is called a Chapter 7 bankruptcy. Or they can seek legal protection that halts collection activities while they attempt to reorganize their business and create a plan for repaying creditors, which is called a Chapter 11 bankruptcy.

There are benefits to a Chapter 11 bankruptcy. For instance, if your association is bound to onerous contracts or leases that are strangling its ability to break even, you may be able to use the bankruptcy process to reject or renegotiate the terms of those agreements. Chapter 11 bankruptcy may also be helpful if your association has been slammed with a devastating legal judgment. It could allow your association to delay enforcement of the judgment while your attorneys attempt to negotiate a less damaging settlement.

However, a Chapter 11 bankruptcy can be expensive since you must pay both attorneys’ fees and court costs. You may also need to pay regular fees to a trustee, if one is appointed, while your association’s reorganization is underway.

In addition, Chapter 11 will only allow your association time to breath and try to reach new agreements. It typically doesn’t allow you to walk away from debts and judgments unscathed, and your case may even be dismissed if the bankruptcy judge determines your association has no real reorganization strategy.

The View West Condo Association learned that lesson the hard way. In June 2009, the bankruptcy court dismissed its bankruptcy petition. That left the association still in debt to Z Roofing, in addition to being liable for its own legal fees and court costs plus those of Z Roofing, which totaled $50,000. To enforce its judgment, Z Roofing began foreclosing on individual View West units in December 2009.

Before Your HOA Considers Bankruptcy

“We’ve managed associations that have considered bankruptcy, and the filings were all strictly directly related to delinquency issues,” says Bill Worrall, vice president of The Continental Group, which is based in Hollywood, Fla., and manages 1,300 condominium and homeowner associations totaling 310,000 residential units. “But we’ve yet to manage an association that did the filing. Board members become a little fearful when they learn of the risks involved. We encourage them to listen to their legal counsel’s advice rather than react to the market in an emotional way.”

If your association is in dire financial straits, Worrall recommends you think carefully about the consequences before moving forward with bankruptcy. “Associations, in partnership with management and legal counsel, need to review the ramifications specifically,” he says. “If you’re going to file for bankruptcy, how will that affect your relationship with your current suppliers, contractors, maintenance personnel—all those people you need to work with to maintain and hopefully increase your property values?”

Ask your attorney if and how much control over the association’s operations your board will lose. If you operate as a debtor in possession, your board will still oversee the association, but its actions can and might be scrutinized by a bankruptcy judge and creditors. And your association may need to submit regular reports showing its ongoing able management. If the board’s management is questioned, a bankruptcy trustee may be appointed to step in to assume the board’s duties of overseeing your association.

“You could have someone else driving the bus,” says Jenny Key, Austin, Texas-based vice president of RealManage, a San Rafael, Calif., association management firm that oversees properties in Arizona, California, Colorado, Florida, Louisiana, Nevada, and Texas. “That person might not look at maintenance and social issues in the same way your board would and may not have the owners’ best interest at heart. If the board doesn’t control decision making, that’s a scary thing.”

Options Other Than Bankruptcy

Instead of bankruptcy, a few of Worrall’s association clients have sought a blanket receivership, which allows the appointment of a receiver to operate on behalf of an entire association to collect rent from delinquent owner-investors. (See HOA Financial Matters: What’s Receivership, and When Do Condo and Homeowner Associations Need It?) “That’s successful in some counties in Florida and not in others,” says Worrall, “and it depends on the judge.”

Worrall says other clients who’ve considered bankruptcy exclusively because of owner delinquencies have listened to their attorneys’ advice to either wait patiently while lenders agree to short sales on owners’ properties or to aggressively pursue foreclosures themselves.

“Bankruptcy is a last resort,” says David Regenbaum, founder, chairman, and CEO of Association Management Inc. in Houston, which manages 239 communities with about 62,000 units. “It’s not something I’d recommend an association do because there are so many complications involved.”

HOA Leader

Matt Humphrey is president of the Alameda, California-based, from which this article was adapted.

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