Berding | Weil Community Association ALERT Newsletter
Legal News and Comments for Community Association Boards and Managers Issue #38 • February 2010
Bankruptcy Won't Work
Why There's No Protection for Members When Community Associations "Go Broke"
By Tyler P. Berding, Esq. and Sandra M. Bonato, Esq.
You're at a board of directors meeting of your homeowners association. Things have been happening around the community—not good things—and you want to find out why. Why have they closed the pool? Why is the landscaping looking so bad? What's with the rumor that the property manager might be let go. You know that money has been tight for the association. You're aware that assessments haven't gone up for years, and now word has it that a large number of owners have stopped paying altogether.
At the meeting the president of the association announces further cutbacks—the association's insurance may have to be dropped. There have been no deposits to the reserve account for several years and, worse, the account has been drained over time to meet monthly obligations. The board proposes a 5% special assessment and approves it, but it's not likely to go far with all there is to do and pay. A report from the manager confirms your worst fears: re-roofing of the project (including for your unit) will have to wait, and even temporary repairs to the leaking portions of the roof may not be done for months. There's no money to pay for it.
A member raises his hand and asks the inevitable question—if the association is too broke to pay its bills, why not simply declare bankruptcy? Hold the creditors at bay until the economy picks up? No one on the board has a good answer. Why? Because it almost never happens. Here are the practical and legal reasons why.
No Big Creditors
The typical association has two principal financial obligations: its regular monthly operating expenses and contributions to its reserve fund for future maintenance and repairs. Vendors who provide regular services to a community association are typically paid monthly or are on limited annual or monthly contracts. This would include the landscaper, the pool service, management, and similar vendors. Any of these vendors can and will cancel further service if the association falls too far behind. So, unless there has been some major project, like re-construction or repair, the amount of any vendor's outstanding invoice is not likely to get too high. And it is unlikely that any association would commence a major reconstruction project without having the funding for it in place. It is even more unlikely to find a willing contractor if the association can't show that it can pay.
Ironically, it is not unusual to find that an association's largest "creditor" is itself. The failure, year after year, to make reserve transfers creates unfunded liability and makes it impossible for the association to effect repairs when the time comes. Consistent with this creditor-as-self theory, the members who haven't paid enough in assessments in the past now have only each other to look to for funds to pay to do the work now. Filing association bankruptcy wouldn't relieve the association of the duty to make (and look to the members to pay for) repairs.
Another type of creditor might be someone who sues and wins a large judgment against the association. If the various insurance policies carried by the typical association remained in force, it is likely that they would cover such a claim. However, if it did not, this could be a substantial unplanned-for expense. It is an expense, however, that would survive any bankruptcy filing because of the ability to reach the assets of individual owners, as discussed below.
Berding|Weil Q&A of the Day
By Lucas J. Olona, Esq.
I have heard that the builder of our condominium may have gone bankrupt. Is this an impediment to a construction defect lawsuit?
No. Even if the builder was still a viable company, it would look first to its own insurance to provide coverage for any claims made by a Homeowners' Association. The same is true for a company in bankruptcy. In other words, a builder's bankruptcy does not affect the liability of its insurer(s) to provide coverage for a covered claim. Even assuming a worst case scenario, that the bankrupt builder has no applicable insurance coverage, the Association's attorneys can still directly sue the other contractors and subcontractors that performed work on the project - even if their identities are not yet known at the time the Association files suit.

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