The collections conundrum: Navigating and determining legal options
Were this the Victorian Era – or at least a Charles Dickens novel – the issue of collecting delinquent assessments would be simple.
In fact, there would be no issue. Either pay up, or off to debtors’ prison ye go. Though there may be room for disagreement as to whether Victorian-era fashion is ripe for a comeback, most morally-conscious individuals would agree that society has appropriately evolved past archaic practices such as criminalizing debt. And, with Queen Victoria and thousands of feudal lords having gone by the wayside, homeowners associations must work within a more modernized system to collect unpaid assessments. To many association boards, tackling the issue of unpaid assessments can seem a daunting task. However, by following a practical, systematic approach, the issue is surprisingly manageable.
This article will provide practical advice for navigating the collections conundrum, as well as an overview of the legal options available to associations.
Collecting assessments is the “neighborly” thing to do.
The question is not whether it is fair to pursue a homeowner who has failed to pay assessments, but how unfair it is to the community if the association takes no action whatsoever. Assessments are the paramount means of a community’s existence. Revenue shortfalls undermine the purpose of a community association and eradicate a board’s abilities to carry out its duties of preserving, maintaining and enhancing the community. If the association is underfunded, the remaining owners must pick up the slack by paying increased assessments, or alternatively, the association will have to pare down important maintenance and upkeep, causing property values to decline.
To this end, associations must be aware that collecting assessments is not an optional task; it is mandatory. Legally speaking, an association’s board of directors has a fiduciary duty to collect assessments from owners. This bears repeating. The board has a fiduciary duty – not a right – to collect assessments. It must be done.
Budget Appropriately.
Although the crux of this article relates to collections practices generally, the issue really begins at the budgeting stage, before the first assessment is levied. Far too many associations craft an annual financial budget based on the conjecture of 100% payment, failing to budget for any bad debt. In many communities, this is unrealistic. Bankruptcies, foreclosures and limitations within the legal system are realities that will impede or delay even the most diligent collection efforts. Accordingly, collecting 100% of the assessments owed in a given year – at least for most communities – is fools’ gold.
Boards that budget based on 100% payment often do so to appease the masses by keeping assessments low. To be sure, nobody wants to pay increased assessments. However, what these boards are really doing is underfunding the community. Creating an unrealistic budget to avoid increasing assessments is shortsighted. An association depends wholly on assessment income to provide maintenance, upkeep and other beneficial services to the community. Failing to budget for bad debt means that if even just a few homeowners fail to pay in a given year, the association must eliminate important services or deplete the community’s reserve account to pay for ordinary operating expenses. Communities should maintain a healthy reserve fund for capital spending projects and other long-term or unforeseen expenses that may arise. If the reserve account is underfunded, the association’s only means of addressing important long-term capital needs that arise is to either levy a special assessment or avoid the project altogether. Resorting to special assessments and curtailing important projects will ultimately lead to even more delinquency issues and eventually cause property values to plummet. Boards must look at the big picture.
Associations must adopt a delinquency policy.
Adopting a collections policy may not be legally required, but it is a practical necessity. The reasoning is twofold. First, having a systematic, well-defined policy in place eliminates the guesswork. Boards can use the policy as a checklist and ensure they are treating every homeowner impartially. Secondly, the policy will keep homeowners aware of the association’s expectations and demonstrate that the board is treating the issue seriously. The policy should be sent to the owners at the start of each year, if only as a reminder of the consequences owners face for failing to pay. Associations will be surprised to learn that the mere adoption of an aggressive policy will be enough to prompt some homeowners to regularly meet their obligations.
Board-adopted regulations may not contradict the provisions of a community’s covenants and by-laws. Thus, in adopting a policy, boards should first review the provisions in the covenants and by-laws relating to assessments. Do they permit late fees? Attorney’s fees? Do they require late notices, and if so, how many? What legal remedies are provided? Associations should operate within this framework when adopting a policy.
The contents of a collections policy can vary, depending on the board’s preferences and any limitations set forth in the community’s covenants. The best policies will include the following:
Assessment due dates;
The address to which payments should be sent;
The number of late notices;
The amount of late fees/interest, and when such fees will be applied to an owner’s account;
How payments will be applied to an owner’s account;
The various legal remedies to which the owners will be subject; and
When cases will be referred to the association’s attorney.
Policies should strike a balance between reasonableness and aggression. Referring owners to an association’s legal counsel 15 days after an assessment becomes due, adding excessive late fees and failing to send a single late notice is not only unfair, but it may also impair or prolong the association’s collections efforts. Nevertheless, the association must also remember that assessments are the lifeblood of the community. Thus, keeping in mind the community’s overall financial needs, the policy should be reasonably aggressive. In this regard, the higher an owner’s balance becomes, the more difficult it is to collect. As a general rule of thumb, associations should wait no longer than three to four months before taking legal action.
Can we agree to payment plans?
A common question from boards is whether they are compromising their objectivity by accepting payment plans in certain circumstances. The answer is no, provided that the board is reasonably consistent in its decisions. Boards must be realistic. The reality is that for some homeowners, payment of their assessments will come at the expense of missing a mortgage payment or losing their electrical power. Depending on what the owner is offering, it may be more practical to accept arrangements in certain circumstances, since the alternative of turning an account over to legal counsel may result in additional expense and a lengthier process. In other words, the association may actually get paid sooner. Remember that the big-picture goal is collecting assessments while minimizing the community’s expenses, not penalizing owners for failing to pay.
Boards have discretion in determining whether to accept or reject an owner’s proposal. In making the decision, boards should consider facts such as the owner’s personal situation, whether the owner has defaulted on prior agreements, the amount owed and the duration of the proposed plan. The board does not have to accept every proposal. Moreover, it is the owner’s responsibility to contact the association and request special consideration. There is nothing unequal about agreeing to payment arrangements with owners who took the initiative to contact the association, while pursuing others who did not.
In some cases, an owner will contact the association’s board of directors or community property manager after their account has been referred to the association’s attorney. They may do this for a couple of reasons. For one, they may be hopeful that the board is more sympathetic than a “bulldoggish,” Dickens-reading attorney. They may also be trying to create confusion and misinformation that will complicate, if not sabotage, the attorney’s collections efforts. If contacted, the board and property manager should courteously refer the owner to the attorney’s office. If anything, this policy will make life easier inasmuch as board members will not be expected to handle angry, sometimes harassing, telephone calls from the neighbors they just sued. Attorneys are beat on often; let them handle the angry calls.
Finally, once an account has been referred to legal counsel, boards should not accept partial payments from an owner without first contacting the attorney. Acceptance of partial payments can, in some cases, adversely affect an association’s collections efforts.
We’ve sent the owner two demand letters and have received zilch. What can we do?
Even after multiple late notices and the incurrence of late fees, some homeowners will fail to pay. Banishment of debtors’ prisons notwithstanding, associations have an array of options available.
Liens. Simply put, a lien is an interest in property that secures a financial obligation. Under Indiana law, associations have the right to record a lien against an owner’s property when one or more assessments have gone unpaid. The covenants in most communities will have language to this effect as well. For the lien to be in full effect, an instrument must be recorded in the county Recorder’s Office. Because association liens must be drafted in accordance with certain statutory requirements, it is recommended that boards seek the assistance of legal counsel in preparing the lien.
The primary benefit of a lien is that it protects the association if an owner sells his or her property. The association’s interest will appear on a title report, and the title company will ensure that the association is paid in full before closing on the property. Thus, an owner cannot avoid his or her obligation by selling the home. In cases where an owner’s property is already listed for sale, it is recommended that associations utilize the lien as their first step in collecting the debt.
Another advantage of the lien is that it provides the association with better protection if an owner files for bankruptcy. Having a recorded lien against the property will make the association a “secured creditor,” which – at least in some types of bankruptcies – will enable the association to collect the full amount owed, irrespective of the bankruptcy filing. If an association does not have a recorded lien when an owner files for bankruptcy, then the chances of collecting anything are slim to none.
There are some disadvantages to this option as well. For instance, a lien is not incredibly aggressive. Candidly, the mere recording of a lien may induce immediate payment in just a handful of circumstances. To that end, an owner may have no intention of selling his or her home, in which case years can go by before the association gets paid. Finally, the association’s lien is subordinate to a mortgage company’s lien. If a mortgage company forecloses, the association’s lien will be extinguished.
Lawsuit. Perhaps the most common and effective tool available is the collections lawsuit. The intention of a lawsuit is to obtain a personal judgment against the owner. In Indiana, lawsuits for amounts of $6,000 or less may be filed in small claims court as opposed to Superior or Circuit Court. This is advantageous since small claims proceedings are ordinarily much cheaper and take less time to resolve than Superior Court cases. If the board has been following their collections policy, or has at least been somewhat diligent in their collections efforts, an account should be referred to the association’s legal counsel long before it ever reaches $6,000.
Prior to filing a lawsuit, an association should verify that the community’s covenants provide for recovery of attorney’s fees. Most covenants have such a provision, but this needs to be verified. In addition, the association’s attorney should assist the board by reviewing the account, verifying the debt, ensuring that the owner has not filed for bankruptcy and obtaining verification that the defendant still owns the property in question.
Typically, a hearing will be set about 60 days after the case is filed. However, simply receiving a court summons will prompt many owners to pay in full or set up arrangements, and cases are often resolved before they get to court. Most of the cases that are unresolved prior to court will end up as default judgments, meaning that the owner failed to appear at the court hearing. In less frequent cases, an owner will dispute the debt, in which case the matter will proceed to trial and be decided by the judge. In the event that a trial is necessary, board members or a community’s property manager may need to appear in court and testify as witnesses for the association. Barring unique circumstances, the vast majority of assessment cases result in judgments for the association.
Foreclosures. Indiana law permits an association to foreclose on its lien for unpaid assessments. This is a more extreme, though often effective, remedy. Association foreclosures generally operate in the same fashion as mortgage foreclosures. The association must file a lawsuit in Superior or Circuit Court, requesting a judgment against the property for the amount owed. When judgment is entered, the court will award a foreclosure decree authorizing the association to have the property sold at a sheriff’s sale. Significantly, the association must proceed underneath any mortgage lien on the property. For this reason and due to a number of other possible variables, the decision whether to foreclose involves a fact-sensitive analysis that should be guided by the association’s attorney.
Typically, lien foreclosures make sense where an owner has accrued a fairly substantial balance, and other options such as obtaining a judgment in small claims court have proven ineffective. A host of factors can play into whether a foreclosure will be effective, including whether there is a mortgage on the property and whether the home has been abandoned. Foreclosures are particularly effective in cases where an owner is current on his or her mortgage and/or intends to keep the home.
We won in court! Yay! Now what?
Obtaining a personal judgment against an owner is only half – if not just a quarter – of the battle. Unfortunately, most homeowners do not voluntarily pay off judgments. As such, the association must work with their attorney to pursue collection of the judgment.
The most commonly-employed post-judgment collections tool is the garnishment. Several types of garnishments are available. The first is the wage garnishment. In Indiana, judgment holders are permitted to garnish up to 25% of a debtor’s take-home pay until the judgment is paid in full. Wage garnishments are especially effective if the owner draws a sufficient income, and in some cases, debtors will pay off their judgments or set up payment arrangements just to avoid the embarrassment of having their wages garnished. To obtain a wage garnishment, the judgment holder must be able to verify the owner’s employment information and may need more personal information such as an owner’s social security number and birth date.
Additionally, a judgment holder has the right to garnish funds in an owner’s checking and savings account, provided that the association’s attorney can verify the owner’s financial institution and account information. If this information can be verified, the judgment holder has the right to draw the money directly from the account. A garnishment can also be obtained on rental income if an owner is renting his or her home. To obtain a rental garnishment, the association must have reliable information about the owner’s tenant.
If a board has any information regarding an owner’s place of employment, bank account or tenant, they should provide this to the association’s attorney. Having this information in advance will help the attorney maximize his or her efforts to collect the judgment.
Notwithstanding the validity of a judgment, there are limitations. For example, a judgment holder may not garnish fixed income such as social security, retirement pensions and disability payments. Likewise, the first $300 in an owner’s bank account is exempt from garnishment, as is employment income below a certain threshold. If an owner is self-employed, then it will be difficult to obtain a wage garnishment. Suffice it to say that not every judgment is collectable. Some cases will invariably get to a point where it is no longer cost-effective to continue pursuing the debt. The association’s attorney should be able to advise the association when efforts have failed and a debt needs to be written off as uncollectable. In some situations, another remedy such as a lien foreclosure may make sense.
A note on bankruptcies.
A resident’s financial distress will sometimes necessitate filing for bankruptcy. When a bankruptcy is filed, an owner is entitled to certain protections under federal law, which will impede the association’s ability to collect. When notified of a bankruptcy, associations should immediately send this information to their legal counsel and take no further action. Actions taken in violation of an owner’s rights, whether intentional or not, will subject the association to significant penalties.
In contrast to what many think, all hope is not lost when an owner files for bankruptcy. The association’s rights will depend largely on which type of bankruptcy the owner files, and whether the owner is keeping the home. To this end, there are two primary types of bankruptcies that an individual owner might file: Chapter 7 and Chapter 13.
Under Chapter 7, a Trustee liquidates the owner’s property and uses the proceeds to pay the owner’s creditors according to priorities set by the Bankruptcy Code. The purpose of filing Chapter 7 is for the homeowner to obtain a discharge of his or her existing debts. In most cases, an association will need to simply write off what was owed prior to the filing of the bankruptcy. Ordinarily, the owner will also surrender his or her home in conjunction with the Chapter 7, which means that the mortgage company will be authorized to foreclose on the property.
Chapter 13 is designed for individuals with regular income who are temporarily unable to pay their debts. In a Chapter 13, the owner is required to give a large portion of his or her wages to the bankruptcy Trustee, who then distributes that money to the creditors according to the dollar amounts owed as of the date the bankruptcy was filed. A Chapter 13 generally lasts about five years. In a Chapter 13, it is necessary to file a claim with the bankruptcy court indicating how much the association is owed. The association will be treated as a secured or unsecured creditor, depending on whether there is a lien recorded against the property. If not, then the association is unsecured, in which case they will receive little to no money on their claim. Where there is a recorded lien, the association should get paid the full amount of its claim – albeit in small increments – over the next five years. Importantly, condominium associations will have an automatic lien by virtue of the Indiana Condominium Act. Thus, condominium associations will ordinarily be secured creditors, regardless of whether a lien has been recorded.
Under the Bankruptcy Code, owners must still pay all assessments that accrue after a bankruptcy is filed, until such time as they no longer own the property. Regardless, the association cannot take legal action against the owner to collect post-bankruptcy assessments until the bankruptcy has closed. In cases where an owner is in active bankruptcy and fails to pay post-bankruptcy assessments, the association must petition the bankruptcy court for the right to pursue the debt.
Collecting assessments is one of the most formidable tasks facing community associations, but it is also the most important. Assessment money is directly correlated with preservation of a community’s aesthetic and financial value. By budgeting appropriately, adopting a collections policy, and understanding and utilizing the various legal remedies available, the association can slash delinquency rates and better protect the financial well-being of the community. The job will never be as enjoyable as Oliver Twist. But, it is manageable.
