Condominium Lien Cannot be Stripped Off in Chapter 13 Bankruptcy

A recent U.S. District Court of New Jersey reversed a prior ruling by a bankruptcy court judge that had permitted the stripping of an association’s lien in a Chapter 13 bankruptcy plan. The New Jersey District Court reinforced its 2016 landmark decision in Whispering Woods Condo. Ass’n v. Rones (In re Rones), 551 B.R. 162.

The impact of these District Court decisions on condominium associations, which are often left penniless by a unit owner’s bankruptcy, can only be fully appreciated by first obtaining a better understanding of the debate that led up to these decisions.

When a unit owner declares Chapter13 bankruptcy (which is a re-organization of debt as opposed to a chapter 7 liquidation of debt), his debts are classified as either “secured” or “unsecured.” Secured debt is a promise to pay that is secured by collateral such as real estate. Secured debt has priority over all other unsecured debt (debt that isn’t secured by collateral) and is required to be paid through the bankruptcy plan if the debtor elects to keep the collateral instead of returning it to the creditor (which would then make the debt unsecured). Unsecured debt is only repaid under chapter 13 if there is enough money after the secured debt has been paid.

All secured debts are subject to the bankruptcy court’s power of modification to change secured debt to unsecured debt with one exception: the anti-modification clause of the bankruptcy code. This clause prohibits the bankruptcy court from modifying debt secured by real estate that is the debtor’s principal residence, such as a purchase money mortgage or a properly recorded New Jersey condominium lien, to unsecured debt. This clause helps prevent creditors from forcing the sale of a primary residence as long as payments are made, but also makes certain the creditor’s investment  remains secured, that is, protected in the form of a physical asset to which that creditor has a paramount right in the event of non-payment through the foreclosure process.

In Rones, the Association recorded a lien against the Rones’ property for unpaid common expense assessments prior to their filing of a Chapter 13 bankruptcy petition. The Rones’ submitted a bankruptcy plan for confirmation which included a bifurcation of the association’s recorded lien against their property. The Rones agreed to include the association’s statutory six-month priority lien (N.J. Stat. Ann. § 46:8B-21(b)) in its plan as a secured debt but excluded other, remaining sums in the association’s lien because it contended that those sums were unsecured. The association rejected the plan on the basis that its lien could not be modified in the manner proposed due to the anti-modification clause of the bankruptcy code (11 U.S.C. § 1322(b) (2)).

The association argued that its entire lien should be deemed secured based on the fact that its claim for the six-month priority lien was already deemed secured, invoking the protections afforded under the anti-modification clause and preventing the remainder of its lien from being subjected to a downward modification.

The Bankruptcy Court found in favor of the Rones’, classifying the remaining sums due under the association’s lien as unsecured (after the six-months of assessments was elevated to secured status) and then stripped the now unsecured debt contained in the association’s lien. It rested its decision on its interpretation of the New Jersey Condominium Act’s priority lien provision to only provide priority to the payment of the six-month priority lien and not to provide priority to the entire lien as a security interest.

On appeal, the District Court overturned the Bankruptcy Court.  The Court reasoned that since the association’s lien was partially secured, then the “one dollar rule” required the lien to be deemed wholly secured and thus protected from modification under the anti-modification clause of the United States Bankruptcy Code. The “one dollar rule” stands for the concept that even if just one dollar of a creditor’s claim is secured by the debtor’s primary residence then the creditor’s entire claim, secured or unsecured, is prohibited from being modified under the anti-modification clause.

The District Court’s consistent rulings on this issue have kept the legal precedent established in Rones largely intact, despite a series of challenges to it by hopeful debtors seeking to avoid payment of a condominium association’s lien. As a result, Rones and its successor cases remain a powerful win for condominium associations.

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