In for a Penny, In for a Pound: Condominium Liens and Anti-Modification Clause of Bankruptcy Code

[1]There are legions of cases interpreting the anti-modification clause of the Bankruptcy Code in the context of stripping off, cramming down or bifurcating residential mortgages. However, when it comes to other security interests recorded against residential properties, the law is not so clear.

In In re Rones, the U.S. District Court for the District of New Jersey analyzed the anti-modification clause in a case involving a condominium lien filed in New Jersey.[2] In reversing the bankruptcy court,[3] the district court held that a properly filed condominium lien is subject to the protections of the anti-modification clause under § 1322‌(d)‌(2) and cannot be stripped off the debtors’ home under the “one dollar” rule.[4]

New Jersey Condominium Lien

Like many states, New Jersey has adopted a set of laws to govern the formation and management of condominium associations.[5] Relevant to this article is the portion of the New Jersey Condominium Act that allows a condominium association to obtain “a lien on each unit for any unpaid assessment duly made by the association for a share of common expenses or otherwise, including any other moneys duly owed the association.”[6] The lien is not effective until it is recorded in the public records of the county in which the unit is located.[7]

However, the New Jersey legislature went further and provided additional protection to condominium associations by elevating a portion of the condominium lien to a first-priority position. Specifically, the New Jersey Condominium Act provides that

b. A lien recorded pursuant to subsection a. of this section shall have a limited priority over prior recorded mortgages and other liens, except for municipal liens or liens for federal taxes, to the extent provided in this subsection. This priority shall be limited as follows:

(1) To a lien [that] is the result of customary condominium assessments as defined herein, the amount of which shall not exceed the aggregate customary condominium assessment against the unit owner for the six-month period prior to the recording of the lien.[8]

     In Rones, the parties agreed that the condominium association properly recorded its lien against the debtors’ home and was entitled to the protections of the New Jersey Condominium Act. However, the parties could not agree on how those protections apply in the context of a chapter 13 case.

Anti-Modification Clause

Section 1322(d)(2) provides that the debtor’s plan may

modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.

If a “security interest” is partially or fully secured by a lien on the debtor’s primary residence, the lien cannot be crammed down or bifurcated under a chapter 13 plan, or stripped off unless the lien is wholly unsecured.[9] For example, if a second mortgage is wholly unsecured because the first mortgage consumes all of the home’s equity, the second mortgage can be stripped off the property and treated as an unsecured claim.[10]

However, the anti-modification clause is not limited to residential mortgages. Other liens that meet the definition of a “security interest” can also reap the benefits of the anti-modification clause. In In re Rones, the bankruptcy court held that a condominium lien under New Jersey law was a consensual lien (not a statutory or judicial lien) and therefore a security interest for purposes of § 1322‌(d)‌(2). Although neither party appealed this issue, it is worth discussing because it is crucial to the analysis of the treatment of condominium liens in general.

The Bankruptcy Code recognizes three types of liens: judicial, statutory and consensual.[11] A “judicial lien” is defined as a lien that has been “obtained by [a] judgment, levy, sequestration, or other equitable process or proceeding.”[12] A “statutory lien” is defined as a lien “arising solely by force of a statute on specified circumstances or conditions ... but does not include a security interest or judicial lien, whether or not such interest or lien is provided by or is dependent on a statute and whether or not such interest or lien is made fully effective by statute.”[13] A “consensual lien” is a lien or security interest that has been created by consent or agreement, such as a mortgage agreement.[14] Under existing case law, the three types of liens are mutually exclusive;[15] the bankruptcy court noted that courts are split on the classification of condominium liens, depending on which state law governs the case, and turned its attention to New Jersey state law.[16]

The bankruptcy court noted that a condominium lien under New Jersey law arises out of the master deed and bylaws for the association, as well as the New Jersey Condominium Act. The debtors focused on the statutory right to file the lien, arguing that the lien is a statutory lien, while the condominium association focused on the contractual right to file the lien, arguing that the lien is a consensual lien. Although the New Jersey Condominium Act does allow for the filing of a lien, the bankruptcy court ultimately found that “it is the act of purchasing the condominium unit, and voluntarily accepting and recording the unit deed, that gives rise to the lien.”[17] As a result, the lien met the definition of a “consensual lien” and was therefore a security interest for purposes of § 1322‌(d)‌(2).

In re Rones

In Rones, the Condominium Association filed a lien in the amount of $18,761.76 for unpaid assessments. Of this amount, $1,494 was entitled to the six-month priority under New Jersey law. On Dec. 30, 2014, the debtors filed for chapter 13. On their schedules, the debtors valued their home at $170,000 and represented that there was a first mortgage on the property in the amount of $288,063.37. For purposes of the appeal, these numbers were not challenged.

The debtors’ chapter 13 plan proposed to pay the first mortgage in full as is typical with most chapter 13 plans. However, with respect to the condominium association’s claim, the debtors proposed to pay the six-month priority portion in full and treat the balance of the claim as unsecured. The debtors took the position that the condominium association’s claim was wholly unsecured, but nevertheless agreed to pay the six-month priority claim. The bankruptcy court confirmed the plan, finding that:

The Act is clear that priority is granted only for an amount equal to six months’ worth of customary charges of the condominium association. It excludes the balance of the lien. It is an exception to the general rule of “first in time, first in right” whereby the oldest recorded lien maintains senior priority status. In limiting the amount a condominium association can collect, the Act addresses payment, not security.[18]

The bankruptcy court found that the New Jersey Condominium Act provides for a payment priority, not a lien priority. Since there was no lien priority under the New Jersey Condominium Act, the entire lien was wholly unsecured.[19] However, the bankruptcy court also held that the debtor could not “strip off the portion of the claim entitled to statutory priority,” despite the fact that the claim was unsecured.[20]

The district court started its analysis by confirming that “even if one dollar of a creditor’s claim is secured by a security interest in a debtor’s principal residence, then the entire claim — both secured and unsecured portions — cannot be modified under Section 1322.”[21] In for a penny, in for a pound.

The issue then turned on whether the condominium association had a partially secured claim, or a totally unsecured claim since only a wholly unsecured claim can be stripped off. The district court noted that pursuant Butner v. United States,[22] the parties must look to New Jersey substantive law to determine the lien rights of the parties.

In analyzing the New Jersey Condominium Act, the district court reviewed the basic tenets of statutory construction, noting that “when the statutory language is clear and unambiguous, there is no need to consider extrinsic aids.”[23] In finding that the bankruptcy court’s ruling conflicted with the plain reading of the statute, the district court held:

In short, the Condominium Act does not merely provide for the payment of six months of a condominium association’s unpaid assessments prior to the payment of other liens. Instead, it ensures that result by elevating the collateral position of a portion of a duly-recorded lien on those unpaid assessments over certain other senior claims, such as the Mortgage in this case. Once recorded, the Lien created by the Master Deed became a single lien with dual priority. The size of the elevated portion was measured by the assessments due for the six-month period prior to the recording of the Lien, and the remainder of the Lien remained junior to prior-recorded claims. See N.J.S.A. 46:8B-21(b). Therefore, the Bankruptcy Court’s holding that N.J.S.A. 46:8B-21 did not change the priority of a portion of the Association’s Lien was [an] error.[24]

Since a portion of the claim was secured by the debtors’ resident, the claim could not be modified.

Condominium associations in other states will need to review their respective state statutes and case law to determine whether the Rones decision is compelling authority. For example, in Florida, the bankruptcy court held that its state law did not provide a condominium association with a super-priority lien, only the right to look to a foreclosing mortgagee to be paid.[25] As a result, the condominium lien could be stripped off in a chapter 13 plan.

The U.S. Bankruptcy Court for the Eastern District of Pennsylvania reached a similar result in a matter involving the Pennsylvania Uniform Condominium Act.[26] Under Pennsylvania law, the condominium association does not obtain a six-month priority lien until there is a judicial sale. Since a chapter 13 plan does not involve a judicial sale, the condominium association only held an unsecured claim in the chapter 13 case, a claim that was stripped off by the bankruptcy court.