Community Associations Should Consider  Splitting of Ledgers When an Owner Files Bankruptcy

Community Associations Should Consider Splitting of Ledgers When an Owner Files Bankruptcy

Many homeowners associations and condominium associations struggle with the manner in which a bankruptcy filing by one of its owners should impact the ledger that is maintained by the association for the property owned by the owner that files the bankruptcy case. I often see associations fail to maintain a ledger, or other account information, which will allow the association to distinguish between: (a) the amounts that came due before the filing of the owner’s bankruptcy petition (often referred to as the “Pre-Petition Amounts Due”); and (b) the amounts that came due after the filing of the owner’s bankruptcy petition (often referred to as the “Post-Petition Amounts Due”). The best way to maintain records that distinguish between the Pre-Petition Amounts Due and the Post-Petition Amounts Due is to separate a ledger for an owner that files bankruptcy into two ledger parts. One part would reflect the Pre-Petition Amounts Due and the other part would reflect the Post-Petition Amounts Due.

The ledger for the Pre-Petition Amounts Due (the “Pre-Petition Ledger”) would reflect the amounts due, itemized by type of charge, as of the date of the filing of the owner’s bankruptcy petition. That ledger balance would increase, after the bankruptcy filing, by the addition of any interest charges or late fees associated with the unpaid assessments listed on the Pre-Petition Ledger and by the addition of any attorney’s fees or legal costs associated with collection efforts relating to the recovery of the Pre-Petition Amounts Due. The ledger for the Post-Petition Amounts Due (the “Post-Petition Ledger”) would include all future accruing assessments after the date of the bankruptcy filing, as well as interest charges or late fees associated with the unpaid assessments listed on the Post-Petition Ledger. That ledger would also include any attorney’s fees or legal costs associated with collection efforts relating to the recovery of the Post-Petition Amounts Due. Once the bankruptcy case ends, the owner’s split ledgers can typically be re-combined into a single ledger.

It is important for an association be able to separate the Pre-Petition Amounts Due from the Post-Petition Amounts Due for a number of reasons. Several of those reasons are discussed below.

First, when a payment is received for an account in which the owner is in bankruptcy, the association will need to apply it to either the Pre-Petition Amounts Due or the Post-Petition Amounts Due. The “side of the ledger” to which the payment will need to be applied will depend upon a number of factors, including whether the payment was made by the owner or the bankruptcy trustee and, in the event of a Chapter 13 filing, the manner in which the association’s claim is to be treated in the owner’s bankruptcy plan. If there is a single ledger that is maintained, there would be no clear way to distinguish the payments made toward the Pre-Petition Amounts Due from the payments made toward the Post-Petition Amounts Due.

Second, in a Chapter 7 case that results in a bankruptcy discharge and in which the association did not have a recorded lien at the time of the filing of the bankruptcy petition, the association will typically need to write-off all Pre-Petition Amounts Due. That task is far easier if the association splits its ledgers or otherwise maintains records which will allow it to easily determine which amounts were included in the Pre-Petition Amounts Due.

An association can continue to seek recovery of post-petition assessments from an owner who files a Chapter 7 case and obtains a bankruptcy discharge. See 11 USC §523(a)(16). However, if an association does not split its ledgers, it may find it difficult to determine the amount of post-petition assessments and other charges that can be demanded as part of the Post-Petition Amounts Due.

Third, if the owner files a Chapter 13 case, he might present a bankruptcy plan that provides for payment of all Pre-Petition Amounts Due, with the payment of all Post-Petition Amounts Due being made outside of the plan. That owner might also present a plan that calls for any lien held by the association which secures the Pre-Petition Amounts Due, to be “stripped away”, with the owner remaining liable for paying all Post-Petition Amounts Due. In either instance, if there is a single ledger that is maintained, there may be no clear way to distinguish those amounts that are being claimed under the Pre-Petition Amounts Due from those amounts being claimed under the Post-Petition Amounts Due.

The penalty for not maintaining accurate information can be severe. An association that seeks to recover debt that has been discharged in bankruptcy or that seeks to recover pre-petition debt (subject to limited exceptions) directly from an owner who is a debtor in an active bankruptcy case, may be liable for monetary damages and/or attorney’s fees for violating the “discharge injunction” or the “automatic stay” provisions of the Bankruptcy Code. See 11 USC §105(a), § 362(a), and §524(a).

At least one bankruptcy court’s written opinion has recognized the need for an association to maintain separate accounting records to differentiate the Pre-Petition Amounts Due from the Post-Petition Amounts Due. In the case of In re Moreno, 479 B.R. 553, 567 (Bankr. E.D. Cal. 2012), the court granted sanctions against an association for its attempt to collect amounts which had been discharged in bankruptcy. In that case, the court noted: “once the Debtor filed for bankruptcy protection, the Association should have started a new and separate accounting to properly track the post-petition debt that would be covered by §523(a)(16).” The court further noted that the association’s attempt “to divide the discharged [pre-petition] portion of the Debtor’s account from the post-petition portion of her account by simply drawing a line across the Accounting [on the date of the bankruptcy filing]” did not result in a proper determination of the post-petition amounts due as that caused post-petition interest to be improperly calculated on both the unpaid pre-petition debt (which was discharged) and the unpaid post-petition debt.  479 B.R. at 567-68.

An association that fails to either split its ledgers into a Pre-Petition Ledger and a Post-Petition Ledger or to take other steps to maintain separate accounting records to distinguish the Pre-Petition Amounts Due from the Post-Petition Amounts Due is likely to encounter greater difficulties in determining the amounts that are due from owners who file bankruptcy. Also, the failure to take the needed steps to maintain separate accounting records can result in an association being subject to sanctions from a bankruptcy court in the event the association seeks to collect amounts which are no longer recoverable.

ShuffieldLowman’s four downtown offices are located in Orlando, Tavares, DeLand and Daytona Beach.  The firm is a 34 attorney, full service, business law firm, practicing in the areas of corporate law, estate planning, real estate and litigation.  Specific areas include, tax law, securities, mergers and acquisitions, intellectual property, estate planning and probate, planning for families with closely held businesses, guardianship and elder law, tax controversy – Federal and State, non-profit organization law, banking and finance, land use and government law, commercial and civil litigation, fiduciary litigation, construction law, association law, bankruptcy and creditors’ rights, labor and employment, environmental law and mediation.

A Stock Sale versus an Asset Sale in a Business Transaction

A Stock Sale versus an Asset Sale in a Business Transaction

When business owners are looking to sell or buy a new business the most common question we get is whether the transaction should be structured as an asset sale or a stock sale.  The below is a brief summary of the differences between the two transaction types.

An asset sale is when a company sells substantially all of their assets in the business to a third party.  Assets will include customer list, all intellectual property, and relationships with vendors, etc.  It is usually negotiated whether the company or buyer will receive certain assets such as the cash, accounts receivable and accounts payable related to the business.  Once the asset sale is completed the company will most often dissolve and then distribute the consideration received in the asset sale to its shareholders.  Buyers most often prefer an asset sale because the company remains liable for all business activities prior to closing and except for a few items (such as sales taxes or other liabilities the buyer agrees to assume) that liability cannot be transferred to buyer.  Buyers also prefer the tax treatment they receive from an asset sale because they can depreciate or amortize the purchase price they paid for the assets based on how the purchase price is allocated to the assets.  An asset sale could cause higher taxes to seller because the allocation of the purchase price to certain assets, such as equipment, real estate and accounts receivable could be taxed at higher ordinary income rates or depreciation recapture rates (compared to capital gain rates).  These tax possibilities should be analyzed before seller agrees to structure the transaction as an asset sale.  One big consideration on whether or not an asset sale structure will work is the assignability of the company’s major contracts.  If those contracts cannot be assigned without undue hardship then an asset sale should not be the choice for the transaction structure.

A stock sale is where the shareholders of a company sell all of their stock in the company to a third party.  A seller most often prefers a stock sale because the company the shareholders are selling remains liable for all pre-closing business activities but since they are no longer shareholders that ultimate liability falls on the new owners.  Buyers will often mitigate this risk in the stock purchase agreement by requiring indemnification by the selling shareholders for certain pre-closing liabilities.  This is often times a major negotiating point between buyer and the selling shareholders.  Sellers also prefer the simpler capital gain tax treatment they will receive in the stock sale.  The company’s major contracts still have to be reviewed to make sure there is no change of control provision that could trigger a default but in general there are less issues with contracts to deal with when the transaction is structured as a stock sale.

Stay tuned for a future blog on a tax election that can be made that can combine the liability benefits of the stock sale for the seller with the tax benefits of an asset sale to the buyer.

ShuffieldLowman’s four downtown offices are located in Orlando, Tavares, DeLand and Daytona Beach.  The firm is a 34 attorney, full service, business law firm, practicing in the areas of corporate law, estate planning, real estate and litigation.  Specific areas include, tax law, securities, mergers and acquisitions, intellectual property, estate planning and probate, planning for families with closely held businesses, guardianship and elder law, tax controversy – Federal and State, non-profit organization law, banking and finance, land use and government law, commercial and civil litigation, fiduciary litigation, construction law, association law, bankruptcy and creditors’ rights, labor and employment, environmental law and mediation.

Who Can a Trustee Turn to for Advice?

Who Can a Trustee Turn to for Advice?

Trustees are required to administer a trust in good faith, in accordance with the terms and purposes of the trust, and the interests of its beneficiaries. There are, however, many aspects of trust administration that can leave even sophisticated trustees searching for advice. The Florida Legislature recognized there are situations in which a trustee must rely on an expert in order to fulfill his or her fiduciary duty when it enacted the Florida Trust Code. Florida Statute Section 736.0816(20) provides that:

A trustee may: Employ persons, including, but not limited to, attorneys, accountants, investment advisers, or agents, even if they are the trustee, an affiliate of the trustee, or otherwise associated with the trustee, to advise or assist the trustee in the exercise of any of the trustee’s powers and pay reasonable compensation and costs incurred in connection with such employment from the assets of the trust, and act without independent investigation on the recommendations of such persons.

Because it provides that a trustee may act on an advisor’s recommendation without independent investigation, Section 736.0816(20) should provide a trustee with immunity from mistakes made by his or her advisors. Indeed, prior to the enactment of the Florida Trust Code, the Third District Court of Appeals found that a substantively identical provision of the Florida Probate Code, Florida Statute Section 733.612(21), shielded personal representatives from liability resulting from errors made by their accountants. See Wohl v. Lewy, 505 So.2d 525 (Fla. 3rd DCA 1987). Personal representatives and trustees are held to the same standard of care and, as a result, Section 736.0816(20) should shield a trustee from liability for a mistake made by an advisor.

Nevertheless, a recent decision by the Fifth District Court of Appeals casts doubt on whether a trustee can rely on an advisor’s recommendation. In Harrell v. Badger, 171 So. 3d 764 (Fla. 5th DCA 2015) a trustee hired an attorney to decant a testamentary trust into a special needs trust. The trustee’s attorney did not, however, follow the requirements of Florida Statute Section 736.04117 in decanting the original testamentary trust. The Trustee argued that, like the personal representative in Wohl, he relied on his professional advisor’s recommendations and therefore should not be liable for the improper decanting. The court rejected that argument.

In light of the decision in Harrell, it is unclear to what extent a trustee may rely on Section 736.0816(20) for protection from liability for erroneous legal, accounting and other negligent professional advice. Unlike personal representatives who are protected by Section 733.612(21), the Harrell decision suggests that trustees are “de facto” insurers of the professionals they hire. Accordingly, trustees should carefully consider who they hire to render them legal and other professional advice.

ShuffieldLowman’s four downtown offices are located in Orlando, Tavares, DeLand and Daytona Beach.  The firm is a 34 attorney, full service, business law firm, practicing in the areas of corporate law, estate planning, real estate and litigation.  Specific areas include, tax law, securities, mergers and acquisitions, intellectual property, estate planning and probate, planning for families with closely held businesses, guardianship and elder law, tax controversy – Federal and State, non-profit organization law, banking and finance, land use and government law, commercial and civil litigation, fiduciary litigation, construction law, association law, bankruptcy and creditors’ rights, labor and employment, environmental law and mediation.