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Bad Debt: When Should Association’s Stop Pursuing a Delinquency?

One of the duties imposed on the Board of a condominium, homeowner association or cooperative (“Association”) is to collect assessments from owners.  When an owner stops paying, typically, the owner’s account is forwarded to the Association’s attorney for collection.  Often a Board approaches us questioning whether the Association should write off certain fees or an owner’s entire balance as bad debt.  Particularly at the end of a fiscal year, Associations are incented to clean up their financial records and write off any uncollectible debt.

An Association’s main source of income is the fees that it collects from owners.  If one owner does not pay, all of the other owners make up the shortfall, either by paying an increased amount the following year or receiving fewer services.  There is also a risk that word will spread throughout the community that if an owner waits long enough, eventually the Association will write the balance off. Due to the impact on all of the owners, Boards must carefully consider whether it is prudent to write-off fees as bad debt.

As a general rule, we only recommend that Associations write-off a balance as bad debt if the debtor is no longer an owner.  For example, if the property (or shares) was foreclosed on by the owner’s lender or, if for some reason, the past due fees are not collected at a closing settlement.  In these instances, particularly if the Association does not have a current address for the former owner, the former owner is unemployed, the former owner’s assets are protected from a garnishment, the former owner has moved out of state or the amount due to the Association is nominal, continuing to pursue the former owner may be a futile exercise and cause the Association to continue expending legal fees with little chance of recouping the past due debt.  This is the notion of “throwing good money after bad.”   If the debtor no longer owns the property, the risk that other owners could expect a write off if they delay payment is significantly reduced.   Moreover, if the debtor no longer owns the property there is a finite amount due to the Association whereas if the debtor still owns the property, assessments continue to accrue.

There are instances when the Board has no choice but to write-off an owner or former owner’s debt because the debt is no longer legally collectible.  For example, if the owner files for bankruptcy protection and the debt is discharged by the Bankruptcy Court, the Association can no longer hold the owner personally liable for the discharged debt.  Note that if the Association filed a Statement of Lien against the Owner’s unit prior to the date of the bankruptcy filing, the Association can still hold the property liable for the any debt that is secured by a lien. For condominiums to be eligible for FHA certification and to retain their FHA certification, thereby enabling purchasers of units to qualify for FHA backed loans, no more than fifteen percent (15%) of the unit can be delinquent in assessments for more than sixty (60) days.  In addition, many private lenders follow FHA guidelines in determining whether to approve a loan to a condominium owner.  Therefore, many Boards consider writing-off bad debt so that the Condominium can keep within the FHA prescribed margins.

There are a myriad of factors for a Board to consider when evaluating whether to write-off fees as bad debt.  Depending upon the circumstances, it may be prudent to write off fees rather than continue to expend funds on collection efforts when the chance of recovery is slim. However, this is not always the recommended course of action. Boards should seek the advice of their attorney and accountant or tax advisor in rendering this decision.

If you have questions about this article, or any other home owners association matter, please contact an attorney in our Community Association practice area.