Today’s daily news highlights the volatile stock market, increased unemployment and devastating financial losses suffered in a slumping economy. Corporate and individual bankruptcies have soared to a five-year high. A dreaded term is now becoming commonplace and individuals of all economic classes are turning to bankruptcy to unburden themselves from mounting debts and collapsing investments. Clubs across the country are seeing increasing member filings, which have resulted in increased requests for resignations and refunds and which may jeopardize the club’s overall operations. Thus, it is important that a club prepares and protects itself for sustainable operations.
This article highlights complications related to member filings, covers how to help protect a club’s interest and suggests when to consult the club’s attorney.
Bankruptcy Basics
Bankruptcy is governed by the United States Bankruptcy Code, with references to state laws. There are three primary types of bankruptcy: chapter 7, chapter 13 and chapter 11.
Simplifying the process greatly, a chapter 7 bankruptcy is a liquidation. Upon filing (the “Petition Date”), a debtor’s estate is created containing all of the debtor’s non-exempt assets and debts. A trustee is appointed to administer and control the estate. Therefore, the debtor only maintains rights to exempt assets (such as specified value in the debtor’s primary residence and one car). The trustee, through a liquidation (sale) of the debtor’s assets, pays creditors on a pro-rata basis as prescribed by the Bankruptcy Code. In a chapter 7, unless otherwise adjudicated, the debtor’s debts as of the date of filing are discharged (i.e., erased). This may include any and all outstanding balances due to the debtor’s club. Once discharged, unless otherwise provided by law, a club is precluded from collecting discharged debts from its members.
In a chapter 13 bankruptcy, the debtor’s income must be above a threshold level. Unlike a chapter 7 which liquidates the debtor’s assets, in a chapter 13 the debtor creates a plan approved by the court to repay certain of its creditors over three to five years. Only upon the debtor’s satisfaction of its obligations over time are the debtor’s debts discharged. In a chapter 13, the debtor (not a trustee) continues to hold and administer the debtor’s assets.
In a chapter 11 bankruptcy, the debtor uses the tools of the Bankruptcy Code to reorganize its assets and debts through a plan of reorganization. Chapter 11 is typically used by companies, but individuals with significant assets and significant debt may qualify under chapter 11.
Automatic Stay
Upon the filing of a bankruptcy, the Bankruptcy Code provides an injunction against any efforts to collect the debtor’s past due debts. The “automatic stay” is intended to provide the debtor breathing room necessary to address his debts without the pressure of collection efforts. Failure to abide by the automatic stay may result in sanctions or damages, including punitive damages.
Types of Claims in Bankruptcy
Once a debtor has filed for bankruptcy, all debts, which are referred to as “claims against the estate,” are divided into secured, unsecured and priority claims. A secured claim is a claim that is secured by a lien on property of the debtor. An unsecured claim is one for which a creditor holds no collateral and was extended based solely upon the creditor’s assessment of the debtor’s creditworthiness. Priority claims are delineated unsecured claims that are entitled to be paid ahead of general unsecured claims including, for example, wages and certain taxes.
What Should the Club Do When a Member Files for Bankruptcy?
Respond without delay. When a member files for bankruptcy, stop and take notice. Do not make assumptions or rely on provisions in club documents about any amounts owed to the club by a bankrupt member. The club documents are superseded by bankruptcy law.
If a member with an outstanding club account files for bankruptcy, the club should receive a notice from the bankruptcy court which includes a notification of the right to file a “proof of claim.” A club’s claim includes a member’s unpaid dues, charges, assessments and fees. A club should always file a proof of claim in a timely manner, as failure to do so may result in a wavier of the claim.
File a Proof of Claim
To file a proof of claim, a club must determine what category of claim the club has. It is not uncommon for the club’s governing documents to include broad language that implies the club has a “lien” or secured interest against the membership. This language, in and of itself, does not satisfy the legal obligations for a valid secured claim. A golf membership is personal property and, under the Uniform Commercial Code, a club must take appropriate steps to document and perfect its security interest in the membership. The mere inclusion of a statement in the club’s governing documents does not satisfy the requirements to perfect its security interest. Therefore, a club’s claim against a member’s membership is most likely unsecured, notwithstanding what the club’s governing documents suggest.
The perfection of a secured claim in the membership is an important aspect that all clubs should review, especially for financed memberships. Clubs that offer internal financing or deferred payment plans often fail to properly document the club’s secured interest in the membership. It may be appropriate to confirm now that the club is properly protecting its interest so it is prepared in the event a member files bankruptcy.
If a club has complied with the requirements to maintain a secured claim, a club may be able to collect the pre-petition account balances owed by the bankruptcy member from the resale proceeds of the membership. To collect this outstanding balance, however, the club must follow the proper procedures under the bankruptcy code and state law to foreclose on its interest. The club’s failure to abide by both bankruptcy and state laws may result in damages assessed against the club. Further, if permitted by state law, an equity club may have a right to set off its pre-petition claims against any equity in the membership based on its rights outlined in its governing documents.
Address Post-Petition Debts
A member’s filing does not relieve the member of its continuing post-petition obligations to the club. The member is required to pay his or her post-petition obligations, and failure to do so allows the club to take such action against the member as outlined in the club’s governing documents, which may include suspension of the member’s rights to use the club, termination or resignation.
Practically, if a member files for chapter 7 bankruptcy, the club must recognize that the membership interest is put in a precarious position. This is especially true for equity clubs. Technically, the trustee “owns” the membership; however, there is no incentive for the trustee to continue to pay dues. For equity clubs, whose operations are based on dues revenues, this can create a financial burden on the club. Prior planning will not eliminate the risks and losses associated with member bankruptcies, but it can help limit the club’s exposure.
Preferences
Under the Bankruptcy Code, a preference payment is a payment for a pre-existing debt that a club received from the member while the member was insolvent and within 90 days prior to the member’s bankruptcy filing, which payment enabled the club to receive more than it would have through the chapter 7 liquidation. In some cases, a club will receive a demand notice that such payment be returned to the debtor, its lawyer or a trustee. Although such demand may be well founded, it does not mean that a club is obligated to comply with the demand. The Bankruptcy Code outlines certain criteria that must be satisfied prior to recovery of the preference payment, and a club should consult its attorney to determine its obligations.
Membership Rights
What does a member’s bankruptcy filing do to his or her membership rights? The simple answer is nothing. Unless the club’s interest in dues is secured by the membership, the club must bifurcate the member’s dues as pre- and post-petition, recognizing that it cannot collect pre-petition dues and charges from the member, but may collect post-petition dues and charges.
Given the potential value in an equity membership, the parties involved in a debtor’s bankruptcy may attempt to use creative measures to gain immediate value from the membership, rather than following the club’s resale procedures. Therefore, it is always important to address promptly any communication received related to a member’s bankruptcy and to consult the club’s attorney. For example, it is not uncommon for a chapter 7 trustee to demand that the membership be redeemed and the equity be provided to the trustee immediately. Unless the club’s governing documents provide otherwise, the trustee only steps into the debtor’s shoes. Therefore, the trustee may be unsuccessful making such demand.
The club should understand its rights under its documents and applicable law so that it is prepared to react if a member files bankruptcy.
In addition, unless otherwise provided in the club’s governing documents, the member’s bankruptcy filing does not automatically forfeit the member’s rights in the membership or to any refund due the member under the club’s documents.
Because bankruptcy issues are important to the club’s overall operations and continued viability, a club should take the steps necessary to protect its interests in the event a member files bankruptcy. No club should assume it will not be impacted by this economic downturn. Appropriate planning, including planning for the potential that a member may file for bankruptcy and protecting the club’s interests in that event is recommended. It is important that a club recognizes the rules and restrictions that apply once a member files, because a club’s failure to abide by these rules may subject to the club to damages or a forfeiture of its claims.