Reaffirmation of Debts – Redemption of Collateral

REAFFIRMATION AGREEMENT

A REAFFIRMATION is an agreement between the debtor and a creditor that a particular debt will not be discharged in the bankruptcy case. This is most typically done with secured debts covering personal property such as motor vehicle loans. This is also done frequently with vehicle leases (called executory agreements). But in the case of a vehicle lease, the new contract or agreement will most likely be called an assumption agreement.

STATEMENT OF INTENTIONS

It is the duty of each individual debtor with secured debts to file a written statement of intentions with the court within 30 days of the bankruptcy filing. This statement sets out the debtor’s intentions with respect to each secured debt and the property that secures the debt. Guess what? This document is called a Statement of Intentions.

The bankruptcy law says in effect that for each secured debt, the debtor must state that the debtor will:

  • Surrender possession of the collateral to the creditor; or
  • Reaffirm the debt and/or redeem the collateral.

Then, within 30 days after the first date set for the meeting of creditors, the debtor must actually perform his or her intention. A conflicting provision of the says

that the debtor must surrender the collateral securing a debt with 45 days after the first meeting of creditors unless the debtor enters into a reaffirmation agreement or redeems the collateral. So the geniuses that so accurately named the Statement of Intentions missed the boat on explaining how it works. You’ll have to discuss this with your lawyer.

PERFORMANCE OF STATEMENT OF INTENTIONS

If the debtor fails to perform the required intention within 45 days after the first meeting of creditors, the automatic stay is terminated (goes away) with respect to any personal property securing the debt. Also, the Code says, “the creditor may take whatever action as to such property as is permitted under applicable nonbankruptcy law, unless the trustee timely seeks and obtains an order from the court requiring the debtor to surrender the property to the trustee.”

What does this mean to a human?

If you don’t voluntarily give back the collateral as you are supposed to do, or if you don’t give the collateral to the trustee if he or she asks for it, then the creditor can come get it, provided they comply with state law. Now here’s some particular technical information that you should also know about the repossession of such collateral.

Creditor’s right to a nonbankruptcy law repossession. A creditor secured by personal property (not real estate) is free to repossess (take back) the collateral. This could be true even if the payments are current. How so? Well, what if you didn’t maintain insurance on your vehicle? Stay with me here and read on.

Even when you are current on your payment to this creditor, you could lose the property if a situation exists that would have given the creditor the right to repossess in a case where a bankruptcy had never been filed. So you can see from the example above, since most motor vehicle financing agreements require the borrower to keep the vehicle insured, and to name the creditor on the insurance policy as a loss payee, you still have to comply with these contract terms or risk losing the car. Failure to carry the required insurance would be a material breach of that contract, allowing the creditor to repossess even though the monthly loan payments are current.

Likewise, most financing agreements state that the insolvency of the borrower or a declaration of bankruptcy by the borrower is a material breach of the agreement. Most financing agreements provide that any material breach of the agreement allows the creditor to repossess. But if the debtor REAFFIRMS the agreement, then presumably the nonmonetary technical default triggered by the act of filing bankruptcy has been cured. But REAFFIRMATION requires an agreement of both the creditor and the debtor and it must be approved by the court (see below).

Nonmonetary breach and a creditor’s right to repossession. Where the only breach of the agreement has been the technicality of the debtor filing Chapter 7, may the creditor repossess anyway? In other words, let’s say that there is no failure to comply with any material contract provision except the clause that says you can’t be insolvent or file bankruptcy. Will they still insist on repossessing the vehicle?

Most creditors (at least banks and other creditors in the motor vehicle financing business) have taken the position that they will repossess IF the debtor fails to REAFFIRM. They want the reaffirmation provisions of the new Bankruptcy Code to be strictly enforced.

This seems reasonable to them because in some cases they are rightly concerned that the debtor is going to abuse the vehicle then “walk” from the obligation as soon as it is convenient for the debtor to do so. Remember that your debt to that creditor gets DISCHARGED, so legally they can’t sue you for the debt after bankruptcy even if you stayed current on your payments for a period of time after you file bankruptcy.

THE REAFFIRMATION PROCESS IS REALLY A “TUG OF WAR”

REAFFIRMATION creates a tension between the best interests of the debtor verses the best interests of the creditor. This makes sense if you just think about it a little bit.It usually helps the creditor to

keep the debtor personally liable for the obligation. So the creditor wants you to REAFFIRM the debt. But it is usually in best interests of the debtor to keep possession of personal property security (such as a motor vehicle) if it can be done without the personal liability that comes from a formal REAFFIRMATION agreement.

When the debtor keeps the collateral without making a REAFFIRMATION agreement, we call that a ride thru (because the debtor’s continued possession of the collateral “rides thru” the bankruptcy and emerges intact at the end of the process minus any direct personal liability of the debtor). Pretty cool, huh?

DEBTOR'S ADVANTAGES OF A RIDE THRU

This is where the debtor keeps and enjoys the collateral (so long as the debtor keeps paying on time, and in the case of a motor vehicle, keeps it properly insured) but does not enter into a REAFFIRMATION agreement.

Essentially, a ride thru relieves the debtor from what used to be the ultimate detriment of every contract, namely, the personal liability for a deficiency balance. This is because the debtor’s personal liability can be discharged in the bankruptcy, even though the creditor’s lien stayed in place against the collateral.

In a ride thru situation, if the debtor fails to make payments in the future, then the debtor is protected from facing a lawsuit for any remaining contractual deficiency. For example, after repossession, a creditor is normally allowed to sell the collateral and then sue the borrower for any remaining loan balance after applying the proceeds received from the sale of the collateral. But not in the case of a ride thru since the debtor “discharged” that liability in the bankruptcy.

If the debtor finishes paying for the obligation, the lender must transfer title to the debtor.

The debtor is left free to walk away from the obligation at any time. This is an enormous advantage, because in effect it creates an escape clause that lets the debtor turn back the vehicle (or other collateral) any time that the debtor decides that it is no longer convenient to keep paying for it.

A subsequent default will still allow the creditor to repossess the collateral, but without a valid REAFFIRMATION agreement the creditor cannot also sue for a deficiency balance.

CAN THE DEBTOR SAFELY IGNORE THE RULE THAT COLLATERAL MUST BE REAFFIRMED OR SURRENDERED?

Prior to enactment the new bankruptcy law of 2005, case law concerning REAFFIRMATION agreements held that the collateral could not be repossessed so long as the debtor stayed current on the payments. So courts ignored or refused to enforce the nonmonetary default provisions in most contracts that are automatically triggered by filing bankruptcy. In effect, this allowed debtors to enjoy the “ride thru” without the detriment of continuing personal liability.

However, the provisions of the new bankruptcy law say that if the debtor fails to perform the required “intention” within 45 days after the first meeting of creditors, the automatic stay is terminated with respect to any personal property securing the obligation. And the Bankruptcy Code says, “the creditor may take whatever action as to such property as is permitted under applicable nonbankruptcy law,” unless the trustee timely seeks and obtains an order from the court requiring the debtor to surrender the property to the trustee. Until these issues are settled in the appellate courts, debtors are taking a big risk if they attempt to retain possession of collateral, especially vehicles, without reaffirming the debt.

REDEMPTION

Redemption is a procedure in which the debtor seeks an order from the court allowing the debtor to buy the collateral–by paying the collateral’s value to the secured creditor. This can be very advantageous to the debtor, because the collateral is often worth a lot less than the amount of the loan.For example,

a car loan might have a $10,000 balance, but the car may actually be worth only $5000. Redemption allows the debtor to buy that car for what it is currently worth. The “catch” is that the debtor cannot force the creditor to accept installment payments of the redemption price. In other words, the redemption value must be paid in full at the time of redemption. And if the creditor and the debtor can’t agree on the value of the collateral, then the debtor has to seek a court determination. This kind of court proceeding may require the assistance of an attorney and can be expensive.

JEFF’S TIP: Sometimes the debtor can negotiate with the creditor for better terms, such as a reduced interest rate and a significant reduction on the balance owed. This is common when the collateral consists of appliances, furniture and jewelry. But when the collateral is a motor vehicle, creditors generally require a REAFFIRMATION for the full balance unless the debtor is going to tender the cash redemption price in full.

REAFFIRMATIONS ARE DISFAVORED BY MOST COURTS

The debtor’s attorney and frequently the court itself will not want a debtor to be burdened with a REAFFIRMATION following the discharge of debts under Chapter 7. This is because it impedes the debtor’s “fresh start.” For this reason the REAFFIRMATION of an unsecured debt such as a credit card balance or a medical debt is extremely rare.

CONTENTS OF REAFFIRMATION FORM

If the debtor does not have an attorney—or if the debtor’s lawyer will not be involved with the REAFFIRMATION agreement—then the proposed form of agreement must be presented to the court for approval. Most judges are very reluctant to approve such agreements and will search for a reason to deny them.The REAFFIRMATION form requires

a disclosure of the current income and expenses of the debtor in order to show whether the debtor can actually afford the required payment. This form also contains mandatory language warning the debtor of the consequences of making the agreement. The agreement is required to disclose certain information, such as the amount of the debt that is being reaffirmed, the payment terms, interest rate, and the consequences of a default.

LAWYERS REPRESENTING DEBTORS ARE RELUCTANT TO SIGN

One of the reasons for the reluctance of lawyers to participate in a REAFFIRMATION is simple.They generally believe

that it’s bad for their clients to do these agreements. Plus, they don’t want to sign a declaration that the law requires if they participate.

The lawyer that assists the debtor with a REAFFIRMATION must sign a declaration under penalty of perjury stating that the REAFFIRMATION would not produce an undue hardship upon the debtor. Most attorneys take their responsibilities very seriously and they are reluctant to sign such a declaration and saddle their client with such obligations.

The reaffirmation becomes effective if signed by all of the parties and the debtor’s attorney, and if it is filed with the court prior to discharge, unless it is presumed to be an undue hardship.

LEON’S TIP: Maybe you shouldn’t be signing something that your own lawyer won’t sign. Many people in financially stressful situations are simply trying to “get by” or “hang on” to things that seem important. But when these same people have the perspective of time passing by, they begin to understand what was so obvious—that freedom from old debts and a truly “fresh start” is more important.

REAFFIRMATION AND THE PRESUMPTION OF UNDUE HARDSHIP

The REAFFIRMATION is presumed to be an undue hardship if the debtor’s monthly expenses exceed the debtor’s monthly income. In that event, the court must examine the agreement and may disapprove the agreement. The presumption may be rebutted by written evidence identifying additional sources of income that will allow the debtor to make the payments called for in the agreement. Interestingly, the presumption of undue hardship does not apply where the creditor is a credit union.

REAFFIRMATION HEARING

The Bankruptcy Code says there must be a court hearing to approve a REAFFIRMATION in a case where the debtor is not represented by an attorney. (Bankruptcy Code Section 524.)At this hearing

the court must inquire as to the circumstances surrounding the obligation and must determine whether or not the REAFFIRMATION would be an undue hardship upon the debtor or any dependent of the debtor.

The court will look at the current income and expenses of the debtor to see if the debtor can actually afford the required payment. The Bankruptcy Code states that the court must approve a reaffirmation as consistent with the debtor’s best interests. For this reason, it appears that the court still holds the discretion to deny a REAFFIRMATION even if the debtor believes it is in his or her best interest to reaffirm. Court approval of a REAFFIRMATION at a hearing is not required if the agreement is a reaffirmation of a mortgage securing real estate.

Reaffirmation of a debt is often a dangerous pitfall for the debtor, because some creditors will use subtle forms of coercion and intimidation to squeeze an unnecessary REAFFIRMATION out of the debtor. Reaffirmation leaves the debtor “on the hook” to pay a debt which would have been discharged. Particularly dangerous is any proposed reaffirmation of a mortgage.

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