Handling Secured Loans in Chapter 7 Bankruptcies.
The dilemma: Reaffirm, Redeem, Surrender or something else?
The most difficult issue in a Chapter 7 bankruptcy is how to deal with property the acts as collateral on a loan, such as a car loan, or a home. Prior to the enactment of the BAPCIPA reform in 2006, debtors who filed a bankruptcy had 4 options when it came to a secured loan. They could:
- Reaffirm the debt. A reaffirmation of a debt means that the debtor is still liable on the amount of debt that has been reaffirmed. If the debtor does not pay the debt, the creditor may proceed against the debtor or the property securing the loan just as if the debtor had not filed the bankruptcy (assuming the automatic stay is still not in place). This can result in the debtor being in deep financial trouble despite the bankruptcy. On the other hand since the debtor is obligated on the debt, the creditor will usually report prompt payments, and this can help reestablish good credit. Reaffirmations are a reasonable way a debtor can retain property that they wish to keep if: the debtor is not backwards on the loan; the debtor can reasonably afford the payments; and the debtor desires to re-establish credit; or the debtor has no other reasonable option to obtain housing or transportation and the debtor can afford the payments.
- Redeem the property. If the debtor can raise a sufficient amount of cash to pay the creditor the market value of the property (what the property would sell for in a retail market) the debtor can “redeem” the property from the creditor. This usually requires the debtor to borrow the money from a family member, friend or one of the redemption financing companies. This can be a viable option for vehicles, especially if the debtor is significantly upside down on a vehicle, say owing $40,000 on a $15,000 vehicle
- Surrender the property. If the debtor does not want the property or cannot afford to keep the property, then the debtor can turn over the property to the creditor without the worry of a deficiency claim if the creditor sells the property for less than the loan amount.
The above three options are still available after the laws changed in 2006. Prior to 2006 the debtor had the legal right to:
- Retain the property and pay the contract on a current basis. If the debtor was current when they filed the bankruptcy and stayed current on the loan, the creditor could not repossess or foreclose upon the property, claiming the debtor was in default in a loan under a standard provision which said if the debtor filed a bankruptcy, it was a default in the loan. The advantage to retaining the property and paying the contract was that the debtor is no longer liable on the debt and if down the road the debtor wanted to walk away from the property, the creditor could not sue the debtor for a deficiency. The disadvantage was that the creditor would not usually report the payments as current loans on a credit report since the debtor was not liable on the debt.
The new bankruptcy laws have been interpreted to allow a creditor to proceed against the bankrupt’s property, even if they are current on the loan. Practically, however, most creditors would rather take the payments, than the property. So as a practical matter, many debtors still can elect to retain the property and stay current on the loan. The concern that we bankruptcy attorneys have, is that a creditor might change its mind or its policy after the debtor had made significant payments on a debt, and now there is equity in the property where before it was underwater. A debtor might be able to prevail in a state court, by contending that the creditor waived the default caused by the bankruptcy by continuing to accept the payments, however, that might be like locking the door after the burglary, especially in a vehicle repossession.
None-the-less, many of my clients still opt for the retain and pay option, especially where they are seriously upside down on a vehicle or on a home mortgage, simply because obtaining another vehicle or buying another house is just not an option. So far, knock on wood, we have not seen any creditors taking the stance that they can keep accepting the payments and then foreclose or repossess the property later. We have seen some credit unions and Ford Motor Acceptance take aggressive stances that "retain and pay" is not an option and that they will repossess if the debt is not reaffirmed or redeemed.