Whenever a person files a bankruptcy petition in Chapter 7, that person is usually looking for a “fresh start” by obtaining a discharge of their debts. With certain few exceptions, the discharge that a person (called the “debtor”) receives as part of the process applies to all creditors who are listed on the debtor’s schedules and who have received notice of the bankruptcy filing. More notable exceptions to the discharge are certain taxes, most student loans, child support and alimony payments along with other debts more specifically described in the Section 523 of the Bankruptcy Code.
This means that the discharge also applies in most instances to secured debts like home mortgages and car loans unless the debtor enters into a Reaffirmation Agreement with that particular creditor saying, in essence, that the debtor agrees to pay the debt even though the debtor filed Chapter 7. The process for reaffirming a debt in Chapter 7 can be found in Section 524(c) of the Bankruptcy Code. The question is when, if ever, should a debtor consider entering into a Reaffirmation Agreement reaffirming a debt that would otherwise be discharged in bankruptcy?
A Reaffirmation Agreement revives the debt that would otherwise be discharged, re-establishing the legal obligation of the debtor to pay the debt just as if the debtor had not filed Chapter 7 at all. This means that if a debtor reaffirms a car loan with a balance of, say, $10,000 but the vehicle securing the loan is worth only $8,000, then if the debtor fails to make the payments, the vehicle can be repossessed, sold at a “meat-axe” price at an auto auction, and the debtor is liable for any deficiency on the sale. So, if the vehicle with a retail value of $8,000 gets sold at auction for $3,000 (certainly not an unusual outcome), the lender holding the reaffirmation agreement will most certainly show up with its hand out looking for the $7,000 balance owed plus costs of the liquidation of the vehicle even though the debtor received a discharge for all of the other debts in Chapter 7 and cannot file another Chapter 7 in which the debtor receives a discharge again for a period of up to eight years from the date of the first filing.
On the other hand, if the debtor declines to reaffirm the debt, the debt gets discharged and the creditor may not demand payment of the debt. All the creditor can do is look to the collateral (the car, the house, etc.) to get as much as it can to satisfy the claim. This is because the creditor does not lose its security interest (e.g. mortgage, lien on car) when the debt is discharged. This is why the creditor obtained collateral for its loan in the first place. But getting its money means the creditor has to either liquidate the collateral, or continue to accept payments on the loan. It turns the debt into something akin to what is referred to in the law as a “non-recourse obligation” meaning that the creditor has no direct recourse against the debtor to get paid.
Notice the distinction between the creditor demanding payments, and accepting them. Section 524(f) of the Bankruptcy Code makes it crystal clear that just because a debt is discharged does not mean that the debtor cannot pay it if the debtor so chooses. The creditor may not “demand” the payment but if the debtor voluntarily sends payments, the creditor can, and usually will, accept them.
When a person files Chapter 7, one of the forms that must be completed, signed and filed is something called a “Statement of Intention” regarding secured consumer debts. The Statement of Intention records the debtor’s intention at the time of filing it as to what course the debtor intends to follow as to the car loan or the home mortgage or the like. In New Hampshire, which is in the First Circuit, the options are specifically limited to surrendering the collateral (and discharging the debt); redeeming the collateral by paying the creditor the value of the collateral; and reaffirming the debt and, subject to repayment, retaining the collateral. There is also a space on the form for “other” which sometimes comes into play in unique circumstances, such as when there is a co-signer on the loan.
The Statement of Intention is the intention of the debtor at the time the debtor signs the statement. The debtor can change his or her mind two minutes after signing it and even has up to sixty (60) days after the signed reaffirmation agreement has been filed with the court to rescind the agreement if the debtor has a change of heart.
Entering into a Reaffirmation Agreement should only be entertained after careful consideration of all of the consequences of doing so. The attorney representing the debtor is also a sometime participant in the process if the attorney decides to sign the agreement as well on the basis that entering into the agreement will not cause an undue hardship on the debtor and/or the debtor’s dependents. Many attorneys refuse to sign reaffirmation agreements at all. If the attorney refuses to sign a Reaffirmation Agreement that the debtor wants to sign and file, then the bankruptcy court will hold a hearing on validating the agreement anyway. And the court will usually approve the agreement after explaining all of the pitfalls that the debtor might encounter after reaffirming a debt. Why will the judge approve it when the attorney would not? The simple reason is that debtors can sue an attorney later for letting them do a reaffirmation agreement that goes bad whereas the judge has judicial immunity meaning that the debtor cannot sue the judge.
I do not have a blanket policy of refusing to sign reaffirmation agreements but I am very selective about doing so. The issues are pretty simple. How much equity does the collateral have such that if a foreclosure or repossession occurs later, will there likely be a deficiency? Will the debtor’s post-bankruptcy budget allow for the payments to the secured creditors without sacrificing other essentials such as food, lights, heat, clothes, etc? Is it likely that the income being relied upon to make the payments will still be there a year from now (or however long) to be sure the payments can be made?
A final question that is inevitably asked by a debtor is what will the creditor do if the debtor does not enter into a reaffirmation agreement for collateral that the debtor wants to retain? The answer largely depends on the creditor.
Some creditors will engage in such petulant activities such as shutting off a debtor’s access to on-line payment procedures on the flimsy basis that by allowing a debtor on-line access somehow violates the automatic stay after the bankruptcy is filed, or later on the discharge injunction after the debtor receives the discharge and the case is closed. They will also stop sending statements to the debtor which is a violation of the automatic stay although I have seen some creditors who will ultimately resume sending them bearing language that the statement is not an attempt to collect a debt but is only for informational purposes. So it is important for the debtor to know where to send “snail mail” payments so that the loan is paid in a timely fashion.
Some creditors will also refuse to report timely payments made to credit bureaus on the basis that since there is no legal debt and any such payments on the debt are only voluntary, they need not be reported. Personally, I think this could well be a violation of the Fair Credit Reporting Act (FCRA) because payments are being made, voluntary or not. The “flip side” of that is, I suppose, that the creditor probably cannot report that payments are NOT being made since that would probably be a violation of the discharge injunction as an impermissible attempt to collect a debt. The debtor, however, can blunt the effect of this by retaining spotless records showing payments being made that can be presented to a future potential lender who wants to know if the debtor made the payments.
But what the debtor really wants to know is if the creditor will still take action to foreclose or repossess even if the payments are made in a timely fashion and my personal experience is that the creditor will usually not take such action. I have heard of it happening anecdotally, but I have never seen it with my clients. Keep in mind that I have seen creditors move quickly to repossess vehicles, more so than usual, where the debtor falls behind on payments if the debt has not been reaffirmed. But in my practice, which stretches out over three (3) decades, I have never had a client tell me that a creditor repossessed a vehicle when the payments were being made in a timely fashion. I have had creditors attorneys TELL me that they would do so; but I have never had one actually do it. Essentially, the choice for the creditors is to either accept money (which one would presume is the better option) or “eat metal.” My experience has been that invariably creditors choose the former.