As consumer bankruptcy filings remain an all-too-common occurrence, many lenders continue to find themselves in the often murky world of bankruptcy. As a result, on top of ensuring adherence to the numerous confusing regulations applicable to commercial loan transactions, lenders must navigate the federal bankruptcy laws. This article sheds some light on one bankruptcy process lenders are often faced with: reaffirmation agreements.
In a chapter 7 bankruptcy, the debtor’s secured personal property can be treated in one of three ways: the debtor can keep the property through a process called reaffirmation, surrender the property to the secured creditor, or keep the property by paying the secured lender for the property in one lump sum through a process called redemption. Chapter 7 debtors most commonly choose to reaffirm or surrender their property.
If a chapter 7 debtor chooses to reaffirm debt related to a secured claim, a reaffirmation agreement must be negotiated and signed by the debtor and the lender within 45 days after the first creditors’ meeting. See 11 U.S.C. § 521(a)(6); see also Bankruptcy Form B240A. The reaffirmation agreement is only enforceable if it is entered before the debtor receives a discharge in the bankruptcy case, and if the debtor does not rescind the reaffirmation agreement at any time prior to receiving the discharge or within sixty days after the reaffirmation agreement is filed with the Bankruptcy Court, whichever occurs later. See 11 U.S.C. §§ 524(c)(1), (4).
If the debtor fails to enter into a reaffirmation agreement within the 45 days after the first creditors’ meeting, the automatic stay, which goes into effect immediately upon the debtor’s filing of the bankruptcy petition and prohibits all creditors from undertaking any collection attempts, lifts and the creditor can pursue its non-bankruptcy collection rights. See 11 U.S.C. § 521(a)(6). However, since the reaffirmation process revives the debtor’s personal liability on the debt and allows lenders to receive payments from the debtor outside of the bankruptcy context and to maintain all state law rights upon non-payment, lenders should be mindful of this deadline to ensure they do not miss the chance to take advantage of the reaffirmation process. It is also important to note that, provided the lender does not coerce or harass a debtor, merely offering a reaffirmation agreement to a debtor does not violate the automatic stay. See In re Carter, No. 10-10459-8, Adversary No. 11-00069-8, 2012 WL 627769 (Bankr. E.D.N.C. Feb. 24, 2012).
If a debtor chooses to reaffirm and a reaffirmation agreement is signed and approved by the bankruptcy court, the debt subject to the reaffirmation agreement remains a personal liability of the debtor and is not discharged in the bankruptcy case. This means the debtor will be required to continue to pay the lender pursuant to the terms of the note (or to the terms of the executed reaffirmation agreement, which often modifies the payment terms). In return, the debtor is allowed to keep the property securing the loan. However, if the debtor fails to make payments after entering the reaffirmation agreement, the lender is entitled to take actions to collect on the loan as though the bankruptcy case never occurred – meaning the lender can repossess the property securing the loan and, if appropriate, seek a subsequent deficiency judgment. Reaffirmation agreements almost always relate to motor vehicles.
This process may seem relatively easy – how hard can it be to get a debtor to sign a reaffirmation agreement when they are desperate to keep their property – usually a car – after filing for bankruptcy? However, like most things, it is not quite so simple. Although debtors can sign reaffirmation agreements on their own (without an attorney involved in the process), the Bankruptcy Court must review the reaffirmation agreement if the debtor was not represented by an attorney during the course of negotiating the agreement to ensure the reaffirmation agreement does not impose an undue hardship on the debtor or the debtor’s dependent and is in the debtor’s best interest. See 11 U.S.C. § 524(c)(6). In addition, the Bankruptcy Court will review the reaffirmation agreement if the debtor’s monthly income does not exceed the total of the debtor’s monthly expenses (including the monthly amount required to reaffirm the debt), meaning there is a presumption of undue hardship. See 11 U.S.C. § 524(m)1.
If there is a presumption of undue hardship, the debtor must rebut this presumption by showing additional sources of funds are available to enable the debtor to make the monthly reaffirmation payments (either due to a change in circumstances after filing the bankruptcy petition – such as a new job – or a third party (such as a relative) offering to make the reaffirmation payments). If the debtor is represented by an attorney, the debtor’s attorney must sign an affidavit certifying the reaffirmation agreement does not impose an undue hardship on the debtor or, if there is a presumption the reaffirmation agreement creates an undue hardship, that in the attorney’s opinion, the debtor can make the monthly payments.
To better understand reaffirmation and to ensure that you are doing everything possible to protect your rights, you should contact knowledgeable legal counsel.
1This subsection of the Bankruptcy Code does not apply if the creditor is a credit union. See 11 U.S.C. § 524(m)(2)