After months of phone calls, loan modifications and discussions with borrowers, one finally receives the dreaded bankruptcy notice in the mail. A chapter 7, no-asset case, with the loan listed on the bankruptcy schedules as a secured claim. After a few short months, one is notified that the debtors have received their discharge in the bankruptcy case. Since the bank hasn’t been paid in months, one discusses internally and decides to initiate foreclosure proceedings. The debtors, faced with imminent foreclosure, ask whether they can sign a new agreement agreeing to repay their outstanding debt, in exchange for the bank’s agreement to withhold on foreclosure proceedings.
Sound familiar? Probably. Whether it’s a refinance, a loan modification or simply a new promissory note, situations similar to the one described above play out as banks attempt to walk the thin line between protecting their interests and maintaining workable arrangements with borrowers still struggling with the after-shocks of the Great Recession. However, banks need to be aware of the risks of entering these agreements – and of the potential unwanted consequences that could arise.
As many in the banking industry already know, a debtor and creditor can enter into an agreement in which the debtor agrees to reaffirm a debt that otherwise would be discharged through the debtor’s bankruptcy case. These agreements, called reaffirmation agreements, are only valid and binding if made in strict compliance with the provisions of Section 524(c) of the Bankruptcy Code. The Code requires, among other things, the following:
· The agreement is made before the debtor received the discharge
· The debtor received certain disclosures
· The agreement is filed with the court
· The debtor does not rescind the agreement within a specified time period. See 11 U.S.C. § 524(c)(1)–(6); see also 11 U.S.C. § 524(d)
Reaffirmation agreements that do not comply with Section 524 will be found void and unenforceable. Further, if the debtor subsequently defaults under the terms of a post-petition agreement to reaffirm an otherwise discharged debt that does not meet the strict reaffirmation agreement requirements, any attempt by the creditor to collect on this post-petition agreement may be a violation of the discharge injunction of Section 727 of the Bankruptcy Code. Thus it could subject the creditor to sanctions.
This brings us back to the situation described above – is the bank’s post-petition agreement an invalid post-petition reaffirmation agreement in violation of the discharge injunction? Or, is a separate agreement creating a new obligation that arose after the debtor received the discharge in the bankruptcy case?
The answer is, unfortunately, it depends. Some courts have viewed an agreement to forego foreclosure as “new and sufficient consideration to support a binding post-discharge obligation.” This means the post-petition agreement constitutes a new, post-petition obligation that is “completely separate from the initial note that was discharged in bankruptcy.” See, e.g., In re Heirholzer, 170 B.R. 938, 941 (Bankr. N.D. Ohio 1994). In contrast, other courts have read the language of Section 524 to mean the post-petition agreement must comply with the reaffirmation requirements if the consideration for the agreement is based on the dischargeable debt, either “in whole or in part” – regardless of whether new consideration for the agreement also exists. See, e.g., In re Stevens, 217 B.R. 757, 761 (Bankr. D. Md. 1998) (quoting 11 U.S.C. § 524(c)).
So what does this mean for you? Well, in short, it means be careful and be cautious. While entering a post-discharge agreement with a debtor might seem like the best way to avoid foreclosure proceedings that neither you or the borrower may want, it is important to realize that doing so might inadvertently land you on the wrong side of a motion for sanctions when you later attempt to collect under the agreement. Bottom line? Speak with an attorney before entering any post-petition agreements with a debtor that relate in any way to a debt that was discharged in the bankruptcy case.