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Answer and Analysis
Absolutely, because how this comes out will depend on the jurisdiction where this case takes place.
Whenever a debtor files a petition in bankruptcy, he must file a statement of intention with regard to any property that he has given as collateral. The statement of intention requires him to state whether he would reaffirm the debt, redeem the debt, or surrender the collateral. If the debtor surrenders the collateral to the secured party or redeems the collateral by making full payment, no problem basically exists.
The problem arises where the debtor continues to make payments and does not choose to reaffirm the debt by means of a reaffirmation agreement. In a reaffirmation agreement the debtor states in writing that he reaffirms the debt and will continue to make payments on the debt, and will continue to have possession of the collateral.
Right to Rescind
Several years ago the United States Bankruptcy Act was amended to set forth specific requirements that must be met before a debtor can reaffirm a debt. The debtor must have a right to rescind the reaffirmation under certain provisions; the reaffirmation must be filed with an attorney's affidavit attesting that the debtor was fully informed, that he was acting voluntarily, and that the agreement does not impose any undo hardship upon him. In addition, the reaffirmation agreement must be filed prior to the discharge of the debtor.
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Some debtors are current on their payments at the time they file a petition and continue to make payments without filing any reaffirmation of the debt. Attorneys for the bankrupts often recommend this procedure to their clients rather than using the device of a reaffirmation agreement, because there are some distinct advantages for the debtor to proceed this way.
Where a debtor merely continues making payments without any written reaffirmation, the creditor has a right to receive the payments and credit them to the debt and to repossess the collateral when the debtor defaults in the payments.
Nevertheless, the creditor loses all rights to sue the debtor for a deficiency if the collateral cannot be sold for a sufficient amount to discharge the debt. Furthermore, the creditor cannot use collection efforts to press the debtor if the debtor defaults. Thus the only recourse is to repossess, so little motivation exists for the debtor to keep the collateral in good condition since he knows that if he defaults in payment and the collateral is repossessed, he will no longer be liable for any deficiency. The debtor is effectively converting his secured obligation in bankruptcy from a recourse obligation to a non-recourse obligation, with no downside risk for failing to maintain or to insure the lender's collateral.
Split Circuits
In plain language Section 521(2) of the Bankruptcy Code does not permit a debtor to retain the collateral without either redeeming the property or reaffirming the debt. Three Circuits have held that a debtor who is current in the payments may retain the collateral without redemption or reaffirmation (4th Circuit--West Virginia, Virginia, North Carolina, South Carolina and Maryland), (2nd Circuit--New York, Vermont and Connecticut) and (9th Circuit--California, Nevada, Arizona, Idaho, Oregon and Washington). Three circuits, on the other hand, have held that the debtor to retain collateral must either redeem or reaffirm the debt, and they do not allow the option of the debtor continuing to make current payments on collateral without reaffirming the debt (7th Circuit--Wisconsin, Illinois, Indiana), (6th Circuit--Tennessee, Kentucky, Ohio and Michigan) and (11th Circuit--Florida, Alabama and Georgia).
The split between the circuit courts in the United States is fairly apparent and the option to the debtor is only available in certain of the bankruptcy courts. At some time in the future, hopefully, the Supreme Court will resolve this question so that we will have a degree of uniformity. In the meanwhile, it is important for you to consult with counsel to determine whether the debtor has the option to make current payments without reaffirming the debt and whether it is in your interest as a creditor to oppose this option in those circuits that allow the debtor to use this device.
Depending upon the facts and circumstances of the particular case, counsel for the creditor may take certain steps in the bankruptcy proceeding which might successfully oppose this generous option afforded to the bankrupt.
Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.
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Outlook 2012
This month's survey explores...
- What the top problems are facing credit execs currently, and
- What the top improvement initiatives are.
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