Bankruptcy eliminates most debts through discharge. However, liens on property remain intact. This means that debtors and secured creditors are faced with a choice of what to do about property that secures debt. In many cases, the best option is a reaffirmation agreement, where the debtor agrees to continue paying the debt in exchange for keeping the property.
Although the debtor is ultimately the one who decides whether to reaffirm a debt, surrender the collateral, or redeem the collateral, a creditor is allowed to propose reaffirmation. Reaffirmation is more complicated than an ordinary credit agreement and comes with its own special restrictions.
This article will review the basics of reaffirmation agreements. However, any creditor facing a decision of whether to accept or propose such an agreement should consult with an experienced attorney who will be able to advise on the best strategy based on their specific circumstances.
Collateral in Bankruptcy
Bankruptcy discharges a debtor’s personal debts but not debts secured by property. Thus, a creditor with a security interest is still entitled to payment as long as it’s within the value of the collateral. Once a bankruptcy case is over and the automatic stay is lifted, the creditor retains the right to repossess collateral to satisfy a debt.
The bankruptcy code gives debtors several options for handling their secured debts. Debtors can always surrender the collateral to the secured creditor and walk away from the debt. Any amount the debtor owes over the value of the collateral is treated as an unsecured debt that will be discharged at the end of the bankruptcy proceeding. In such cases, the creditor will only receive a portion of what is owed, if anything.
Many debtors would prefer to keep the collateral, especially if it has sentimental value or is necessary for their daily life, such as the debtor’s car. A debtor who wants to keep the collateral has two options. First, the debtor can pay the creditor either the value of the debt or the value of the collateral (whichever is lower) in cash. This option is rarely used because people who file for bankruptcy generally don’t have the money to pay off their debts, let alone pay them off in one installment.
In recognition of this fact, the bankruptcy code allows debtors and creditors to renegotiate and reaffirm a debt. This is called a reaffirmation agreement. When a debt is reaffirmed this way, the debtor remains obligated to continue making regular payments throughout the bankruptcy proceeding and to keep making these payments after its completion.
Reaffirmations are essentially a new agreement, and the terms can be different from the original debt. This means the creditor can negotiate different rates or payment schedules. However, it’s important not to overreach; the debtor’s attorney must sign off on the deal, and the bankruptcy court also has the right to invalidate it. Thus, a creditor who wants to negotiate a reaffirmation would be wise to hire a lawyer to draft a strong deal that won’t be struck down by the court.
How Reaffirmation Works
Within 30 days of the 341 hearing, debtors are required to indicate their intent of how they plan to deal with their secured debts. If the debtor selects reaffirmation, the creditor must propose a reaffirmation plan and negotiate it with the debtor. Neither the creditor nor the debtor is required to accept any particular plan.
Courts allow creditors to offer reaffirmation before the debtor indicates their intent. Such offers do not necessarily violate the automatic stay. However, if a court deems the language of the communication with the debtor to be abusive or threatening, the creditor may face penalties for violating the automatic stay. For this reason, it’s best to have a lawyer draft the communications to ensure that they do not violate the stay and expose the creditor to liability.
The reaffirmation agreement is a new contract, so its terms can vary from the original debt. It’s possible to negotiate for higher payments, an altered payment schedule, attorneys’ fees, or other concessions from the debtor. However, the court may invalidate a reaffirmation if it finds the terms impose undue hardship on the debtor. A bankruptcy attorney can help draft a reaffirmation in a way that a court won’t find abusive.
Being too aggressive in seeking and negotiating reaffirmation agreements can have severe consequences. In 1997, Sears was forced to pay $265 million to bankrupt customers that it pressured into reaffirming credit card debt with threats of repossessing merchandise they had bought. Sears also broke the law by failing to seek court approval for these reaffirmations.
The creditor is also required to provide a lengthy and detailed set of disclosures to the debtor notifying the debtor of their rights and responsibilities under the bankruptcy code and the reaffirmation. Failure to include these disclosures can result in the agreement’s invalidation. It’s wise to have a lawyer look over the agreement and make sure the disclosures are correct.
When Reaffirmation Makes Sense
Whether reaffirmation is a good idea depends on the circumstances. Reaffirmation is a contract, so both the creditor and debtor must agree to it. Thus, even if a debtor proposes reaffirmation, the creditor is free to turn it down if it seems like a bad idea.
The main factors in deciding whether to reaffirm are the debtor’s income and the difficulties of reselling the collateral. If the debtor still won’t have enough money to pay the debt despite the bankruptcy (for example, if the debtor is unemployed), it would be unwise for the creditor to accept reaffirmation, as the creditor would risk losing out on any payments made through the bankruptcy proceeding and would be forced back into using the legal process to collect on the debt.
If a debtor has a regular flow of income, reaffirmation can be a good idea. Oftentimes, debtors fall short on debt payments because they’re trying to keep up with multiple debts. If bankruptcy results in the discharge of the other debts, the debtor will have an easier time making payments on the collateral.
One of the benefits of reaffirmation is that a creditor does not have to repossess and resell the collateral. Repossession and resale involve their own expenses, such as hiring a repossession company and finding a buyer. Many assets, such as cars, fetch a lower price when they are used, so the amount gained on resale might be less than the debt is worth. The harder it is to resell, the more reaffirmation is useful.
Restrictions on Reaffirmation
Although the creditor and debtor negotiate reaffirmation like any other contract, reaffirmation agreements are subject to more legal scrutiny than other contracts. The bankruptcy code sets up two possible obstacles to reaffirmation agreements.
First, if the debtor has a lawyer, the debtor’s lawyer must certify that the agreement does not impose an undue hardship on the debtor. Without the lawyer’s signature, the agreement is considered invalid. If the debtor does not have a lawyer, this requirement does not apply.
Second, the bankruptcy judge also must determine that the agreement does not impose an undue hardship on the debtor. This involves analyzing the debtor’s income and expenses alongside the reaffirmation agreement. If the reaffirmation agreement would leave the debtor without enough income to pay their expenses, the agreement will be invalidated. If the agreement is invalidated, the creditor and debtor will have to negotiate a new reaffirmation.
Reaffirmation of Unsecured Debts
Technically, reaffirmation is possible for both secured and unsecured debts. However, because unsecured debts are either discharged in bankruptcy or survive in their original form after the bankruptcy, there is usually very little reason for the debtor to reaffirm an unsecured debt.
In certain circumstances, a creditor might have enough leverage to convince a debtor to reaffirm an unsecured debt. For example, debtors often agree to reaffirm a debt in exchange for keeping their ability to borrow from the creditor in the future. If a family member who isn’t a party to the bankruptcy cosigned a debt, the debtor might also be willing to reaffirm.
However, bankruptcy judges and debtors’ attorneys closely scrutinize reaffirmations of unsecured debts. Even if the debtor is willing to reaffirm the debt, the reaffirmation might still be invalidated. An unsecured creditor who wants to make a reaffirmation agreement with a debtor will likely need a lawyer’s help to convince the judge to approve the agreement.
Enforcing a Reaffirmation Agreement After Bankruptcy
Ideally, a reaffirmation agreement will be manageable and the debtor will be able to make payments on time after the bankruptcy. However, if the debtor stops paying, the creditor will need to take action to enforce the agreement. The exact options available to a creditor depend on the terms of the reaffirmation agreement itself.
Reaffirmations of secured debts should always include the right to repossess the collateral if the debtor defaults. Assuming the creditor did not give up this right, repossession and resale of the collateral is the easiest remedy for default.
If the reaffirmation was for an unsecured debt, the creditor must resort to a lawsuit if the debtor defaults and is unwilling to pay. Once the creditor obtains a judgment against the debtor, the creditor will be able to levy assets or garnish wages.
What Should I do if a Debtor Declares Bankruptcy?
If someone who owes you money has filed for bankruptcy, contact Rosenblum Law for a free consultation today. Our experienced bankruptcy attorneys can evaluate your situation and determine whether or not reaffirmation is a good option for you. Call 888-815-3649 or email us today.