Reaffirmation Agreements

Generally

For home and vehicle loans, a debtor that wants to keep the property may be required to sign a "reaffirmation agreement." A "reaffirmation agreement" is a contract which waives the bankruptcy discharge with respect to a particular debt. A debtor that signs a reaffirmation agreement must continue making the contract payments and will remain personally liable on the reaffirmed debt if he fails to pay. The reaffirmed debt will be completely unaffected by the bankruptcy filing, and will survive the bankruptcy discharge, as if the bankruptcy had never been filed.

Unsecured creditors will often solicit a debtor to reaffirm all or a portion of an unsecured debt by offering to extend additional post bankruptcy credit. The unsecured creditor will usually try to sell the reaffirmation agreement by arguing that the additional credit will help the debtor to reestablish a positive post bankruptcy credit history and minimize the adverse impact of the bankruptcy on the debtor’s credit report. It is almost never a good idea for a debtor to reaffirm a completely unsecured debt. Almost all debtors will have numerous sources for obtaining post petition credit, and can reestablish a positive post bankruptcy credit history, without agreeing to pay any portion of the prior debt.

Rescission of Reaffirmation Agreements

The Bankruptcy Code permits a debtor to rescind a reaffirmation agreement at any time prior to the date the Bankruptcy Court issues a discharge order, or within 60 days after the reaffirmation agreement is filed with the court, whichever event occurs later. In other words, a debtor that signs a reaffirmation agreement can change her mind until the later of:

(a) the date the court issues a discharge order, or

(b) 60 days after the reaffirmation agreement is filed with the court.

The Bankruptcy Code states that a reaffirmation agreement can be rescinded merely by "giving notice of rescission" to the creditor. Written notice is not legally required; oral notice is sufficient. However, a debtor will find it virtually impossible to prove that she verbally gave notice of rescission. Therefore, as a practical matter, to properly rescind a reaffirmation agreement, the debtor (or her attorney) should always prepare and send a written notice to the creditor expressing her intent to rescind the agreement.

Redemption of Property

Redemption permits a debtor to obtain possession of (and title to) collateral for a loan by paying its market value instead of the contract price. The redemption procedure permits a debtor to avoid paying the full contract amount for property that has depreciated in value.

Informal Redemptions

An informal redemption occurs if the debtor and creditor reach an agreement concerning the value of the collateral and payment terms. Most department stores will negotiate with debtors concerning the amount and terms of payment, including the interest rate and amount of any monthly payments.

An "informal" redemption is informal because the debtor and creditor negotiate the deal between themselves. The bankruptcy court stays out of the process. All price and payment terms can be negotiated in an informal redemption.

Most redemptions are informal because both the debtor and creditor have an incentive to compromise. The debtor will usually want to keep the property if he can pay a reasonable price on fair terms. The creditor will gain little or nothing by taking the property. It is difficult for most creditors to profit from selling used consumer goods in a retail store. The repossession, storage and sale costs make it economically unwise for creditors to play hard ball in negotiating a redemption of consumer goods.

Redemptions

(a) Basics. A "formal" redemption is a bankruptcy court procedure permitting the debtor to redeem the collateral. To start the procedure, the debtor’s attorney must file a written motion requesting the court to authorize the redemption. The court will determine the property value and enter an order requiring the creditor to deliver the property (and legal title) to the debtor when the debtor pays the money.

A formal redemption is useful only if the debtor and creditor can not agree on the property value. Most creditors understand (or should understand) that if the debtor and creditor agree on the property value, it is pointless to force a debtor through a formal redemption process because the right to redeem is automatic. The only real function of the court in a formal redemption is to establish the redemption amount (the market value of the property) and force the creditor to complete the transfer.

(b) Legal Requirements. The formal redemption procedure is not available unless the debtor can prove the following:

(i) Personal, Family or Household Use. The property must be used primarily for personal, family or household use. The property can not be primarily used for business purposes.

(ii) Dischargeable Debts Only. The property must secure a dischargeable debt. A debtor can not formally redeem property securing a debt that is non-dischargeable in bankruptcy, such as a student loan, divorce settlement, or non-dischargeable tax debt.

(iii) Exempt Property Only. The property must be exempt from seizure under applicable federal or state law. See the "Exemptions" page for a discussion of federal and state exemptions.

(c) Disadvantages. The formal redemption procedure is rarely used because of two major limitations: the legal cost and the requirement of a cash payment.

(i) Legal Cost. A major draw back of formal redemption is the legal cost. To complete a formal redemption, the debtor’s attorney will need to prepare a motion and proposed order, and appear at a court hearing. The hearing may involve a small trial on the valuation issue. The debtor may also need to hire an expert to appraise the property and appear in court to testify about the value.

(ii) Cash Payment. Formal redemption also requires the debtor to pay the full amount in cash. The court may not allow the debtor to pay the redemption amount in installments. Most debtors do not have the funds available to pay for the property in cash.

Priority Debts

The bankruptcy code contains a list of 9 different types of unsecured debts which have "priority" status over other unsecured debts. If money is available for distribution to creditors (a rare occurrence in a consumer Chapter 7 case), creditors holding priority claims will receive payment before any other unsecured creditors. All priority debts are "unsecured" because no specific property secures repayment of the debt. Priority claims receive payment in accordance with their rank in the priority scheme. Priority claims with a higher rank must be paid in full before priority claims of a lesser rank will receive any payment. Most priority classifications are not relevant in consumer Chapter 7 cases. The most important types of priority debts, and their rank, are as follows:

Administrative Expenses

Claims for expenses incurred by the trustee or debtor in preserving estate property, including wages, salaries or commissions for services rendered after the case has been filed. This category includes attorney’s fees incurred by the trustee or debtor in preserving estate property, or bringing property into the estate.

Child Support, Alimony and Support

Debts owed for accrued but unpaid support or alimony payments owed to a spouse, former spouse or child.

Tax Claims

Debts owed to governmental units for certain unpaid taxes. The following tax claims are considered priority debts:

Income Taxes

Any income tax if: (1) less than 3 years elapse between the date the bankruptcy is filed and the date the tax return was last due, including all extensions; (2) the tax is assessed within 240 days of the date the bankruptcy is filed; or (3) the tax has not been assessed, but is legally assessable after the bankruptcy is filed (e.g. additional taxes assessed as a result of an audit).

Employment Taxes

Most employment taxes owed by employers.

Sales Taxes

A sales tax owed to a governmental entity.

Property Taxes

A property tax more than one year in default before the bankruptcy petition is filed.

General Unsecured Debts

All debts other than secured and priority debts are classified as "general unsecured debts. Unsecured debts are debts which do not entitle the creditor to repossess any specific property if the debt is not paid. A "general" unsecured debt is an unsecured debt which is not entitled to priority.

Most credit card debts and medical bills are general unsecured debts. Debts obtained through the entry of a court judgment are also general unsecured debts, but can become secured against specific property if the judgment holder takes steps to secure the judgment in accordance with state law.