Consumer Chapter 7
A secured creditor's lien will survive the debtor's bankruptcy unless avoided. In a Chapter 7 this is true even though the debtor's personal liability on the debt is discharged. At first blush it may seem odd that a lien survives even though the debt it secures is discharged; after all, the lien arose to secure a debt and, if the debt is now eliminated, how can the lien have any meaning? It may help for you to think that the in personam liability of the debtor is discharged but the in rem liability of the collateral remains to the extent of the amount of the debt that has been discharged, or to the extent of the value of the collateral, whichever is less..
Consider two typical examples involving a Chapter 7 debtor who is a natural person.
(1) The debtor's debts include $10,000 owed to Bank, secured by a purchase-money security interest in an automobile. In the usual case the debtor's personal liability on the $10,000 debt will be discharged. However, the security interest, which cannot be avoided, will remain. If the automobile is worth $12,000, the lien is "worth" $10,000. If the car is worth $8,000, the lien is "worth" $8,000. This means that following termination of or relief from the automatic stay the bank may repossess the car and keep up to $10,000 of the proceeds of sale of the car.
(2) The debtor's debts include $150,000 borrowed from a Savings and Loan to finance purchase of a residence; the debt is secured by a first deed of trust on the residence. The debtor's personal liability on the debt, if any, will be discharged. The lien of the deed of trust, which cannot be avoided, will remain. Following termination of or relief from the automatic stay, the Savings and Loan may foreclose on the property.
Where the security interest cannot be avoided, the Bankruptcy Code offers the debtor three alternatives to repossession or foreclosure, as the case may be. The options are specified in Bankr. Code 521(2), a section that requires the debtor to notify the secured creditor of the debtor's intentions with respect to collateral.
First, the debtor may surrender collateral to the secured creditor or, in the case of real property, not oppose the foreclosure.
Second, under certain conditions, a debtor may redeem certain personal property collateral from the lien by paying the secured creditor an amount equal to the value of the collateral or the amount of the debt, whichever is less. See Bankr. Code 722. This offers little solace in most cases because, absent creditor agreement to the contrary, the debtor may not pay in installments; the debtor must pay a lump sum. Typically, a debtor who has just filed bankruptcy does not have the resources to make that payment. In our illustration above, the debtor will likely be unable to pay $10,000, or $8,000, as the case may be.
The debtor's third alternative is to negotiate a reaffirmation agreement with the creditor. Through such an agreement, the debtor obligates himself or herself anew to pay the debt that has been discharged and agrees that this reaffirmed debt will be secured by the same collateral that secured the old debt. With respect to automobiles, creditors almost always require that the debt repayment be on the same terms as the old. The debtor is not entitled to a reaffirmation agreement; creditors are free to decline and assert their right to the collateral. In most cases, however, the creditor prefers the debtor's payment under the reaffirmation agreement (now more likely because the Chapter 7 discharge has lightened the debtor's financial burdens) to the prospect of repossession.
In some circuits, debtors have successfully invoked a fourth alternative to repossession of personal property: continue making payments called for under the original contract and resist the creditor's request for a reaffirmation agreement. This strategy (sometimes colloquially referred to as "ride through"), where successful, avoids the debtor's potential liability for a deficiency under the reaffirmation agreement in the event the debtor defaults on the reaffirmation agreement.
Empirical evidence suggests the percentage of debtors exercising each of the alternatives. Based on a statistically significant random sample of consumer Chapter 7 cases filed in bankruptcy courts in seven districts in 1995, law professors Marianne Culhane and Michaela White, of Creighton University School of Law, report the following in M.Culhane & M. White, Debt After Discharge: An Empirical Study of Reaffirmation, 73 Amer. Bankr. L.J. 709 (1999):
(1) Vehicles: Approximately 50% of debtors entered Chapter 7 with automobiles, trucks, or motorcycles subject to a lien. The mean amount of debt secured by a motor vehicle was $7,607 and the median amount of debt secured by a motor vehicle was $7,265. With respect to these secured debts, approximately 22% of debtors surrendered the vehicle to the secured party or lost possession of the vehicle through repossession following relief from the automatic stay. Another 21% reaffirmed the debt. Another 3% proposed to redeem the vehicle from the lien but the files do not contain information about whether redemption in fact occurred. The files in these cases contain no information about what happened to the vehicle in the remaining 55% of the cases. One is left to infer that in most of these remaining cases the debtor either retained the vehicle by continuing to make payments without reaffirming the debt or signed a reaffirmation agreement which, because it was not timely filed in the bankruptcy case, is unenforceable (although the debtor may not know that the agreement is unenforceable).
(2) Residences: 30% of the debtors owned homes (including mobile homes). 25% of those debtors either proposed to surrender their home or likely lost it through foreclosure following lifting of the automatic stay. 15% of the debtors in the entire sample reaffirmed the debt secured by their home, but none of the debtors in the sample drawn from the Northern District of California did so. The absence of reaffirmations in California for debts secured by residences might be attributable in part to relevant anti-deficiency legislation that would make such an agreement unenforceable. There is likely an alternative explanation. An Omaha, Nebraska practitioner representing approximately a dozen residential lenders offers this explanation for the absence of agreements reaffirming loans secured by residences: Often a residential mortgage lender no longer owns the loan (Fannie Mae and Freddie Mac do) or the loan has been guaranteed by the FHA. Consequently, the original lender is often just servicing the loan (collecting and forwarding payments, sending reminders in case of late payments, pursuing foreclosure and collection) and is reimbursed by the loan's owner for only about 90% of the costs of loan collection they incur. If a debtor's payments are current, such "lenders" have little or no incentive to seek a reaffirmation since they will eat 10% of the processing costs. (Note, however, that in Nebraska 31% of debtors reaffirmed the debt secured by a home).
The files in these cases contain no information about what happened to the home in the remaining 60% of the cases. One is left to infer that in most of these remaining cases the debtor retained the home by continuing to make payments without reaffirming the debt. Generally, we surmise, such creditors are content if they continue to receive timely mortgage payments. The debtor who defaults in mortgage payments will, ultimately, lose the home in foreclosure absent reinstatement, a mutually agreeable arrangement with the creditor to cure the arrearage, or a cure that might be forced on the creditor if the debtor invokes Chapter 13 of the Bankruptcy Code.
To summarize:
1. Most Chapter 7 debtors are natural persons whose in personnam liability on debt is discharged;
2. Where properly perfected, consensual purchase-money liens on automobiles and residences cannot be avoided in bankruptcy;
3. More than half of Chapter 7 debtors appear to keep their automobile by reaffirming the debt incurred to purchase the automobile on the same terms and conditions as the original contract or by continuing to make payments as called for in the original contract without reaffirmation.
4. More than half of Chapter 7 debtors who own a home will keep their home without reaffirmation by continuing to make timely mortgage payments, but lose their home if unable to continue making mortgage payments. A debtor facing arrearages in mortgage payments must negotiate a cure with the creditor or consider forcing a cure on the creditor under Chapter 13, either following or in lieu of Chapter 7.