Lenders make secured loans expecting to recover the collateral in the event of a default. The collateral is sold to satisfy the debt. Experienced secured lenders understand that the automatic stay in bankruptcy stops recovery of collateral recovery without permission of the court. However, many secured lenders do not understand rights related to the statement of intention every debtor is required to send to each secured creditor.
The obligation of a debtor to send the statement of intention is in §521(a)(2) of the Bankruptcy Code. A debtor that owns property subject to a security interest, whether real property or personal property, must choose to either surrender, reaffirm, or “redeem” the collateral securing the debt. Each Debtor is required to inform each secured creditor in writing of the debtor’s choice no more than 30 days after the bankruptcy was filed and before the scheduled meeting of creditors. First, the debtor may state an intention to “surrender” the collateral, which means turning the collateral over to the secured creditor. Second, the debtor may state an intention to “reaffirm”, meaning that the debtor executes a new written agreement to continue making payments and retain the collateral as if the bankruptcy had not occurred. Third, the debtor may state an intent to “redeem” the collateral. This means “buying” the collateral back from the secured creditor at fair market value. A common example of redemption is when a debtor has a vehicle with low market value but a significant debt. The debtor can pay the market value and discharge the balance of the creditor’s claim. The drawback to redemption for a debtor is that the full redemption value must be paid in full and in cash, unless the creditor agrees to some other payment arrangement.
Many lenders do not understand that the Bankruptcy Code also requires the debtor to perform his or her intention within 30 days after the conclusion of the meeting of creditors. Section 521(a)(6) of the Bankruptcy Code states that a debtor must surrender personal property collateral in a chapter 7 case unless the obligation is reaffirmed within 45 days after the first meeting of creditors. Furthermore, the automatic stay against recovery of collateral is terminated under §362(h) of the Bankruptcy Code if the debtor fails to file a timely statement of intention; or to indicate whether the Debtor intends to surrender, reaffirm or redeem the collateral; or if the debtor fails to enter into a reaffirmation agreement after stating an intention to do so.
Secured creditors often fail to enforce the obligation of the debtor to file a timely statement of intention and then carry out the stated intention. This may occur, in part, because the debtor does not timely file and serve the statement of intention. Also, most debtor’s attorneys expect a secured creditor to provide a draft reaffirmation agreement to the debtor for signature. If the debtor and the secured creditor wish to reaffirm the secured debt, the agreement must be reached before the discharge is entered and the agreement must be filed with the bankruptcy court for the agreement to be enforceable.
Another significant problem is that secured creditors often allow the “ride-through,” which means that the Debtor retains the collateral and simply continues to make required payments without reaffirming the debt. Federal courts are divided on whether this is permissible. There is nothing specific in the Bankruptcy Code which allows a debtor to keep collateral without otherwise complying with the statement of intention. Secured creditors often continue accepting monthly payments and fail to enforce the debtor’s obligations because this is the path of least resistance for the creditor. However, this tolerance of bad debtor behavior will create problems in the event of a subsequent default. For example, if the Debtor has received a discharge, the secured creditor will not be able to collect a deficiency. Also, unless the bankruptcy case is closed, the automatic stay may bar the creditor from recovering the collateral. If the bankruptcy case has been closed the Debtor may refuse to cooperate or obstruct repossession of the collateral and the secured creditor will have to sue in state court to recover the collateral.
Creditors making loans secured by property should understand the obligation of each debtor to provide a statement of intention, the options each debtor has and then establish procedures to take advantage of the significant protections given each secured creditor under the Bankruptcy Code.