June 27, 2017

Reaffirmation in Bankruptcy: What, How, When and Why

picture of a broken eggThe goal in any bankruptcy case is to discharge debts. Discharge is the technical legal term that means the debts no longer exist. Literally, they are gone and can never come back.

An exception to discharge can come in the form of the reaffirmation of a particular debt. Reaffirmation means that the debt is excepted from the discharge and is not affected by the bankruptcy discharge.

Reaffirmation is voluntary.  In other words, the debtor must agree to the reaffirmation. It must be done during the course of the bankruptcy case and cannot be done after the case is closed.

What types of property are affected by reaffirmation?

There are two types of property that can be affected by reaffirmation, real property (land and buildings) and personal property (anything that is not land or buildings; e.g. cars, furniture, stocks, bank accounts and the like). 

Reaffirmation almost always pertains to secured creditors and in better than 95% of the cases involves reaffirmation of obligations secured by automobiles. 

Creditors with mortgage liens can require the debtor to reaffirm the automobile in order to keep it. The typical situation is that the debtor must have an automobile to conduct the business of everyday life. The creditor requires reaffirmation. In order to keep the car, the debtor must either reaffirm or redeem the property.

Redemption means immediately paying the actual value of the secured property to the creditor.  There will be more on this subject in a later post.  For now, that leaves the debtor with only the reaffirmation option.

How does reaffirmation work?

Three steps. First, the debtor must keep the car; therefore, he or she agrees to reaffirm. Second, the necessary documents are filed with the bankruptcy court. Third, the bankruptcy court blesses the reaffirmation.

Thus, for all practical purposes, the debtor has entered into a new contract with the creditor. It is as if the bankruptcy case has never existed as to that creditor.  The debtor must make the payments.

In the event of default in payment, the creditor can repossess the automobile, sell it at a foreclosure sale, and pursue the debtor for a deficiency. Deficiency means any amount left owing after the automobile is sold and the proceeds of sale is applied to the debt.

Reaffirmation of personal property

The foregoing applies to any personal property in which there is a purchase money security interest. Purchase money means that the loan or financing secured by the property was used to enable the debtor to acquire the property. 

This applies to such things as furniture, electronics, jewelry and the like. In theory, the secured creditor can require the debtor to reaffirm to keep the property. In practice, secured creditors rarely try to enforce security interests in these types of personal property. 

It is worth noting that the bankruptcy law forbids enforcement of non-purchase money mortgage liens in household goods. In other words, a debt owed to a finance company that is secured by the debtor’s furniture is not enforceable in the situation in which the debtor owned the household goods at the time the loan was made.

Reaffirmation of real property

The other type of reaffirmation applies to real property. Almost invariably, this will be the debtor’s home. 

With real property, the creditor cannot require the debtor to reaffirm or surrender the property. The debtor may elect to retain the property and continue to make the payments. 

The discharge is effective as to the underlying debt owed to the mortgage lien creditor. The debt has ceased to exist; however, the real estate continues to be mortgaged to secure the debt. 

In the event of default, the lender may foreclose on the real estate but cannot seek to recover a deficiency from the debtor.  

My advice on reaffirming real property

For most debtors, the home loan is their largest debt. A default on a home loan can result in a catastrophic deficiency. Thus, almost invariably, I advise clients not to reaffirm home loans. Too many times I have seen clients seek to retain their home only to have a subsequent job loss or domestic separation result in their inability to make the house payments. When this happens, I can advise them that they did not reaffirm; and thus, a foreclosure will not result in a new obligation.  

If your real estate is “under water” this white paper may help you sort through the issues before you, but it is not a replacement for legal advice from a qualified bankruptcy lawyer.