LSCU SMALL CREDIT UNION WORKSHOP STRENGTHENING YOUR COLLECTIONS PROGRAM Leonard N. Math Chambless Math ˜ Carr, P.C. P.O. Box 230759 Montgomery, Alabama 36123-0759 334-272-2230 I. EFFECTIVE AND EFFICIENT COLLECTION PROGRAM A. The Purpose of Collection Letters and Phone Calls B. Progressive Collection Letters & Phone Contacts C. Modification and Forbearance Agreements D. Repossession of Personal Property E. Use of Legal Counsel II. MAXIMIZING BANKRUPTCY RECOVERIES A. Chapter 13 1. Proof of Claim Filing 2. Proof of Claim Objections and Allowance 3. Insurance Issues 4. Plan or Direct Payment Defaults B. Chapter 7 1. Securing the Reaffirmation Agreement 2. Failure to Reaffirm, Redeem or Surrender 3. Post Reaffirmation, Pre Discharge Payment Defaults III. CMC CLIENT COLLECTIONS & BANKRUPTCY SEMINAR - May 12, 2011
LSCU SMALL CREDIT UNION WORKSHOP Leonard N. Math Chambless Math Carr, P.C. 5720 Carmichael Rd. Montgomery, Alabama 36117 334-272-2230
These materials are a copyrighted work and may not be reproduced and\or shared with other persons, parties or entities without the permission of the author. The discussion and opinions herein are those of the author. The discussion and opinions expressed herein are for general educational purposes and are not to be construed as legal advice or a legal opinion on any specific case or matter. These materials reflect an analysis of selected provisions of the collection law not legal precedents applicable to specific collection cases. Questions about individual cases, policies or procedures should be discussed with your legal counsel. To the extent that these materials and accompanying presentation is construed to be a solicitation by the Alabama State Bar Association, we are required to advise you that “No representation is made that the quality of the legal services to be performed is greater than the quality of legal services performed by other lawyers.”
Dated: 03/22/11
I. Collection Techniques and Tools A. Purpose of Collection Techniques To be a successful collector, you must have an understanding and knowledge of the techniques and tools at your disposal, but more importantly, you must also understand the reasons for using those tools. The ultimate goal of all collection activity is to secure payment of a debt, but the reason for using different collection tools in pursuit of that goal varies depending on the individual circumstances of each account. Most successful collection programs are based on making increasingly firmer demands for payment followed by specific consequences if the debtor fails to respond to each demand. In order for these demands to be effective, they must be continuous and persistent. Making firmer demands without any consequences for the failure to comply, is usually time consuming and ineffective. Once the debtor determines that there are no consequences for the failure to comply with payment demands, calls will go unanswered and demands will be ignored. On the other hand, when the debtor realizes that a broken promise to pay will result in another phone contact and that the length of time he has before the account will be referred for repossession or legal action, he will take the demand for payment seriously. It is only when the debtor realizes that the consequence for ignoring the payment demand is greater than he is willing to bear, that the debtor will make some attempt at payment. In many respects, collections are like a game of poker. Like a card player evaluating his opponent’s hand, you are making an evaluation of the debtor’s circumstances. Like a card player, you are betting by using negative consequences as money and you have to determine which consequence will ultimately make the debtor pay the debt. Likewise, the debtor is making an evaluation of what will happen if he does not pay and what you will do if he fails to pay. If the debtor thinks you are bluffing, he will call the bluff and ignore your demands. B. Assessment of the Ability to Pay While the goal of collection activity is to secure payment of the debt, there are several purposes for collection activity. First and foremost of these purposes is to make an assessment of the debtor’s ability to pay the debt. While most collectors are good at making demands for payment, they often fail to recognize that if the debtor does not have the present ability to pay the amount being demanded, the demand for payment will not be successful. Moreover, if the debtor does not have the present ability to pay, if no attempt is made to evaluate whether the debtor will have the ability to pay in the immediate future, the persistent and continuous demand for payment and imposition of consequences based on that failure to pay will also fail. The end result will be time consumed on an account that was not collectible in the first instance and delay in imposing the ultimate consequence, legal action or repossession. Making an assessment of a debtor’s ability to pay requires some finesse and good communication skills. In some cases, you will be dealing with sophisticated debtors such as self employed persons and small business owners. In other cases, you will be dealing with poorly
educated persons with poor communication skills. You must tailor your approach depending on the knowledge and education of your debtor. Moreover, in my experience, rather beginning cross examination of the debtor and his finances, many times engaging the debtor in other conversation about their circumstances will yield better results. There are certain basic elements of the debtor’s ability to pay: 1. Is the debtor employed and if so, where and what kind of income does the debtor have? 2. Is the debtor married and if so, is there other household income? 3. How many persons depend on that income and what are their ages? 4. How much is the debtor’s monthly rent or mortgage obligation? 5. What has caused the debtor’s default in payments? 6. Are the circumstances that caused that default temporary or permanent? 7. Does the debtor have a motivation to pay the debt according to its terms? 8. Does the debtor dispute liability for the debt? 9. Does the debtor have the ability to borrow sufficient funds from another source such as family member or other financial institution to become current or payoff the debt. C. Securing Information and Verification The second purpose of contacting a delinquent debtor is to secure information and verification about the debtor, their employment, and your collateral which serves as security for the loan. This information can be essential if a promise to pay is later broken. At a minimum, your contacts with the debtor should be designed to obtain the following information: 1. The debtor’s current physical and mailing address. 2. The debtor’s employment and income from employment. 3. The location and condition of any collateral which secures the loan. It is important to realize that as a condition of accepting a payment promise or granting an 2
extension of payment that you can request virtually any information from the debtor which verifies the information provided by the debtor. Therefore, you can request a copy of the debtor’s most recent pay stub and copies of tax returns and W-2 forms to verify that the information provided by the debtor is truthful. You can also sometimes obtain information from sources within your institution or company. For instance, most insurance binders will list an address for the debtor which can then be used to verify the debtor’s physical or mailing address and any discrepancy can be addressed at this time. Insurance binders may also list additional covered drivers, which may be the family member who is an actual possession of a vehicle which secures your debt. D. Payment Demands Most collection activity begins with one or a series of mildly worded letters inviting the debtor to contact the bank about missed payments. A debtor who responds to these letters is, by his very actions, indicating a desire to pay the debt or make arrangements to pay the debt. Of course, it is only when the desire to pay is coupled with a present ability to pay, that the collection action is successful. Most collection departments have guidelines which determine what accommodations may be made to delinquent debtors. The important thing at the early stages of collection is to determine whether the debtor will be able to comply with the accommodations available. In other words, if the debtor must cure a 90-day delinquency within 15 days and simply does not have the income to pay that amount or the ability to borrow that amount, there is no reason to allow the debtor 15 days to do the impossible. It is far better to concentrate your time on those persons who have an ability and desire to pay. Not surprisingly, when you tell the debtor there is nothing you do to help them get current and you need to make arrangements to recover the collateral, the debtor often finds an undisclosed source of income or ability to borrow from a third party. The most important thing about payment demands is that they must be clear and unconditional and the debtor must be advised at the time the demand is made that there will be consequences for his failure to comply. If there is sufficient time, a confirmation letter should be sent to the debtor which reminds the debtor of his new payment obligation. Finally, there must be timely follow up to determine whether the debtor has complied with the payment demand. E. Phone Contacts When making a phone contact with the debtor, it is best to start with an objective or series of objectives in mind. If the phone contact is initiated by the debtor, which indicates a desire to pay, that debtor will often provide employment and other information which you need to make a determination of the ability to pay. If you are one who initiates the phone contact, the purpose of the call may be to determine why the default occurred and whether it can be remedied. If it is a second or third contact or a follow up on broken promise to pay, a firmer tone can be effective in communicating to the debtor that this a serious matter and that if he fails to comply 3
with your demands that there will be consequences for that failure. Communicating consequences for failure to comply need not be threatening. But the debtor should be reminded that you are trying to assist him and if he does not meet you half way, your options to assist him become limited by Institution policy and practices. Almost all communications should be ended on a positive note indicating that you really want to assist the debtor within the limits of your authority. Only the most recalcitrant debtors should be outright threatened. You will generally do better with the carrot than the stick. F. Forbearance and Workout Agreements In many cases, a Workout Agreement or Forbearance Agreement can maximize the recovery of a delinquent account. Workout agreements usually take the form of a Modification Agreement. They generally involve a compromise on the part of the lender to accept less than the terms of the loan with the borrower would otherwise provide or a modification of the terms, such as a lower payment or longer term of repayment than provided in the original contract. Lenders may be willing to compromise and enter into a workout because they believe they will recover more than they would through liquidation of the collateral. By their very nature, no two workouts are the same since their terms are dependent upon the lender’s and borrower’s creativity in putting together an alternative to collection or repossession. Such a plan will take into account any number of factors such as collateral loan to value ratio, the borrower’s financial resources including present and projected income, and/or the borrower’s ability to pledge additional collateral. Workouts may involve a payment grace period, a temporary or permanent reduction in the regularly required payments, a principal and/or interest reduction, extension of the note term or the pledge of additional collateral by the borrower. Whatever its terms, the goal of any workout from the lender’s perspective is to maximize recovery of its loan. Forbearance agreements differ from workouts in that they are temporary arrangements to delay collection of the debt usually without a modification of the loan terms. They generally do not involve long-term rearrangement of debt or a compromise by the lender to accept significantly less than it would receive under the terms of the original loan documents. Forbearance agreements are typically used when the borrower defaults as the result of what appears to be a short-term income or expense or when the lender is willing to provide the borrower with a set period of time to refinance the defaulted loan with another lender. Forbearance agreements are structured so that the lender has the right to immediately repossess or foreclose collateral in the event the borrower fails to meet the terms of the forbearance agreement within the specified time frame. Often forbearance agreements are accompanied by a payment in exchange for the delay n collection or repossession. In forbearance agreements, it is often possible to establish terms which permits the expedited liquidation of the loan and the waiver of any potential defenses to the enforcement of the debt. It is common to require the borrower to agree: 4
1. That a default has occurred and the loan has been properly accelerated and is fully due and payable; 2. Lender agrees to forebear from foreclosing so long as borrower makes all payments required by the forbearance agreement and otherwise complies with its terms; 3. Lender has the right to commence repossession or foreclosure in the event borrower defaults under the terms of the agreement and/or the borrower agrees to execute a deed in lieu of foreclosure or surrender other collateral on demand; 4. Borrower waives all defenses to the enforcement of the debt and releases the Lender from any and all claims against the Lender for existing or future conduct related to the collection of the debt; and 5. After the forbearance period has ended, the Lender may repossess or foreclose on the collateral if not paid in full and\or the borrower consents to entry of judgment for the balance due on the debt. A forbearance agreement is therefore used to provide the borrower one last chance to become current or pay off the loan without significant compromise of the lender’s position. Whether to forebear, workout or repossess\foreclose on collateral is a business decision. In evaluating how to proceed, the Lender must evaluate its options in light of the value of the collateral securing the loan, the borrower’s ability to meet the proposed financial requirements, and whether the proposed arrangement is likely to yield a greater recovery or avoid greater losses than would be expected if the Lender immediately proceeded with foreclosure, repossession or legal collection. II. Repossession of Personal Property Once it has been determined that a delinquent account debtor does not have the ability or desire to voluntarily repay the debt according to its terms, the Institution has the option to recover any collateral which secures the loan. Repossession of security is one of the primary means of collecting a debt and done properly can reduce losses that would otherwise occur in the absence of collateral. However, even a slight error in the repossession process can expose the Institution to damages for an improper repossession. Policies and procedures are a starting point for reducing the potential liability for an improper repossession. You should be aware that even a small deviation from established procedures can be very costly.
A. Repossession Checklist
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1. Loan Document Review a. Signed Security Agreement b. Collateral Description c. Perfection on Cert of Title or Filed UCC-1 2. Acceleration of the Debt 3. Assignment to Repossession Agent a. Instructions to Agent b. Hold Harmless Agreements c. Periodic Contractor Due Diligence 1. Proof of General Liability Insurance 4. Recovery of Collateral a. Condition Report b. Pre Sale detailing and repairs c. Documentation of NADA/Kelly Blue Book Values 5. Disposal of Collateral a. Notice of Sale and Right to Redeem b. Notice of Deficiency or Surplus c. Disclaimer or Warranties III. Use of Legal Counsel The use of outside legal counsel for collections is a necessity for most small credit unions. Given the smaller staff available for collection activity, the use of legal counsel provides a strong motivation to pay in most delinquent members. Specifically, legal counsel can usually perform the following activities more efficiently than most small credit unions: 1. Post acceleration, pre suit demand letters 2. Filing suit and securing judgment 3. Post judgment collection by garnishment and execution 4. Detinue actions to recover collateral which member refuses to surrender Most firms in Alabama, including our firm, handle regular collections for a contingent fee based on the money collected from the member. The Credit Union only has to advance the costs of suit, which are the same whether the Credit Union files its own cases (only available for balances under $10,000.00) or whether they use legal counsel to handle the accounts. However, recall that the use of legal counsel can only provide the member with the motivation to pay the delinquent account. The use of legal counsel will not generally be successful if the member does not have the ability to pay the account. If the member is on social 6
security or retirement benefits which are exempt from garnishment and has no non-exempt assets from which to recover the balance owed, then the reduction of a claim to judgment will preserve the Credit Union’s rights, but may not result in a actual recovery to the Credit Union. On the other hand if the member’s inability to pay is temporary in nature, such as a loss or break in employment, then use of legal counsel provides a regular and consistent follow up for collection when the member regains their financial health. IV. Maximizing Bankruptcy Recoveries A. Chapter 13 A Chapter 13 bankruptcy is a wage earner repayment plan whereby the debtor proposes to make payments to a Chapter 13 trustee for period of 36-60 months and those funds are paid by the Chapter 13 Trustee to the creditors in accordance with a plan of repayment approved by the Court. The is commenced with the filing of the bankruptcy petition at which time the debtor proposes his plan of repayment. Once the plan is proposed and after the meeting of creditors, the plan must be confirmed by the court. Confirmation by the court means that the plan complies with the requirements of the Bankruptcy Code. After confirmation, the court enters a confirmation order and the debtor begins his payments to the Chapter 13 Trustee. The Chapter 13 Trustee then disburses the money to the creditors in accordance with the debtor’s plan. One of the main differences between the Chapter 13 Trustee and the Chapter 7 Trustee is that in Chapter 13, the Trustee pays both secured and unsecured claims in accordance with the plan, whereas in a Chapter 7 case, the Trustee only pays the unsecured claims. Generally creditors cannot force a plan to pay over more than 36 months even if it would pay a higher dividend to the creditors. The proposal of plan is the debtor’s exclusive right and creditors may object to plan provisions, but cannot propose an alternative plan. If the debtor’s plan does not comply with the Code, creditors can file an objection to confirmation. Objections to confirmation are generally based inadequate valuation of collateral or capitalization\interest rates on secured claims, lack of insurance on collateral or failure to make direct payments as proposed by the plan. If the court sustains the objection the case is ordered not confirmed and if the debtor cannot cure the objection with an amended plan, the case is ultimately dismissed. If the court overrules the objection, the case is confirmed. If the debtor makes all the payments called for under the plan, he gets his discharge. The Chapter 13 discharge is less broad than the Chapter 7 discharge. In Chapter 13, long term debts, such home mortgages, survive the discharge. If the debtor fails to make his payments, then his case can be dismissed by the court. If the debtor has good reason for the failure to make payments, the debtor can request a hardship discharge in lieu of dismissal. A hardship discharge has the same effect and scope of a Chapter 7 discharge 1. Filing the Proof of Claim
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Since the creditor is to receive payments from the Chapter 13 trustee, the creditor must file a proof of claim which lists the amount and nature of claim. The trustee then pays the claim as filed unless the debtor files an objection to claim. The proof of claim must be filed by the deadline set by the court or they are disallowed. There are only a few provisions that allow for a late filed proof of claim. For instance, if you have a secured claim and fail to file a claim, then you can file a Motion for Relief from stay based on the non-payment of the claim due to the failure to file. If you do not receive notice of the filing of the case because of an incorrect address listing, you can file a claim after the claims bar deadline. Since the proof of claim is filed with the Court, it should reflect the balance due as of the date of filing. No unmatured interest or additional fees are allowed except is limited cases where the value of the collateral securing claim is greater than the balance due. The proof of claim must attach copies of the promissory note or account agreement upon which the claim is based and proof of a perfected security interest, such as a recorded mortgage, certificate of title or a UCC financing statement must be attached to the proof of claim. The bankruptcy notice contains a deadline for filing the proof of claim. If you fail to file a claim or timely refer a case to legal counsel to file the proof of claim, your claim may be disallowed and you will not receive any distributions from the case. 2. Proof of Claim Objections and Allowance A Debtor or Chapter 13 Trustee as the right to object to a proof of claim filed in a bankruptcy case. Most objections relate to form or amount of the proof of claim or its status as a secured or unsecured claim. In most Alabama Bankruptcy Courts, an objection to a proof of claim is served on the creditor and if no response is made to the objection, then the objection to claim is granted without a formal hearing on the objection. If no response is made, the claim can be disallowed in part, changed from secured to unsecured status or disallowed entirely. Therefore, if you receive and objection to a proof of claim filed on your behalf, contact your legal counsel immediately. 3. Insurance Issues The Bankruptcy Code requires a debtor who elects to retain collateral, whether through Trustee payments or direct payments to provide the creditor with proof of insurance within 30 days of the filing of the case. It is therefore essential for you review your file, determine whether any prior policies are in effect or have been cancelled. If there is no insurance coverage, an objection to confirmation can result in dismissal of the case or more likely a future default order regarding insurance wherein if the debtor lets insurance lapse in the future, the stay lifts without further notice or hearing. We recommend that a creditor secure either a blanket collateral protection insurance policy covering all uninsured collateral or that forced placed coverage be added to accounts 8
without insurance where the value of the collateral merits such an expense. As a general rule, such charges cannot be added to claims paid through the Chapter 13 Trustee, but may be added to accounts where the payments are made directly by the debtor by including the charges in the arrears claim or adding it to end of the loan. However, once proof is obtained, the forced placed insurance must be cancelled and any premium rebate credited to the account. 4. The Chapter 13 Plan and Direct Payment Defaults A Chapter 13 plan must meet a number of requirements to be confirmed by the Court. Many courts are now using a model plan which makes the plan disclosure more uniform and easier for creditors to read. The plan must propose to submit to the supervision and control to the trustee all or such portion of the debtors earnings or income as is necessary for the execution of the plan. Note that the requirement of submission of future income is not dependent on other parties to the case, thus where a creditor fails to file a claim, the debtor may not reduce their payments to the trustee. Rather, the pro rata share to all other creditors is increased or the plan pays out faster. The plan must provide for full payment, in deferred cash payments of all claims entitled to priority under Section 507 of the Code, unless the holder of the claim agrees to different treatment. A plan may provide for a modification of the rights of holders of secured and unsecured claims other than a claim secured only a security interest on real estate which is the debtor’s principal place of residence. This means that on debts other than a real estate loan on a home mortgage, the debtor can alter the amount of payments, the timing of the payments and the duration of the payments that would otherwise be due under the contract. Note that real estate loans secured by property other than the debtors principal residence can be modified. This provision is generally used to alter terms of secured debts and unsecured debts secured by reamortizing the loans with lower payments and generally an extension of the maturity date of the original note. A plan may provide for the curing of any pre-petition default in payments or other terms on any type of debt or any kind of default. Therefore, notwithstanding any pre-petition acceleration of the debt by the creditor, the debtor can provide for a cure of the default and reinstate the obligation and pay by modifying the terms of under 1322(b)(2) or maintaining payments under 1322(b)(5). Similarly, the plan may allow the debtor to reinstate and resume regular payments on any secured or unsecured claim for which the last payment is due after the date on which the final plan payment is due. As to other debts, gives the debtor the choice to modify under 1322(b)(2) or cure and resume regular payments under 1322(b)(5). If the debtor elects to cure a default and maintain payments on long term debt, the amount required to cure is that required by the underlying agreement and non-bankruptcy law, includes all interest and late charges, misc charges, escrows shortages. etc. Once the petition for relief is filed, the law automatically imposes something called the automatic stay which prohibits creditors from any act to collect the debt from the debtor as well as other actions. In substance, the automatic stay prohibits any action to collect the debt, 9
including but not limited to calling or writing the debtor to make a demand for payment, repossession of collateral for loans, or actions to disable to prevent the debtor from using collateral. The automatic stay also prohibits a creditor from submitting an application for lien on a certificate of title or filing a UCC financing statement to perfect a security interest in other collateral. It also prohibits the filing of a real estate mortgage to perfect a lien on real estate. The Bankruptcy Code allows a creditor to seek to modify or terminate the automatic stay to permit repossession of collateral if a Debtor fails to make payment to the Chapter 13 Trustee or if the Debtor fails to make direct payments to creditors as proposed in the confirmed plan. You should have a system on place to monitor receipt of and breaks in payments from the Chapter 13 plan and direct payments and should contact legal counsel of a debtor becomes sixty days or more delinquent in plan or direct payments. When a debtor fails to make regular payments to a Chapter 13 Trustee or otherwise fails to comply with the Bankruptcy Code, his case can be dismissed. WHEN A CASE IS DISMISSED, YOU MAY PROCEED WITH FURTHER COLLECTION OF THE ACCOUNT AS IF THE CASE HAD NOT BEEN FILED. Dismissal is accomplished by the filing of a Motion to Dismiss. A Motion to Dismiss may be filed by the debtor (Voluntary Dismissal) or by a creditor, by the Chapter 13 Trustee, or by the Bankruptcy Administrator. The Motion to Dismiss is set for hearing and notice of hearing is sent to all creditors. A hearing where the motion is either granted or denied. Creditors are mailed a copy of the Curt’s decision on the Motion to Dismiss. If the motion is denied, the case continues on its course towards discharge. If the motion granted, the Court enters a DISMISSAL ORDER which dismisses the case. Remember, if the motion is denied, the case remains pending and the automatic stay is in effect. However, if the motion to dismiss is granted and the DISMISSAL ORDER entered,, YOU MAY PROCEED WITH FURTHER COLLECTION OF THE ACCOUNT AS IF THE CASE HAD NOT BEEN FILED. Conditional Dismissals - Middle District of Alabama. The Middle District of Alabama (Montgomery, Opelika, & Dothan) has a procedure called a conditional dismissal. The procedure is generally used in Chapter 13 cases where the debtor has defaulted in plan payments to the Chapter 13 Trustee. The Chapter 13 Trustee files a Motion to Dismiss based on the default in payments. Instead of the Court sending Notice of a Hearing on a Motion to Dismiss, the Court enters an order which provides that unless the debtor files an objection to the motion to dismiss, that the motion to dismiss will be granted in 20 days. The automatic stay continues in effect during the 20 days objection period and if the debtor files an objection to the motion to dismiss, the motion to dismiss is then set for hearing. There are two potential pitfalls with this procedure for creditors. First the conditional order of dismissal looks like an order dismissing the case, so you must actually read the order and make sure that if it states that the case will be dismissed in 20 days, that you keep the account flagged as a bankruptcy until the actual dismissal order is entered. If you repossess 10
collateral during the 20 day period, you have violated the automatic stay. The second pitfall is that if the debtor files an objection to the motion to dismiss, you will not receive a copy of the objection. Therefore, you should NOT act on a conditional dismissal after the 20 days has passed without confirming that the case has actually been dismissed. Dismissals With Injunctions - Southern District of Alabama. The Southern District of Alabama (Selma & Mobile) have a procedure for dismissal for non-payment to the Chapter 13 Trustee. In their motions to dismiss, the Chapter 13 Trustee asks the court to add to the dismissal order, a provision which prohibits the debtor from filing a new bankruptcy case for specific period of time, generally 90 days from the date of dismissal. That provision is called an injunction against refiling because that is the legal term for a court order which bars the debtor from doing a certain thing. If you receive a dismissal with an injunction against refiling, you have opportunity to act quickly to recover your collateral without the worry of a new bankruptcy filing. B. Chapter 7 Recall that the effect of the discharge order is to prevent the creditor from collecting the debt as a personal liability of the debtor. However, the discharge order does not invalidate any properly perfected liens in collateral pledged as security for a debt. When a debtor files Chapter 7, the Bankruptcy Code allows the debtor three options for secured debts: 1. Surrender: The debtor can surrender the collateral to the creditor for sale with the proceeds applied to the debt. If there is any balance remaining, it is called a deficiency balance. The deficiency balance becomes an unsecured debt and the if the debtor complies with the requirements for Chapter 7 and receives his discharge, the deficiency balance is not collectable from the debtor. However, the deficiency balance is an unsecured claim and may participate in any distributions from other debtor property liquidated by the trustee if there is any. Note that until the discharge order enters the automatic stay prevents the creditor from involuntarily repossessing collateral, even if the debtor proposes of says that he is going to surrender the collateral in his statement of intent. Therefore, until the discharge enters, if a creditor wants to recover its collateral or proceed with a mortgage foreclosure, the creditor must seek to have the automatic stay lifted. There are two ways that the automatic stay can be lifted prior to discharge. The debtor and creditor can execute an agreed order terminating the stay in which the debtor, the creditor and the Trustee advise the Court that the stay may be terminated. Once the agreed order terminating stay is signed by the Judge, the stay is lifted and if the debtor fails to refuses to surrender the collateral or make it available for recovery, the creditor may assign the account for repossession. The second way to terminate the stay is with a motion to lift stay in which the creditor asks the court to lift the stay as against the debtor and the trustee. Each court has a 11
different procedure for chapter 7 motions to lift stay, but generally the creditor files the motion, it is set for hearing and absent any objection by the debtor or the trustee at the time of the hearing the motion to lift stay is granted and court enters and order terminating stay. Once the order terminating stay is signed by the judge, the stay is lifted and if the debtor fails to refuses to surrender the collateral or make it available for recovery, the creditor may assign the account for repossession. Note that the lifting of the automatic stay only removes the collateral from the jurisdiction of the bankruptcy court. Therefore, if a debtor skips with the collateral, you may have to proceed with a detinue action to secure a state court order to recover the property. In addition, the Uniform Commercial Code requirements for Notice of Sale and disposition of the property are still applicable and special Notice of Sale is required. Failure to give a Notice of Sale after termination of the automatic stay can expose the Bank to liability for damages for an unauthorized disposition of the collateral. 2. Redemption. Redemption under the bankruptcy code is where the debtor offers to pay the creditor the value of the collateral and retain it. This is accomplished through a Motion for Redemption. If the debtor and creditor agree on a value of the collateral, that amount is stipulated to and the debtor is given a short time, usually 30 days to pay the agreed amount in a lump sum payment. Redemptions in Chapter 7 cases may not be made in installment payments. Once the lump sum is paid the remaining balance is a deficiency balance and it is an unsecured claim, and may participate in any distributions from other debtor property liquidated by the trustee if there is any. If the debtor complies with the requirements for Chapter 7 and receives his discharge, the deficiency balance is not collectable from the debtor. Redemption under the Bankruptcy Code is different from redemption under the Uniform Commercial Code. Redemption under bankruptcy code is permitted by paying the value of the property, whereas a redemption under state law UCC is done for amount of the debt, plus the expenses and costs of repossession 3. Reaffirmation agreement: A reaffirmation agreement is an agreement between the debtor and the creditor whereby the debtor agrees to keep the collateral and repay the debt. The reaffirmation agreement can make modifications in the amount or timing of payments or make provisions for curing any delinquency existing at the time the reaffirmation agreement is executed. There are several requirements for the agreement to be valid. The reaffirmation agreement has to have certain specific information and disclosures mandated by the Bankruptcy Code. It must be executed by the debtor and the debtor’s attorney, and the creditor and it must be filed with the court. The agreement must contain a certification of the debtor’s attorney regarding the debtor’s ability to repay the debt. If the debtor is pro se, the agreement must be approved by the court. Lastly, the reaffirmation agreement must be filed with Court before the entry of discharge. 12
Once a reaffirmation agreement is properly completed, filed with and approved by the Court if necessary, it obligates the debtor to repay the debt as a personal liability notwithstanding the discharge order. In other words, if the debtor reaffirms and later defaults after the entry of discharge, the debtor is liable or the deficiency balance as if the bankruptcy had never been filed. Because of the consequences of reaffirming the debt, the Bankruptcy Code allows a debtor to rescind a reaffirmation agreement within a specified period of time after execution. The debtor may rescind a reaffirmation agreement at the later of: 1. 60 days from the filing of the agreement with the Court or 2. The date of the discharge order, whichever is later. Currently many credit unions and other consumer lenders require that a debtor reaffirm all debts with the lender as a condition of reaffirming their secured debt. We need to be advised whether the Bank intends to require reaffirmation of all debts as a condition of reaffirming any secured debts. This policy often results in a recovery on an unsecured debt that would have been otherwise discharged. However, it can also result in the repossession of foreclosure of collateral, where the debtor would reaffirmed only the secured debt. 2. Failure to Reaffirm, Redeem or Surrender Under §521 of the Bankruptcy Code, an individual Chapter 7 debtor whose debts include consumer debts must file a statement of intent indicating whether the debtor intends to reaffirm, redeem or surrender the property securing such consumer debts. Under §362(h) of the Bankruptcy Code, the stay is terminated as to personal property collateral if the debtor fails to timely file a statement of intentions indicating that the debtor will reaffirm, redeem or surrender, or assume the lease and take timely action to perform the intentions. Under §521(a)(2), the debtor has 30 days from the date of filing to file the statement of intent and 30 days to perform the stated intention. The termination of the stay provided in §362(h) does not take effect if Chapter 7 trustee files a motion prior to the expiration of the stay and the Court determines that the personal property is of value to the estate, i.e. the debtor has equity in the property, orders adequate protection for the creditor/lessor and orders the debtor to deliver the personal property to the trustee. This section must also be read in conjunction with new §521(a)(6), which eliminates the retain and pay current option for purchase money security interests in personal property. In the case of a PMSI in personal property, §521(a)(6) requires the debtor to either reaffirm, redeem, or surrender the property must within 45 days after the first meeting of creditors. If debtor does not reaffirm or redeem within 45 days the property is no longer property of the estate and the stay is terminated unless the Court on motion of the trustee, filed within the 45-day period, determines the property is of consequential value to the estate. 3. Post Reaffirmation, Pre Discharge Payment Defaults 13
A common question arises when the debtor enters into a reaffirmation which has been properly filed and approved by the Court, but then later defaults in payments either discharge or before the time to rescind the agreement has passed. The creditor has basically two options: 1. If the discharge has not entered, the creditor can file a Motion to Lift Stay to repossess the collateral. Of course, if you do that and the motion is granted, the debtor will simply rescind the reaffirmation agreement. Once that is rescinded, you have recovered your collateral, but lost the deficiency claim. 2. Alternatively, you can elect to play softball with the debtor until the reaffirmation agreement becomes final after the discharge and after the 60 days from the date the agreement was filed with the Court. You can send the debtor a extremely mild payment reminder letter advising the debtor that you have the reaffirmation agreement, but wanted to make sure that the payment had not been lost or mis-posted. Once the reaffirmation agreement becomes final, you can then play hardball and make demands on the debtor and repossess the collateral with the assurances that the debtor will be liable for the deficiency balance.
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