Reaffirmations & Credit Reporting – Theory & Practice (Part 1)

A key component to helping people rebuild credit after filing for bankruptcy are post-filing payments on reaffirmed debts.  However, there’s a lot of confusion – even among attorneys and other professionals – about creditors’ obligations to report these payments.  So today, we’re going to examine key statutes, case law, and some anecdotal evidence.  We’re going to discuss what creditors legally are and are not obligated to do, and how these obligations may differ from what we see in common, every day practice.
But first, I’m going to assume that you have not read other posts on this blog about reaffirmations, so let’s hit up some basics: What is a reaffirmation agreement?

Contrary to common belief, almost all secured debts are dischargeable.  In terms of dischargeability, they are no more or less special than other unsecured debts like credit cards, payday loans, or medical bills.  This is how and why people are able to file for bankruptcy, walk away from a home or vehicle that they don’t want, and not be liable for a deficiency balance.
But secured liens are not extinguished in bankruptcy (except in rare case of stripping unsecured mortgages in Chapter 13, judgment liens, etc.).  So while a secured creditor may not be able to pursue you for a deficiency balance, they can act upon their security interest and foreclose or repossess collateral if you default on the loan.  And of course, that right exists even if you don’t file for bankruptcy – bankruptcy just extinguishes their right to pursue you for money on the loan.  So you can’t just stop paying your mortgage and expect to be able to continue to remain in your home, even if you file for bankruptcy.
A reaffirmation agreement takes your dischargeable pre-petition obligation and converts it into a post-petition obligation that is not discharged in bankruptcy.  In other words, if you enter into a reaffirmation agreement and default, then not only can the creditor repossess the collateral, but they can also pursue you for a deficiency judgment.
Reaffirmations are NOT required.  On the contrary.  They are voluntary agreements.  A creditor can no more require you to sign a reaffirmation agreement than you can require a creditor to sign one.  In fact, some creditors – as a policy – don’t bother with reaffirmation agreements.
Strictly from a liability standpoint, I (along with most other attorneys I’ve spoken to) would prefer that our clients not enter into a reaffirmation agreement.  There is always the possibility that something will happen down the road, and you are unable to continue to make payments on your mortgage or car loan.  Without a reaffirmation agreement – the worst thing that the creditor is entitled to do is repossess the collateral.  With a reaffirmation agreement – the creditor can repossess the collateral AND seek a deficiency balance.
What I (and most other attorneys) prefer are what we refer to as a “ride-through”.  A ride-through is when a bankruptcy debtor retains collateral, continues to make normal monthly payments on a secured loan, but does so without a reaffirmation agreement.  This way, the debtor keeps their property, but minimizes their risk in case something happens down the road.
Sounds great!  Why doesn’t everyone do a ride-through?  Why don’t attorneys INSIST that their clients just do a ride-through?  Well, two reasons.
#1 – The Risk of Repossession
This almost never happens.  Many years ago, there were rumors that Wells Fargo was foreclosing on homes and repossessing vehicles, even though the debtors were current on their payments.  The sole reason they foreclosed and repossessed?  The debtors had not signed a reaffirmation agreement, which Wells Fargo considered a technical default and grounds for exercising their security interests.
11 U.S.C. § 521(a)

(6) [I]n a case under chapter 7 of this title in which the debtor is an individual, not retain possession of personal property as to which a creditor has an allowed claim for the purchase price secured in whole or in part by an interest in such personal property unless the debtor, not later than 45 days after the first meeting of creditors under section 341(a), either –
(A) enters into an agreement with the creditor pursuant to section 524(c) with respect to the claim secured by such property; or
(B) redeems such property from the security interest pursuant to section 722.

In Steinhaus, Idaho Central Credit Union argued that this language (revised under BAPCPA in 2005) limited a debtor to 3 options: reaffirm, redeem, or surrender.  Since Steinhaus had not entered into a reaffirmation agreement within the proscribed time period, ICCU demanded termination of the automatic stay, an order compelling surrender of property, and an order authorizing foreclosure.  The court agreed that 11 U.S.C. § 362(h) permitted ICCU to obtain termination of the automatic stay, but disagreed that it had authority to compel surrender of collateral or to authorize foreclosure.  In re Steinhaus, 349 B.R. 694 (Bankr. Idaho, 2006).

The right to repossess is still controlled by applicable state law, and we get a pretty good discussion of that in Henderon, a Nevada case that specifically deals with Nevada law that differs from the Uniform Commercial Code.  In this particular case, it was decided that the contract provision invoking an ipso facto right of recovery based solely on the filing of bankruptcy or lack of a reaffirmation agreement was invalid under Nevada law.  In re Henderson, 492 B.R. 537 (Bankr. Nev., 2013).

Wisconsin’s default provisions are outlined at Wis. Stat. § 425.103.  I’ll include them here for reference, but I’m not going into an analysis of the code.  The point is that since the right of recovery is an issue of state law, the bankruptcy court has no authority to compel surrender of collateral, which means you – as a bankruptcy debtor – can force this issue before a state court judge.  An informal survey suggests that most judges are not inclined to permit repossession based solely on the lack of a reaffirmation agreement.

(2) ”Default”, with respect to a consumer credit transaction, means without justification under any law:(a) With respect to a transaction other than one pursuant to an open-end plan and except as provided in par. (am); if the interval between scheduled payments is 2 months or less, to have outstanding an amount exceeding one full payment which has remained unpaid for more than 10 days after the scheduled or deferred due dates, or the failure to pay the first payment or the last payment, within 40 days of its scheduled or deferred due date; if the interval between scheduled payments is more than 2 months, to have all or any part of one scheduled payment unpaid for more than 60 days after its scheduled or deferred due date; or, if the transaction is scheduled to be repaid in a single payment, to have all or any part of the payment unpaid for more than 40 days after its scheduled or deferred due date. For purposes of this paragraph the amount outstanding shall not include any delinquency or deferral charges and shall be computed by applying each payment first to the installment most delinquent and then to subsequent installments in the order they come due;(am) With respect to an installment loan not secured by a motor vehicle made by a licensee under s. 138.09 or with respect to a payday loan not secured by a motor vehicle made by a licensee under s. 138.14; to have outstanding an amount of one full payment or more which has remained unpaid for more than 10 days after the scheduled or deferred due date. For purposes of this paragraph the amount outstanding shall not include any delinquency or deferral charges and shall be computed by applying each payment first to the installment most delinquent and then to subsequent installments in the order they come due;(b) With respect to an open-end plan, failure to pay when due on 2 occasions within any 12-month period;(bm) With respect to a motor vehicle consumer lease or a consumer credit sale of a motor vehicle, making a material false statement in the customer’s credit application that precedes the consumer credit transaction; or(c) To observe any other covenant of the transaction, breach of which materially impairs the condition, value or protection of or the merchant’s right in any collateral securing the transaction or goods subject to a consumer lease, or materially impairs the customer’s ability to pay amounts due under the transaction.

As a matter of practice, most creditors will permit a ride-through, and there are two major reasons for this.  First – if a debtor is willing to continue make payments on a secured debt, they’re going to receive more money if they permit the ride-through rather than immediately demanding turnover of the collateral.  If the debtor defaults, they still have a right of recovery and sale later on.  (For example, if collateral is worth $10k at auction and a debtor makes $500/mo payments for a year before defaulting, the creditor potentially gets $16k out of the deal; whereas they only get the $10k if they repossess immediately.)  The circumstances in which a creditor may not want to wait for a default is where there is significant risk or danger that the property will be damaged or wasted before the default, significantly devaluing the asset by the time it can be sold.

The other reason most creditors permit a ride-through is because threatening to repossess in the absence of a reaffirmation agreement would conceivably be a violation of the discharge at 11 U.S.C. § 524(c)(3)(A).

Alternatives to Bankruptcy: is debt settlement a good idea?

Most people don’t want to file for bankruptcy, even if they have to.  There’s a lot of stigma attached to bankruptcy, and so people try to avoid it except as a last resort.  In the process of trying to avoid bankruptcy, people try certain alternatives.  Some of them are wise efforts.  Others – not so much.
Generally-speaking, efforts to modify your budget and living without incurring additional debt are the best way to try to avoid bankruptcy without causing yourself more harm.
One of the more common tactics people use is to try to settle their debts.  Is this a good idea?
Answer: it depends.  As with most complicated situations like this, your best options will always depend on the specific facts of your case.  No two people are identical, and what may work for one person is not always the best option for another person.  An experienced attorney can help you parse the pros and cons of various approaches to determine which is likely to be the best option for you.
What is debt settlement?  Let’s use an example to illustrate.  Let’s say you have a $20,000 credit card bill.  You’ve defaulted, and your creditor is worried that you will file for bankruptcy.  To try to tempt you to avoid bankruptcy, your creditor offers to settle your account for $7,000.  In exchange, they will forgive the remaining $13k balance.  Should you pay it?
  1. Since you’re not paying the balance as contractually required, debt settlement will still negatively impact your credit.  So, if both bankruptcy and debt settlement are going to ding up your credit, the question you have to answer for yourself is whether you want to spend $7,000 to wipe out $13,000, or spend a fifth of that to wipe out $20,000.  (Factors that will impact that decision include whether you have other debts besides this one credit card that will still weigh on your credit.  Remember that payment history and bankruptcy are not the only factors that affect your credit.  Your credit is also affected by debt to income ratios, number of open accounts, types of debts, length of credit history, residential and occupational stability, and the amount of available credit for use.)
  2. Although debts discharged in bankruptcy do not count as taxable income, debts forgiven in debt settlement are taxable.  Which means $7,000 may end up being closer to $11,000 after all is said and done.

Furthermore, in this example, you actually have to have $7k.  If you have that liquid, then that may be a feasible – perhaps even a wise – choice.  But if you don’t?  Then you have to set-up a payment plan.
Well, first of all, you’re not going to be able to set-up a payment plan with the creditor itself.  In exchange for offering to have $13k of credit card debt wiped out, they want a lump sum payment.  If you’re going to make them accept installment payments, then they’ll take the full $20k balance you owe, thank you very much.
For many people, the alternative then is to hire a “debt settlement firm”, which my clients have consistently found to put them in a worse situation.  Basically, a debt settlement firm acts as a middle-man, and little more.  They accept installment payments from you, trimming a chunk off the top to pay for their services.  They keep taking those payments until they have enough to settle with one of your creditors.  In the meantime, collections actions are continuing.  Interest and penalties continue to add to your balance, making it tougher to reach an amount sufficient to settle on.  And the settlement firms settle with creditors in an order to maximize how much time they have to spend working on your case and – accordingly – maximizing their fee.  Also, expect to have to pay the debt settlement firm additional fees (on top of their flat rates for operating costs) – a percentage of whatever debt gets canceled.  And then you STILL have to contend with the credit reporting and tax consequences.
Debt settlement is only a viable and wise course of action if you have the liquid cash to make the lump sum payment, and even then, you need to consider the credit reporting and tax consequences.  Even then, you should weigh what you’re spending on the settlement plus any debts you must still contend with, and weigh that against the cost and benefits of bankruptcy.

Alternatives to Bankruptcy: is Chapter 128 a good idea?

Most people don’t want to file for bankruptcy, even if they have to.  There’s a lot of stigma attached to bankruptcy, and so people try to avoid it except as a last resort.  In the process of trying to avoid bankruptcy, people try certain alternatives.  Some of them are wise efforts.  Others – not so much.
Generally-speaking, efforts to modify your budget and living without incurring additional debt are the best way to try to avoid bankruptcy without causing yourself more harm.
One of the more common tactics people use is to file a Chapter 128.  Is this a good idea?
Answer: it depends.  As with most complicated situations like this, your best options will always depend on the specific facts of your case.  No two people are identical, and what may work for one person is not always the best option for another person.  An experienced attorney can help you parse the pros and cons of various approaches to determine which is likely to be the best option for you.
That being said, it has been my experience that Chapter 128 is useful only in a small percentage of situations.  Here are some of the common reasons why:

  1. There is no eligibility for a discharge in Chapter 128.  Whatever debts you fold into the filing must be paid in full.
  2. All debts rolled into a Chapter 128 filing must be paid in full within a 3 year plan.
  3. Chapter 128s are ineffective against federal debts (like taxes or student loans) and not effective at preventing foreclosure or repossession.
  4. In contract, a Chapter 13 bankruptcy can be amortized out over 5 years with the possibility of a discharge, can cover federal debts, and can stop both foreclosure and repossession.
In short, Chapter 128 is a cheaper and simpler version of Chapter 13.  And while certain people with low amounts of debt or people who are ineligible for a discharge may benefit from Chapter 128, Chapter 128 offers fewer protections and has less flexibility where flexibility is important (you get what you pay for).  Accordingly, most people benefit from a Chapter 13 more than they do a Chapter 128, assuming Chapter 7 isn’t a viable choice for the individual (which it might be).

Alternatives to Bankruptcy: are 401(k) draws or loans a good idea?

Most people don’t want to file for bankruptcy, even if they have to.  There’s a lot of stigma attached to bankruptcy, and so people try to avoid it except as a last resort.  In the process of trying to avoid bankruptcy, people try certain alternatives.  Some of them are wise efforts.  Others – not so much.
Generally-speaking, efforts to modify your budget and living without incurring additional debt are the best way to try to avoid bankruptcy without causing yourself more harm.

For example, say you were doing fine with a mortgage and a car loan, but then you were involved in an accident and racked up $20,000 in medical bills, and now you can’t afford to pay everything.  One possible strategy might be to use payday loans to “punt” the problem down the field.  That’s a bad idea and will most likely cause you more harm.  On the other hand, if you can scale back on other expenses and slowly pay down the medical debt – that’s likely to be more successful.

One of the more common tactics people use is to withdraw money from their retirement accounts or to take a loan out from their 401(k).  Is this a good idea?
Answer: it depends.  As with most complicated situations like this, your best options will always depend on the specific facts of your case.  No two people are identical, and what may work for one person is not always the best option for another person.  An experienced attorney can help you parse the pros and cons of various approaches to determine which is likely to be the best option for you.
That being said, it has been my experience that drawing or borrowing from a retirement account is usually not a good idea.  Here are some of the common reasons why:
  1. Drawing from a 401(k) is going to trigger tax consequences.
  2. Borrowing from a 401(k) means you’re still paying on a debt, with interest.  It’s the proverbial “robbing Peter to pay Paul” except in this case, you’re robbing yourself.
  3. The obvious: you’re depleting savings that is meant to carry you through your retirement.
  4. You’re doing so to pay a debt that may be dischargeable in bankruptcy, and using an asset that is fully exempt in bankruptcy.  (In other words, someone who burns $10k of his retirement funds to pay a $10k credit card bill could have had the $10k debt paid off and fully retained his retirement money in Chapter 7.
  5. If you are using these funds to settle a debt (pay less than what is contractually owed), your credit will still be impacted negatively, and you are likely to have tax consequences as a result of the canceled debt.

3 for 7

Days like today make me feel particularly proud of the work I do.
This morning, I represented seven debtors in Chapter 13 cases.  Three of them were my own clients. The other four – I was covering for two other attorneys who, due to scheduling conflicts, couldn’t attend the hearings themselves.  All three of my cases were recommended for confirmation.  All four of the other cases were adjourned to next month to fix a variety of issues.
By no means am I criticizing the other two attorneys.  Both are fine attorneys and I have respect for them.  If I didn’t, I wouldn’t have agreed to cover their cases.  Nor was today some sort of anomaly.  Some Chapter 13 cases get recommended for confirmation.  Other cases have to be held up for a month or two to straighten out issues that crop up – issues that are not always within an attorney’s control.
But I have always taken pride in the fact that a large number of my Chapter 13 cases get recommended for confirmation at the first hearing.  The same is not true of most other attorneys, based on my observation.  And today’s scores of 3/3 and 4/4 demonstrated – albeit by a small sample size – my track record versus the track records of other attorneys.
Oftentimes, clients will complain that I demand too much information and paperwork, and they think that I’m being too nit-picky.  I am.  And what happened today is a good illustration of why.  I prefer to do my homework before a case is filed.  I prefer to grill and examine my own clients until I am satisfied and confident that a case is ready to go.  I would rather do it that way and get a speedy confirmation which makes everyone happy, as opposed to watching a case blow-up after it has been filed, when certain revelations may be beyond my ability to exert much control over.

New Bankruptcy Forms effective December 2015

The majority of updated bankruptcy forms are being rolled out this December, and they’re a lot lengthier.  The voluntary petition, for example, currently 3 pages, will grow to 7 pages.
The asset schedules (A & B) are being consolidated to a single schedule and broken up into more intuitive categories, including real estate, vehicles, liquid assets, business assets, and other assets.  Similarly, the Statement of Financial Affairs has been reorganized in a more intuitive manner.
The new schedules ask for some new information.  I’ve yet to see anything of substantial consequence, but it looks like attorneys are going to have to ask some additional creditors that we didn’t necessarily concern ourselves with in the past.  If you’re preparing to file your bankruptcy case shortly after December 2015, expect that there may be a brief adjustment period as we get accustomed to the new forms and new material needed.  Many of our internal-use forms will likely be changing, as well.