Debtor's dilemma: the economic case for ride-through in the Bankruptcy Code.

• Author: Moren, Amber J.

NOTE CONTENTS INTRODUCTION I. A TALE OF TWO DEBTORS A. In re Price: Ride-Through Before BAPCPA B. The BAPCPA Amendments C. In re Miller: The Death of Ride-Through II. RATIONAL AVOIDANCE OF [section] 521 A. Economic Framework B. The Inadequacy of Surrender, Redemption, and Reaffirmation III. ASSET-RETENTION ALTERNATIVES A. Chapter 13 Bankruptcy B. Forbearance on Repossession C. Backdoor Ride-Through IV. SHORTCOMINGS OF THE STATUS O UO A. The Three Policy Goals of Chapter 7 B. The General Case Against Reaffirmation C. The Drawbacks of Chapter 13 and Forbearance D. The Trouble with Backdoor Ride-Through V. TOWARD STATUTORY RIDE-THROUGH A. Blueprint for Reform B. How Statutory Ride-Through Improves Uniformity C. The Pro-Debtor Case for Statutory Ride-Through D. Statutory Ride-Through as a Pro-Creditor Policy CONCLUSION INTRODUCTION

On August 11, 2011, Carolyn Denise Bowden filed a Chapter 7 bankruptcy petition in North Carolina. (1) Bowden's Chapter 7 petition allowed her to discharge her unsecured obligations, such as credit card debt. For secured debt, however, Bowden's creditors retained a set of ownership rights with respect to the collateral securing her loans. Bowden owed a loan balance of $4,534 on a 2006 Chevrolet Trailblazer to Ally Financial when she filed for bankruptcy. (2) For Bowden and Ally Financial, the treatment of the outstanding debt on the Trailblazer presented a key procedural inquiry in the bankruptcy process, determining who would retain the vehicle and how retention costs would be allocated.

Bowden was one of nearly one million individuals who flied a Chapter 7 petition in 2011. (3) Chapter 7 bankruptcy filings that year amounted to more than twice the total of all civil and criminal cases filed in federal district courts. (4) In her colossal debtor class, Bowden's vehicle-retention dilemma was commonplace: one study estimated that the average Chapter 7 debtor entered bankruptcy with about $4,890 of secured motor vehicle debt. (5) In total, Bowden and her peers brought collective assets of more than $108 billion and liabilities of $196 billion into bankruptcy proceedings-particularly significant figures considering each debtor earned an average annual income of just over $30,000. (6) In both human and economic terms, the aggregate significance of secured personal debt in consumer bankruptcy is dramatic.

Given the stakes, the recurrent vehicle-retention dilemma seems the sort of modest procedural puzzle for which the Bankruptcy Code ought to have a straightforward solution. Yet the treatment of secured debt in Chapter 7 bankruptcy has long proven woefully opaque. Three options have been available to Chapter 7 debtors for decades. Section 521 of the Bankruptcy Code ("the Code") permits Bowden either to surrender the Trailblazer to Ally Financial to satisfy her outstanding debt, redeem the Trailblazer by paying Ally the value of the Trailblazer, or reaffirm the debt by agreeing to a post-bankruptcy repayment schedule and renewing her commitment to pay Ally in full. As this Note describes, each of these options presents significant drawbacks for Bowden and other Chapter 7 debtors.

Beyond the three statutory options lies a prospective fourth, which is the focus of this Note. In addition to redeeming or reaffirming, a debtor may in certain circumstances retain an asset simply by continuing to make regular payments according to the pre-bankruptcy loan schedule, or "ride-through" the asset. Unlike the statutory retention options, ride-through allows a debtor to retain an asset without entering a new repayment agreement, renewing personal liability, or paying the remaining loan balance up front.

This Note distinguishes between three types of ride-through: common law, backdoor, and statutory. Beginning in the 1990s, courts divided over whether the Code allowed a Chapter 7 debtor to retain an asset by common law ride-through. By the time Congress reacted in 2005, common law ride-through was recognized in five circuits and rejected in four others. (7) One professor called the circuit split on common law ride-through the "most controversial consumer credit issue arising in cases under the United States Bankruptcy Code." (8)

In 2005, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). (9) Courts initially struggled to interpret the amendments but eventually reached the consensus that BAPCPA had eliminated common law ride-through. Ride-through was not entirely defunct, however, because courts construed BAPCPA to prevent a creditor from repossessing collateral as long as the debtor attempted to reaffirm, even if the reaffirmation agreement was later rejected. This opened a new retention option termed backdoor ride-through.

Still other retention options exist entirely outside of Chapter 7. In certain cases, a Chapter 7 debtor may retain an asset by reaching an informal agreement through which the creditor promises not to repossess as long as the debtor continues regular payments. A debtor may also convert to Chapter 13 bankruptcy, although, as this Note explains, conversion is unlikely following BAPCPA. The complex spectrum of retention options--reaffirmation, redemption, backdoor ride-through, forbearance, and Chapter 13--creates unpredictability, thwarts bankruptcy's vision of uniformity, (10) and fosters bargaining inequities among debtors and secured creditors involved in Chapter 7 proceedings. Moreover, the existing options are inconsistent with the policy goals underlying Chapter 7 bankruptcy.

To resolve the debtor's dilemma, this Note advocates replacing reaffirmation with statutory ride-through, which would give Chapter 7 debtors the option to retain an asset by simply electing to continue payments post-bankruptcy. In Bowden's case, statutory ride-through would allow her to elect to retain the Trailblazer without entering a revised repayment agreement or renewing personal liability for the asset. If she failed to make a single payment on the Trailblazer, however, Ally could repossess. This Note argues that statutory ride-through would improve the position of debtors without injuring creditors, compared with the status quo.

Other scholarship has recognized the merit of ride-through. As early as 1997, the National Bankruptcy Review Commission (NBRC) recommended replacing reaffirmation with ride-through, but it later abandoned its position. (11) In 2002, Professor Scott Ehrlich made a similar argument at length, reasoning that ride-through generally benefits both debtors and creditors compared with reaffirmation. (12) More recently, a student note examined the effect of BAPCPA on ride-through and offered policy reasons for why courts should continue to recognize common-law ride-through after BAPCPA. (13) Another note detailed the development of backdoor ride-through in the Eastern District of North Carolina, offering reasons why the new option is consistent with bankruptcy policy and the Code. (14)

This Note builds on existing scholarship in three principal ways. First, it introduces and applies a simple economic framework to explain the incentives of debtors and creditors during Chapter 7 proceedings, which is critical to measuring the merit of various asset-retention alternatives. Second, it examines the effect of backdoor ride-through from a creditor's perspective, offering reasons why the new option should lead creditors to prefer statutory ride-through to the status quo. The creditor focus has practical importance because creditor coalitions have historically wielded significant lobbying power in Congress on bankruptcy issues. Finally, this Note moves beyond a discussion of existing alternatives to propose that Congress formally enact statutory ride-through as a [section] 521 retention option.

Part I of this Note illustrates the effect of BAPCPA on the asset-retention options available by statute. Part II then introduces an economic framework to explain why debtors and creditors rationally avoid each of the statutory options. Part III describes the retention alternatives that exist outside [section] 521 in practice. Part IV shifts from analysis to advocacy, explaining the policy objectives of Chapter 7 bankruptcy and describing how the current retention alternatives fail to promote those goals. From this foundation, Part V shows how statutory ride-through is consistent with Chapter 7 policy and improves the position of debtors and creditors relative to the status quo. In economic terms, statutory ride-through is a "Pareto superior" policy compared with the status quo, because it improves the position of at least one player without worsening the position of another. (15) As asset-retention options have splintered and Chapter 7 petitions hover near one million, (16) the need for reform of [section] 521 is more pressing than ever.

1. A TALE OF TWO DEBTORS

   For Michael and Christine Price and Kimberly Miller, "it was the worst of times." (17) Like Carolyn Bowden, both debtors--Michael and Christine Price filing jointly (18) and Kimberly Miller individually--sought to cure their insolvency by filing Chapter 7 bankruptcy petitions. Both debtors filed in Delaware. (19) Both hoped to retain their motor vehicles, encumbered by creditor liens, after emerging from bankruptcy. But the Prices filed their petition in 2001, and Miller filed hers in 2010. During the intervening decade, BAPCPA had taken effect.

   Because of the BAPCPA amendments to the Bankruptcy Code, the Price and Miller courts reached opposite conclusions as to whether a debtor could elect to ride-through an asset in bankruptcy. This Part illustrates how BAPCPA modified debtors' post-bankruptcy collateral retention options and describes the textual basis for the Delaware bankruptcy court's reversal on the issue of common law ride-through. It then situates these developments in a national context in which the circuit split gave way to the extinction of common law ride-through following BAPCPA.

   1. In...