The Fourth Option of Section 521(2)(a) - Reaffirmation Agreements and the Chapter 7 Consumer Debtor - Scott B. Ehrlich

Publication year2002

The Fourth Option of Section

521 (2) (A)—Reaffirmation

Agreements and the Chapter 7

Consumer Debtorby Scott B. Ehrlich*

I. Introduction

From 1980 through 2000, over fifteen million consumer bankruptcy petitions were filed in the United States, and consumer filings continue at a rate well in excess of one million annually.1 Approximately seventy percent of these consumer filings were chapter 7 liquidation cases,2 and, in most of those cases, the debtor3 owned personal property subject to a security interest. The Code4 requires that a debtor file with the bankruptcy court a "Statement of Intention," which indicates the debtor's intention to retain or surrender such property if the security interest secures a consumer debt.5 In pertinent part, section 521(2)(A) states:

(A) within thirty days after the date of the filing of a petition . . . the debtor shall file with the clerk a statement of his intention with respect to the retention or surrender of such property and, if applicable, specifying that such property is claimed as exempt, that the debtor intends to redeem such property, or that the debtor intends to reaffirm debts secured by such property; . . ,6

This seemingly simple requirement, added to the Code in 1984, has been the subject of serious disagreement regarding the obligations of debtors who are not in default on their secured consumer loan obligations and intend to retain property without taking the formal step of negotiating a reaffirmation agreement with their secured creditors.7

On the one hand, creditors have asserted that section 521(2)(A) imposes a duty on the debtor to undertake one of three limited options: (i) surrender the property to the secured creditor, (ii) retain and redeem the property under section 722 by paying the secured creditor the full amount of the secured claim,8 or (iii) retain the property and sign a reaffirmation agreement. Creditors have asserted this position, even though the debtor is not in default in making loan payments (or otherwise in default with respect to the debtor's affirmative obligations under the loan documents), and the debtor intends to continue making timely payments.

On the other hand, debtors have asserted that, when not in default, they may simply retain the collateral and continue to make their payments in accordance with the terms of the original loan documents, without entering into a reaffirmation agreement or redeeming the collateral. Proponents of this interpretation take the view that section 521(2)(A) does not impose a substantive requirement to enter into a reaffirmation agreement in all cases when the debtor owns property that secures a consumer debt. Rather, these proponents assert section 521(2)(A) is a notification statute that requires the debtor to inform the secured creditor of the debtor's intentions to reaffirm "if applicable." This interpretation provides the nondefaulting debtor with a fourth option not expressed in section 521(2)(A): the debtor may retain the collateral and continue making loan payments in accordance with the original terms of the loan documents without a reaffirmation agreement.

Eight circuit courts of appeal have considered the issue and have split evenly. The Second, Fourth, Ninth, and Tenth Circuits have sided with consumer debtors and held that section 521(2)(A) allows nondefaulting debtors to retain the collateral without negotiating a reaffirmation agreement with the secured creditor.9 In this Article, I shall refer to this interpretation as the "Notification Interpretation."

The First, Fifth, Seventh, and Eleventh Circuits have sided with creditors and held that the fourth option—retention without reaffirmation—is never available to debtors.10 These courts impose a requirement that all chapter 7 consumer debtors seeking to retain property subject to a security interest must negotiate and execute a reaffirmation agreement with the secured creditor. In this Article, I shall refer to this interpretation as the "Required Reaffirmation Interpretation."

Resolution of this dispute is important for several reasons. First, the transaction costs involved are enormous. In hundreds of thousands of cases annually, nondefaulting consumer debtors seek to retain property subject to a security interest that secures consumer debt. If the only alternatives available to these debtors are surrender, redemption, or reaffirmation, a substantial burden is placed on them to work out a reaffirmation agreement with their lenders.11 Each reaffirmation agreement must be individually negotiated between the debtor and the creditor and filed with the court. The additional costs of negotiating reaffirmation agreements may range from a few hundred to several thousand dollars for each agreement and may, in some cases, outweigh the benefits of reaffirmation.12 In addition, if debtors must reaffirm to retain property, creditors are elevated to an unfair bargaining position where they can demand fees and changes in payment terms as a condition to agreeing to the reaffirmation.

Second, the Required Reaffirmation Interpretation imposes a substantial burden on the judicial system. In those cases where the debtor is not represented by an attorney, the bankruptcy court must hold a hearing and assure that the requirements of section 524 have been satisfied.13 Currently, many cases ride through bankruptcy without this additional judicial involvement. If every secured consumer loan must be reaffirmed, a large scale increase in the judicial resources required to comply with section 524 will occur.

Third, the amount of money involved in the reaffirmation process is staggering. Using the statistics gathered in one well-conducted study, a reasonable estimate of the aggregate motor vehicle debt involved in bankruptcy in the year 2000 was $5.9 billion.14 Resolution of this issue will have substantial economic consequences.

Fourth, when Congress enacted the Code in 1978, it was deeply concerned about the problem of debtors entering into improvident reaffirmation agreements that would interfere with the ability of debtors to pursue a fresh start after chapter 7 bankruptcy. If the Required Reaffirmation Interpretation is adopted, consumer debtors who need to retain household goods, automobiles, or other personal property subject to security interests may feel compelled to enter into reaffirmation agreements that bind them to repay debts which they cannot, in fact, afford to pay. This defeats the effectiveness of the chapter 7 discharge.15

This Article will explore the statutory basis, legislative history, public policies, and case law behind the two competing interpretations of section 521(2)(A) and will conclude that the Notification Interpretation is the appropriate interpretation. A strong case will be made for the position that debtors who are current in making their loan payments on secured debt have a "fourth option"—retention of the property subject to a security interest without reaffirmation or redemption.

II. History and Purpose of Section 52l(2)(A)

Prior to enactment of the Code in 1978, no federal statutes prohibited the execution of reaffirmation agreements following bankruptcy.

Although the pre-1978 discharge provisions insulated the debtor from debt collection activities based on pre-petition debts, the absence of anti-reaffirmation provisions in the former Bankruptcy Act16 allowed creditors to pursue reaffirmation agreements with debtors following the bankruptcy discharge. The creation, effectiveness, and enforcement of such post-discharge reaffirmation agreements were governed entirely by state contract law. When the Code was adopted, the provisions dealing with discharge and reaffirmation were substantially changed from the provisions under the former Bankruptcy Act. The protective effect of the discharge injunction was reinforced to assure that, in the absence of a reaffirmation agreement executed prior to discharge and approved by the bankruptcy court, creditors would not be allowed to pester debtors to repay discharged debt.17 The legislative history indicates that:

The injunction is to give complete effect to the discharge and to eliminate any doubt concerning the effect of the discharge as a total prohibition on debt collection efforts. This paragraph has been expanded over a comparable provision in Bankruptcy Act sec. 14F .... The change is consonant with the new policy forbidding binding reaffirmation agreements under proposed 11 U.S.C. [Sec.] 524(b), and is intended to insure that once a debt is discharged, the debtor will not be pressured in any way to repay it. In effect, the discharge extinguishes the debt, and creditors may not attempt to avoid that.18

These injunctive restraints on post-discharge creditor collection activities are consistent with the post-petition restraints imposed by the provisions of section 362(a), which expanded the scope of the automatic stay to prohibit most post-petition debt collection or lien enforcement activity.19 Sections 362(a) and 524(a) work in partnership to assure that, from the time of the filing of a voluntary petition through the debtor's discharge, creditors will be restrained from collection activities—including creditor initiated attempts to obtain a reaffirmation agreement binding the debtor to repay pre-petition debt.20

The Code imposed strict procedural and substantive roadblocks in front of creditors who were seeking reaffirmation agreements from consumer debtors. As adopted in 1978, sections 524(c) and (d) required that all of the following factors be established as a precondition to approval of reaffirmation agreements: (1) The agreement must be executed before the discharge is granted; (2) The debtor has not rescinded the agreement for 30 days after it becomes enforceable; (3) The bankruptcy court approves the agreement as either: (a) "not imposing an undue hardship on the debtor or debtor's dependent" and is "in the best interests of the debtor," or (b) was "entered...

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