Consumer Bankruptcy Committee

ABI Committee News

Keeping the Car After Bankruptcy: Practical Solutions for Chapter 7 Debtors After BAPCPA

Editor's Note: The following article, "Keeping the Car After Bankruptcy: Practical Solutions for Chapter 7 Debtors After BAPCPA," won the prize for third place in the Fifth Annual ABI Law Student Writing Competition. The article discusses vehicle liens and discharges in a typical chapter 7. The author, Henry Hildebrand, is a student at the University of Tennessee College of Law in Knoxville. In addition to recognition and publication of his article in the Consumer Bankruptcy Committee Newsletter, Mr. Hildebrand received a cash award of $750, sponsored by Thompson & Knight LLP, and a one-year ABI membership.

The average worker in the United States spends roughly twenty-five minutes commuting to work each day.[1] Many suburban employees have minimal access to reliable public transportation, so it is not surprising that 76.1% of Americans make this commute alone in their own private vehicle.[2] After all, the average employee would have no way to get to and from work without a car. Based on the behavior of a strong majority of workers in the United States, it is clear that having a personal vehicle is critical to maintaining steady employment.

This need for a vehicle poses a unique problem for debtors who file for bankruptcy under Chapter 7 of the Bankruptcy Reform Act of 1978 (the Code). In a typical Chapter 7, a debtor will obtain a discharge of most prepetition debts, including the personal liability on a car note.[3] However, though the bankruptcy discharges the note, the car lender’s lien on the vehicle will survive.[4] The Code provides for this issue by requiring a debtor who owns a vehicle subject to a lien to choose whether to surrender the vehicle to the secured lender or keep it.[5] Assuming the debtor elects to keep the car, he must next choose whether to redeem it or reaffirm personal liability on the note.[6]

Redemption under § 722 allows a debtor to buy the car outright by paying the value of the lender’s allowed secured claim, or rather, the value of the car itself.[7] Thus, if a debtor owed $15,000 on a car note, but the car securing the note was worth only $5,000, the debtor could redeem the car by paying the lender $5,000. Redemption allows the debtor to own the vehicle free and clear of any liens while simultaneously discharging liability on the car note. However, with rare exception, courts have interpreted § 722 to require redemptions to be paid in one lump sum of cash.[8] Debtors have no right to pay by installments without lender consent.[9]

Because Chapter 7 debtors often cannot produce such a large amount of cash in such a short period of time, redemption is relatively rare.[10] Instead, many debtors are forced to reaffirm personal liability on the original car note in order to maintain possession of the vehicle.[11] However, reaffirmation poses a serious risk to a debtor; specifically, if a debtor reaffirms and later defaults, the creditor can pursue any collection methods authorized by state law, regardless of the Chapter 7 discharge.[12]

While redemption and reaffirmation are the only choices expressly authorized in the Code, certain jurisdictions have historically permitted a separate, non-statutory option for retaining vehicles following a Chapter 7.[13] This option, called a “ride through,” allowed a Chapter 7 debtor who was current on his car payments to discharge personal liability on the car note while still keeping the car subject to the lien. So long as the debtor continued making payments according to the original note, the lender had no right to repossess even if the original loan contract contained a “default on bankruptcy” clause.[14] This option was obviously appealing to debtors as they could keep their vehicles without making a large lump-sum payment or reaffirming personal liability on the note. However, with the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), Congress eliminated the statutory ride through option contained in the Bankruptcy Code. This paper will analyze the impact of BAPCPA on the ride through and, acknowledging the importance of a vehicle to employed debtors, will offer advice for practitioners to help their clients keep their cars without signing burdensome reaffirmation agreements.

Circuit Split on the Ride Through Prior to BAPCPA
Prior to the passage of BAPCPA in 2005, the Code required Chapter 7 debtors to decide what they wanted to do with their cars. Specifically, § 521(2) stated:

[W]ithin thirty days after the filing of a petition under Chapter 7 of this title . . . 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 exempt, that the debtor intends to redeem such property, or that the debtor intends to reaffirm debts secured by such property.[15]

Subparagraph C of that section further stated, “[N]othing in . . . this paragraph shall alter the debtor’s or the trustee’s rights with regard to such property under this title.”[16] Most circuits held that these were the exclusive options, and that if a Chapter 7 debtor wanted to keep his car, he had to specifically elect to either redeem or reaffirm.[17] If a debtor failed to make such an election, the secured creditor would have the right to enforce the contract based on non-bankruptcy law, including the enforcement of a “default on bankruptcy” clause. A standard provision in automobile contracts, these clauses define the filing of a bankruptcy petition as an event of default, entitling the lender to repossess the vehicle.[18] While these provisions are not enforceable in bankruptcy, they are generally enforceable in non-bankruptcy proceedings.[19] As a result, after a debtor has received his discharge, the automobile lender could declare a default under the contract and repossess the vehicle even if the debtor was current on his payments.
             
Pre-BAPCPA, five other circuits disagreed with this analysis.[20] Focusing on Congress’s use of “if applicable” in § 521(2), these jurisdictions held that the two listed choices, redemption and reaffirmation, were not exclusive. Instead, they held that a separate non-statutory option existed in which debtors could retain their vehicles without making an election. These courts held that, so long as the debtor was current on all payments under the note, the secured lender could not repossess the vehicle despite the debtor’s default under the “default on bankruptcy” clause. Because of the obvious benefits to this option, namely the ability of the debtor to keep his car without paying a lump sum of money or reaffirming personal liability, this choice was extraordinarily popular with Chapter 7 debtors in these jurisdictions.[21]

BAPCPA and the Supposed Death of the Ride Through
With the passage of BAPCPA in 2005, Congress amended the Code and added several sections, which, when read together, indicate its intent to eliminate the ride through. First, it amended § 521(2), renaming it § 521(a)(2). In this amended version, the same “if applicable” language appears with the requirement that the debtor specify whether he intends to redeem the collateral or reaffirm the debt secured by the collateral. However, Congress added an additional provision to § 521(a)(2)(B), stating, “[N]othing in [§ 521(a)(2)] shall alter the debtor’s or the trustee’s rights with regard to such property under this title, except as provided in section 362(h).”[22] Under §362(h), if a debtor is an individual who fails to timely file a statement of intention under § 521(a)(2) electing to reaffirm the debt or redeem the collateral, the automatic stay is terminated regarding personal property, and such property ceases to be property of the estate. This section therefore allows the creditor to pursue collection methods without risk of violating the automatic stay.

BAPCPA also created § 541(a)(6), which prevents a Chapter 7 debtor from retaining personal property subject to a security interest unless, within forty-five days of the first meeting of creditors under §341, such debtor either reaffirms personal liability on the debt under § 524(c) or redeems the collateral under § 722. Because an encumbered automobile is personal property subject to a security interest, § 541(a)(6) requires a debtor to either redeem or reaffirm. Finally, BAPCPA added § 521(d), stating that if the debtor fails to make the election required under § 521(a)(6), the secured party can declare a default pursuant to a “default on bankruptcy” clause.[23]

The Response of the Five Circuits
In response to these amendments, each jurisdiction that formerly allowed the ride through changed its course and now had a ruling at the district or appellate level that disallowed it.[24] The Ninth Circuit addressed the issue in In re Dumont.[25]Reading the BAPCPA amendments together, the court in this case stated, “Given the amendment of section 521(a)(2) and the enactment of 362(h), it is unlikely that Congress failed to foresee that BAPCPA would have a major impact on ride-through . . . . The direction and tenor of the changes . . . suggest that Congress did not intend to increase access to ride-through by passing BAPCPA.”[26] The court ultimately held that its former decision in In re Parker, which authorized the ride through, had been superseded by BAPCPA.[27] The other four circuits, using the same reasoning, also held that the ride through had been destroyed by the BAPCPA amendments.[28]

The Statutory Death of the Ride-Through and its Impact on Chapter 7 Debtors
By eliminating the ride-through, BAPCPA had a substantial impact on Chapter 7 debtors. Chapter 7 was designed by Congress to protect the “honest debtor” by allowing an individual burdened by debt to obtain a fresh start and discharge all of his prepetition debts.[29] However, because access to a vehicle is essentially a prerequisite to stable employment, the death of the ride through has led to a sizeable increase in the number of debtors reaffirming personal liability on their car loans.[30] This result impairs the debtor’s ability to obtain a fresh start, as he is burdened by more personal debt immediately following his discharge, and faces serious risks going forward.[31] For example, if a debtor who reaffirms later defaults due to job loss or other financial emergency, the creditor can sue the debtor, garnish wages, levy bank accounts, and repossess the encumbered property.[32] This result was completely avoided prior to BAPCPA, as the Chapter 7 debtor that utilized the ride through had no personal liability upon default; the creditor’s only recourse was the collateral itself. Now, reaffirmation is seemingly the only way for a debtor to keep his car.
           
An increase in the number of reaffirmations also puts a substantial burden on the attorney of the reaffirming debtor. In one case from the United States Bankruptcy Court for the District of New Jersey, a debtor’s attorney was forced to refund all of his attorneys’ fees after the debtor entered into a reaffirmation agreement that she ultimately could not pay.[33] The court in that case cited § 329(b), which allows a court to require an attorney to turn over the amount to which his compensation exceeds the reasonable value of his services.[34] Finding that the attorney failed to provide any valuable service to the debtor through his failure to examine the debtor’s ability to pay under the reaffirmation agreement, the court required the attorney to disgorge his fees back to the bankruptcy estate.[35] The elimination of the ride through has thus had a negative impact both on Chapter 7 debtors and their attorneys.

Practical Solutions for Debtors to Keep the Car While Avoiding Reaffirmation

I. State Law May Prohibit Repossession on a Default Based on a “Default on Bankruptcy” Clause

Prudent consumer bankruptcy attorneys must determine if a creditor’s repossession of a vehicle based solely on a default under a “default on bankruptcy” clause is authorized under the applicable state law. While bankruptcy law is embodied in a uniform federal statute, the Supreme Court of the United States has made clear that, apart from provisions invalidating certain types of property transfers, Congress intended for state law to govern the scope, definition, and limitations of property interests.[36] This means that a creditor’s right to accelerate payments on a car loan or repossess a vehicle upon a default is governed exclusively by state law.[37] The new sections added by BAPCPA, § 362(h) and § 521(d), state only that if the debtor fails to make the required election regarding surrender, redemption, or reaffirmation, the automatic stay shall terminate with respect to the collateral, and the creditor may take any action to repossess the collateral that is authorized by non-bankruptcy law. However, this does not create an independent right to repossess the collateral; it merely authorizes the creditor to take any action that he would be authorized to take with regard to the collateral based on state law.[38] Under state law, a creditor generally cannot foreclose on collateral absent a default as defined in the contract, so if the lender is current on payments, the contract must provide for some non-monetary event of default, such as a “default on bankruptcy” clause, to enable the creditor to declare a default and repossess the vehicle. However, if the contract does not provide this, and thus the debtor is not in default under the contract, state law generally prohibits the creditor from repossessing the car.[39]

These considerations are made clear through Dumont. In Dumont, the Ninth Circuit held that the BAPCPA amendments prohibited a debtor from utilizing the ride-through, a mechanism formerly allowed within that jurisdiction.[40] Relying on the plain reading of § 362(h) and § 521(d), the court held that when a debtor who owns a vehicle subject to a security interest fails to make the required election between surrender, redemption, and reaffirmation, the property leaves the estate and ceases to be protected by the automatic stay, allowing the creditor to take any action authorized by state law.[41] The court clarifies this relationship between § 521(d) and state law, explaining:

Section 521(d) gives [the secured creditor] no substantive right to take action against the collateral. Where there is no ispo facto clause in the contract, it does not allow [the secured creditor] to pencil one in. Rather it removes the last remaining impediment under federal bankruptcy law to enforcement of an ipso facto clause that already exists.[42]

Thus, if the contract does not contain such a clause, and if the debtor is not in default based on any other provision, state law prohibits the secured creditor from repossessing the vehicle.
           
Unfortunately for debtors and their attorneys, nearly every automobile contract includes a “default on bankruptcy” provision.[43] However, some states may prohibit any automobile repossession based on a non-monetary default, even if the contract contains a “default on bankruptcy” clause.[44] For example, Pennsylvania’s motor vehicle sales financing statute states, “No installment sale contract shall contain any acceleration clause under which any part or all of the time balance represented by payments, not yet matured, may be declared immediately payable because the seller or holder deems himself to be insecure.”[45] Courts in Pennsylvania have construed this statute and its application to a Chapter 7 debtor in Malachin.[46] In that case, the defendant, an automobile lender, accelerated the plaintiff’s loan and repossessed her car based solely upon a “default on bankruptcy” clause.[47] The plaintiff argued that, because she was current on all payments, Pennsylvania’s motor vehicle sales financing statute prohibited the repossession. The court agreed with this analysis and ultimately ordered the defendant to return the vehicle to the plaintiff.[48] A prudent debtor’s attorney should therefore investigate both the contract and the laws of his state pertaining to installment sales of vehicles and determine if a mechanism exists to keep the Chapter 7 debtor in his vehicle without requiring a reaffirmation agreement.

II. Redemption Lending Offers a Cheaper and Less Risky Alternative to a Reaffirmation

Before a Chapter 7 debtor agrees to a reaffirmation, the debtor’s attorney should first advise the debtor of the availability of a redemption lender and, if possible, help the debtor obtain a redemption loan. As previously discussed, redemption under § 722 is a process under which a Chapter 7 debtor can pay his car lender the current value of the vehicle and discharge the remaining deficiency.[49] If the debtor fails to redeem, the only way that he can keep the vehicle is by executing a reaffirmation agreement with his car lender. However, because vehicles depreciate rapidly in value, most car loans carry a balance in excess of the value of the vehicle securing the loan. Bankruptcy courts are clear that a redeeming debtor must pay the redemption price in one lump-sum payment; he cannot pay by installments absent lender consent.[50] Because Chapter 7 debtors generally face a cash shortage after their discharge, they cannot make the lump sum payment, and if they want to keep their car, they must enter a reaffirmation agreement.

Redemption lenders fill this void by providing financing to cover the lump-sum cost of the redemption.[51] In exchange, the redemption lender takes a security interest in the vehicle and accepts payments pursuant to a new note with the debtor. While these loans often carry high interest rates, the outstanding principal balance is so much less than it would have been in a reaffirmation. As a result, despite the high interest rate, Chapter 7 debtors are able to retain their vehicles while paying substantially less per month on the note. Attorneys for debtors should inform their clients of the availability of redemption lenders and the benefits of redemption relative to reaffirmation. While the short time frame can pose an obstacle to a redemption loan, as the debtor is required to file his statement of intention within thirty days of filing the petition or before the first meeting of creditors, debtors’ attorneys can always petition the court to extend the period pursuant to the court’s general equitable powers under § 105 of the Code.[52] By helping clients obtain redemption loans, attorneys can substantially lower their clients’ monthly car payments and greatly increase their clients’ chances of truly reaching their “fresh start.”

Conclusion
Despite the presumed death of the ride through by the BAPCPA amendments, Chapter 7 debtors may not be completely out of luck when it comes to keeping their cars. Even after BAPCPA, a creditor cannot declare a default based on the bankruptcy unless it included a “default on bankruptcy” clause in the installment sale contract. Furthermore, even if the contract contains such a clause, state law may prohibit repossession based solely on the filing of a bankruptcy. Debtors’ attorneys should closely inspect both the contract and the motor vehicle financing laws of their state, as the creditor may have no right to repossess the vehicle notwithstanding the BAPCPA amendments. Finally, debtors’ attorneys should also investigate redemption financing as an alternative to a reaffirmation, as the redemption loan can result in a dramatically lower principal balance and monthly payment for the debtor. Prudent attorneys should investigate each of these potential solutions before recommending a reaffirmation to their clients.

 

1. Brian McKenzie & Melanie Rapino, Commuting in the United States: 2009, Am. Cmty. Surv. Rep., Sept. 2011, at 2.

2. Id.

3. 11 U.S.C. § 727(b) (2012).

4. Id. § 524(a)(1) (“A discharge in a case under this title voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged under 727 . . . .”).

5. Id. § 521(a)(2)(A).

6. Id.

7. Id. § 722.

8. In re Bell, 700 F.2d 1053, 1055-56 (6th Cir. 1983).

9. Id.

10. In re Perez, 318 B.R. 742, 745 (Bankr. M.D. Fla. 2005) (“[I]t is also rare that this option is exercised because it requires the debtor to pay cash equal to the value of the automobile.”).

11. 11 U.S.C. § 524(c) (2012);see Perez, 318 B.R. at 745 (“[T]he most likely option to be exercised by a chapter 7 debtor is . . . a reaffirmation agreement with the creditor.”).

12. § 524(c).

13. See In re Boodrow, 126 F.3d 43 (2d Cir. 1997); In re Price, 370 F.3d 362 (3d Cir. 2004); In re Belanger, 962 F.2d 345 (4th Cir. 1992); In re Parker, 139 F.3d 668 (9th Cir. 1998); Lowry Fed. Credit Union v. West, 882 F.2d 1543 (10th Cir. 1989); In re Kasper, 309 B.R. 82 (Bankr. D.D.C. 2004).

14. Installment sales contracts generally include a clause treating the filing of a bankruptcy as an event of default, allowing the creditor to repossess the collateral. Pursuant to § 541(c)(1)(B) and § 365(e), bankruptcy courts will refuse to enforce such clauses. However, these clauses are generally enforceable outside of bankruptcy. In the cases cited in footnote 13, the courts refused to enforce the “default on bankruptcy” clause as the sole grounds for a default even though the debtor had already received his discharge.

15. 11. U.S.C. § 521(2) (2000) (emphasis added).

16. Id.

17. See In re Burr, 160 F.3d 843 (1st Cir. 1998); In re Johnson, 89 F.3d 249 (5th Cir. 1996); In re Lock, 243 B.R. 332 (Bankr. S.D. Ohio 1999); In re Edwards, 901 F.2d 1383 (7th Cir. 1990); In re Podnar, 307 B.R. 667 (Bankr. W.D. Mo. 2003); In re Taylor, 3 F.3d 1512 (11th Cir. 1993).

18. Robert L. Eisenbach III, Are “Termination on Bankruptcy” Contract Clauses Enforceable?, In The Red: The Bus. Bankr. Blog (Sept. 16, 2007), http://bankruptcy.cooley.com/2007/09/articles/business-bankruptcy-issues/are-termination-on-bankruptcy-contract-clauses-enforceable.

19. Id.

20. See supra note 13 and accompanying text.

21. Magdalena Reyes Bordeaux, Reaffirmation Agreements in Chapter 7 Bankruptcy Proceedings, Los Angeles Lawyer, 12 (Mar. 2012).

22. 11 U.S.C. § 521(a)(2)(B) (2012) (emphasis added).

23. Id. § 521(d) (“If the debtor fails to take the action specified in subsection (a)(6) of this section . . . nothing in this title shall prevent the operation of a provision in the . . . agreement by reason of the occurrence, pendency, or existence of a proceeding under this title or the insolvency of the debtor.”).

24. See In re Dumont, 581 F.3d 1104 (9th Cir. 2009); In re Herrera, 454 B.R. 559 (Bankr. E.D.N.Y. 2011); In re Anderson, 348 B.R. 652 (Bankr. D. Del. 2006); In re Jones, 591 F.3d 308 (4th Cir. 2010); In re Rowe, 342 B.R. 341 (Bankr. D. Kan. 2006); In re Ray, 362 B.R. 680 (Bankr. D.S.C. 2007).

25. Dumont, 581 F.3d at 1107 (overruling In re Parker, 139 F.3d 668 (9th Cir. 1998)).

26. Id. at 1112.

27. Id.

28. See note 24 and accompanying text.

29. Amber J. Moren, The Debtor’s Dilemma: Economic Analysis of Asset Retention in Consumer Bankruptcy, Student Scholarship Papers, Paper 126 (2012) (citing H.R. Rep. No. 95-595, at 125.).

30. Melanie Sonnenborn, Reaffirmation Agreements: Basic Practice Tips and Pitfalls, ABI Committee News, Vol. 6, No. 1, Nov. 2008, available at http://www.abiworld.org/committees/newsletters/Young/vol6num4/ reaffirmation.html.

31. Moren, supra note 29, at 30.

32. Michael G. Doan, Ninth Circuit Eliminates “Ride Thru,” Bankruptcy Law Network, http://www.bankruptcylawnetwork.com/ninth-circuit-eliminates-ride-thru (last visited Feb. 26, 2013).

33. See In re Vargas, 257 B.R. 157 (Bankr. D.N.J. 2001) (holding that attorneys have a duty to investigate the impact that reaffirmation agreements will have on their clients’ finances, and when attorneys fail to fulfill this duty, the court should require disgorgement of all attorneys’ fees).

34. Id. at 166-67.

35. Id. at 167.

36. See Butner v. United States, 440 U.S. 48 (1979).

37. Id.

38. In re Dumont, 581 F.3d 1104, 115 (9th Cir. 2009) (“521(d) gives [the creditor] no substantive right to take action against the collateral. Where there is no ipso facto clause in the contract, it does not allow [the creditor] to pencil one in.”).

39. U.C.C. § 9-601.

40. Dumont, 581 F.3d at 1113.

41. Id.

42. Id. at 1115 (citing In re Steinhaus, 349 B.R. 694, 710 (Bankr. D. Idaho 2006)).

43. Eisenbach, supra note 18, at X.

44. Malachin v. Daimler Chrysler Fin. Servs., 2007 Pa. Dist. & Cnty. Dec. LEXIS 158 (2007).

45. 69 Pa. Stat. Ann. § 615 (West).

46. Malachin v. Daimler Chrysler Fin. Servs., 2007 Pa. Dist. & Cnty. Dec. LEXIS 158 (2007).

47. Id.

48. Id. (“The law is clear. There having been no default except the filing of the bankruptcy petition, Defendant was not entitled to repossess the vehicle.”).

49. 11 U.S.C. § 722 (2012).

50. In re Bell, 700 F.2d 1053, 1055-56 (6th Cir. 1983).

51. Several lenders specialize in redemption financing under § 722 of the Bankruptcy Code. Such lenders include Redemption Funding, Inc. (RFI), based in Sweetwater, Tennessee, and 722 Redemption Funding, Inc., based in Cincinnati, Ohio.

52. § 105(a) (2012) (“The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”).