At one point or another, a business or individual is likely to experience a bankruptcy proceeding from a creditor's perspective. In the vast majority of Chapter 7 cases, there may be little that the creditor can do. The case of a creditor whose debt is secured by some collateral of the debtor is an entirely different story. The first question that secured creditor must ask concerns the debtor's intentions with respect to the collateral. Will the debtor be “reaffirming” the debt?

Reaffirmation essentially excepts the debt from the bankruptcy discharge, and the underlying obligation remains enforceable against the debtor personally after the bankruptcy, in addition to being enforceable against the property pledged to secure payment of the loan. There are two components to a mortgage or secured transaction. The first component is the promissory note wherein the debtor promises the pay the creditor a certain amount of money, with interest, over time, in exchange for the loan. The second component is the security agreement/mortgage lien wherein the debtor grants the creditor a collateral interest to assure payment of the promissory note. A bankruptcy discharge relieves the debtor of the personal obligation to pay under the note, but bankruptcy does not discharge the creditor's lien.

When a debtor reaffirms the obligation to a creditor, it is a reinstatement of the enforceability of the promissory note. As such, upon default after the bankruptcy, the creditor can proceed to seek personal judgment after the collateral is sold for less than the note balance. Without reaffirmation, the creditor has the right to reclaim the property securing the debt but cannot obtain a monetary judgment.

Prior to the enactment of the 2005 Bankruptcy Reform Act, debtors in this Circuit had four options with respect to a creditor's collateral: (1) surrender; (2) redeem (i.e. pay the present value of the collateral); (3) reaffirm or (4) merely retain the collateral and keep current. The fourth option, commonly referred to as the “ride-through,” has been eliminated by the new bankruptcy law. Under the new law, the debtor must perform his or her stated “intention,” being only redeem, surrender or reaffirm, within 30 days of the meeting of creditors, or the creditor will be automatically granted relief from stay to pursue its remedies in state court. Technically, then, no ride-throughs are authorized under the new code.

It remains to be seen, however, exactly what would happen to a Vermont debtor should he or she keep current on the note and NOT reaffirm the debt (the tantalizing legal question being would the creditor be permitted to allege bankruptcy as default at the state court repossession hearing if the debtor is current in payments-in other words, can a creditor repossess a car if the debtor is making timely payments just because they went through bankruptcy without reaffirming?). More often than not, either from fear of violation of the bankruptcy discharge or to simply exert leverage, a creditor will not provide monthly statements to a debtor unless the debtor reaffirms, even if the debtor requests them. So payment default after bankruptcy is likely, but, without reaffirmation, the creditor's sole remedy would be repossession of the depreciated collateral.

A secured creditor's first task upon receiving a bankruptcy notice should therefore be to review the debtor's “statement of intention” to avoid the possibility of an involuntary “ride-through.” The creditor would be wise to seek reaffirmation from the debtor. The new bankruptcy code section governing reaffirmation agreements and the companion form are incredibly complex and detailed. There is exposure for the debtor's attorney if the debtor is unable to perform. The reaffirmation also risks being denied by the court if not prepared properly.

Reaffirmations in this district have been clogging up the court hearing days due to errors made by creditors and attorneys in preparing them. In fact, the Vermont bankruptcy court has recently issued an order citing the eight most common reasons why reaffirmations are not approved in an effort to educate the filers. Going even further, this court will now be denying reaffirmation agreements without hearing if they do not comply. Vermont is the only district in the country which requires a separate certification from the preparer that the filed agreement complies literally with the bankruptcy code. Failure to strictly comply will result in denial.

Because of the subtle complexities of reaffirmations under the new law, a secured creditor is best advised to review a bankrupt debtor's schedules thoroughly and seek an experienced, competent attorney when faced with a bankruptcy filing of any kind.

The information provided in this article is offered for informational purposes only; it is not offered as and does not constitute legal advice. Every situation is unique— you are encouraged to seek legal consultation to address your individual circumstances.