Reaffirmation, Surrender, and Redemption
The debtor's obligations regarding collateral in a Chapter 7 case.
Chart of Chapter 7 Debtors Obligations and Deadlines (Click on Chart for full size view)
In a Chapter 7 bankruptcy case, the debtor's financial obligations are divided into categories. One of these categories is called Secured Debt. Common examples include auto loans, house mortgages, even financed purchases of furniture. What all these have in common is the concept of "security" also known as "collateral." That is, not only has the purchaser in these transactions signed a contract to purchase something, but also the contract has gone further than just promising to make payments on time. The purchaser has also stated that in the event the purchaser fails to pay on time the lender or seller may seize the very item being purchased and forcibly sell it off to raise some money to help pay down the loan. In these situations, the buyer is said to have offered security or collateral to back up the loan. So these are referred to as secured loans. Contrast this arrangement to another where the buyer or borrower has done nothing but sign the agreement to pay with no offer of security to the seller/lender. If there is no collateral, then the buyer/borrower has offered really nothing more than his signature on an IOU promissing to pay, so these are often referred to as "Signature loans."
Therefore secured loans involve the borrower offering security to the lender. The document that actually offers the security goes by different names, depending on the type of thing that will act as the collateral. If land is offered as collateral, then the document offering the collateral is called a "mortgage." If anything other than land is offered as collateral, then document is called a "security agreement." Take the common loan to buy a house, a mortgage loan. There are three pieces of paper involved, (1) the deed, (2) the promissory note (also called the "mortgage note" or simply "the note"), and (3) the mortgage. Think of the last document, the mortgage, as a bridge between the deed and the note. The mortgage connects the deed to the note and says "If I don't pay you on that Note, then you can foreclose on the property described in that Deed." Or in the case of an auto loan, you have the (1) Certificate of Title (2) the car loan IOU and (3) the Security Agreement. Again, the Security Agreement functions as a bridge between the IOU and the vehicle Certificate of Title and says "If I fail to pay you on that auto IOU contract, then you may repo that particular car." Often the Car Loa (IOU) document and the Security Agreement are combined into one long physical piece of paper, but they are really two difference concepts that appear one after the other on the same paper.
What does all this have to do with Chapter 7 bankruptcy cases? In a Chapter 7 case the debtor has to make a decision about each secured loan. These are most commonly a house mortgage or a financed auto loan, although it can apply to other situations such as financed furniture. For each secured loan, the debtor must choose one of the following three alternatives (1) Reaffirmation, (2) Surrender, and (3) Redemption.
Reaffirmation. In a Reaffirmation, the debtor is signing a special bankruptcy document called a Reaffirmation Agreement that says that the debtor wishes the loan arrangement to continue, usually under the same terms, as though bankruptcy had never occurred -- at least as to this one loan. A typical example is a house mortgage where the debtor wants to stay in the house and continue with the mortgage payments. Also common are auto loans where the debtor wants to keep the car and agrees to keep up the payments. The reaffirmation agreement operates as a detour around bankruptcy. For this one particular contract, it will continue in force as if bankruptcy had never happened. (As a side note, it should be observed that there can be re-negotiation of terms in a Reaffirmation Agreement, but that is not the usual case.) Whether a debtor is
wise to sign a reaffirmation agreement is a different discussion altogether, but the point here is that Reaffirmation is the first of three possible choices the debtor has on a secured debt.
Surrender. The second choice a debtor has on a secured debt is Surrender. Under this choice the debtor allows the lender to repossess the collateral and sell it, reducing the balance owed. However, because of the bankruptcy, the balance owed after the sale of the collateral will be
forgiven when the bankruptcy court enters the order granting the Discharge. Surrender is essentially the equivalent of a person returning an item to the store for a full credit and no more money is owed. Surrender is usually the best choice when more money is owed on a debt than the collateral is worth, for example upside-down house mortgage debts and upside-down vehicle loans.
Redemption. The third choice is Redemption. To understand this, let's take an example. The debtor has a car loan with First National Bank for the purchase of a Ford F-150. Let's assume the Ford is worth $5,000 but the auto loan balance at the bank is $8,000. The debtor has just filed Chapter 7. The debtor does not want to choose Reaffirmation, because that binds him to a contract under which he will pay $8,000 for a car only worth $5,000. So, Reaffirmation is not a good choice. What if the debtor chooses Surrender? First National Bank repos the car, then presumably will sell it for its value of $5,000, but the $3,000 balance will be forgiven by the Discharge if the debtor has chosen "Surrender." The bank ends up with $5,000 from the sale of the vehicle, but that's it. The bank has to eat the missing $3,000 loan balance. If the debtor chooses, instead of Surrender, the debtor could choose Redemption. This third choice of Redemption operates as follows: the debtor in bankruptcy, after the case is filed, comes up with $5,000 and says to First National Bank, "I propose to hand you $5,000, the value of the Ford. In return, you give me the Ford Certificate of Title and you stamp the Title "Lien Paid." If the bankruptcy court decides (or the parties agree) that the value of the Ford is indeed $5,000, then the Bank has no choice. It must accept the $5,000 and give the collateral (the Ford) back to the debtor with a clean title. But do you see that the Bank is no worse off than if the debtor had elected "Surrender" instead. In both cases, the Bank ends up with $5,000 but the collateral is gone (in Surrender the collateral and car title go to whoever buys it from the repo sale and in Redemption the collateral and car title end up with the debtor. But the bank ends up in the same position. That is why Redemption is viewed as fair to the bank. The practical problem with Redemption is this: where is the debtor going to come up with $5,000 to pay to the bank in a Redemption? After all, the debtor has just filed for bankruptcy. Sometimes the answer is an IRA the debtor owns can be cashed in. Sometimes there is a family member that will lend the debtor the money. There are even finance companies that specialize in making high interest loans to fund redemption agreements. Still, redemptions are relatively rare.
What are the dance steps in a Chapter 7 bankruptcy case on Reaffirmation, Surrender, and Redemption? For starters, the debtor files with the bankruptcy court a document called the Debtors Statement of Intentions. It lists each secured debt and states whether the debtor intends to reaffirm the debt, surrender the collateral, or redeem the collateral. There is a deadline for the filing of the Debtor's Statement of Intentions, and that is the earlier of the following two dates: (a) the date set for the Meeting of Creditors, or (b) 30 days after the bankruptcy Petition was originally filed with the bankruptcy court. In common practice lawyers file the Statement of Intentions at the same time the Petition is filed, so there is hardly ever a complete failure to file the Statement of Intentions on time when the debtor is represented by counsel. However, it is not rare to see individuals representing themselves file a bankruptcy petition yet fail to file all the rest of the schedules and Statement of Intentions on time. If there is a failure to file the Statement of Intentions, the resulting penalty is not completely clear. There seems to be no automatic penalty if the collateral is land, like a home. But if the collateral is not real estate, then the collateral is called "personal property (translation - "not land). If the collateral is personal property, the statute is not completely clear, but it appears that the Automatic Stay may be terminated. The creditor benefits from termination of the automatic stay, if termination has occurred, because it entitles the creditor to forcibly auction off the collateral and at least get some of their money right away rather than waiting for the bankruptcy case to play out over time.
But even if the debtor files his Statement of Intentions on time, he must act on that stated intention. The deadline to act is 30 days after the date for creditors' meeting. If the collateral is real estate, then again there doesn't seem to be an automatic penalty. But if the collateral is personal property (like a vehicle) then:
1. If the debtor stated an intention to redeem the collateral and has not done so, the Automatic Stay is automatically terminated (translation: the creditor may repo).
2. If the debtor stated an intention to surrender the collateral and has not done so, the Automatic Stay is automatically terminated.
3. If the debtor stated an intention to reaffirm the collateral and has not done so... then it's a little more complicated. Sometimes (not often) the debtor has offerred to reaffirm and the creditor has refused to reaffirm. In such a case the debtor is doing the best he can to reaffirm but for some reason the creditor is not cooperating. The result is the Automatic Stay continues in force and there can be not automatic rights in the creditor to repo -- the creditor will need to ask the Court for permission to repo or wait till the case is over. However, if the debtor has not tried to reaffirm or has been uncooperative even though the creditor is being cooperative, then the Automatic Stay is automatically terminated.
The chart above lays out the requirements of the Statement of Intentions and the consequences of failure by the debtor to act upon those intentions by certain deadlines.