Section 523 of the Bankruptcy Code sets out a number of situations in which credit card debt will not be discharged.  Section 523(a)(2)( c) makes non-dischargeable consumer debt totaling more than $500 for luxury goods and services owed to any one creditor that are incurred within 90 days of filing, or cash advances totaling $750 or more owed to any one creditor made within 70 days of filing.

Section 523(a)(2) makes non-dischargeable debt owed to a creditor that was incurred by false pretenses or by fraud.

Basically, then, Section 523 gives credit card lenders at least two arguments to challenge a debtor:

1. recent credit card use (within 3 months) for anything but necessities like food, clothing and shelter
2. any credit card use in the recent past (in my experience this can be up to a year prior to filing) if a debtor makes charges where there is no reasonable expectation of repayment.   

Another way to look at this – if you have lost your job and for the last year your sole source of support are credit cards and cash advances, you should not expect to avoid a challenge by the credit card issuer just because you wait 91 days after your last use of your cards.

What, then, should you do if you need to buy food or gasoline in the weeks before you actually file?

First, you should recognize that shortly after you file, there is a very good chance that your credit cards will all be canceled and you are going to have to find another way to pay for your food and gasoline.  A bankruptcy may eliminate old debt but it will not help you pay your current or on-going bills.

Second, I advise my client that if they have to access their credit in the weeks and days before filing, I would choose one card – preferably a low interest card – and use that one only.  Expect that even if this card was used for food, gasoline and other necessities that you will have to pay some or all of it back.  If you can walk away from bankruptcy with 90% of your debt discharged, you will be better off than you are today and it is possible that any one creditor may not pursue a non-dischargeability complaint.

Three, as a practical matter you are not going to want to spend the money litigating Section 523 dischargeability actions.  Bankruptcy litigation is expensive and if you are scraping to buy food and gasoline, you will be able to afford litigation.  The fee you pay your bankruptcy lawyer will almost never include litigation.

Four, it is not always the worst idea to reaffirm one credit card, especially if it has a low balance and low interest rate.  Keeping one card can help you rebuild your credit quickly and some lenders will be open to aggressive negotiation on your part about balances and interest rates.

In my Atlanta area practice I often meet with a potential client weeks or months before we actually decide to file.  As such I encourage potential clients to call me as soon as they have any thoughts that bankruptcy may be even an unlikely option.  The more time we have to evaluate options and engage in pre-bankruptcy planning, the better.

Further, you may be able to negotiate a more favorable deal when you reaffirm.  Other than cars, secured creditors are often not set up to liquidate used merchandise and since you already have possession of the property (collateral), many lenders are happy to negotiate more favorable terms with you so they can avoid the hassle of recovering and disposing of property.   This negotiation option is less true with motor vehicles, because there is an active used car market, but the negotiation option can work well when you are dealing with furniture or electronics.

Reaffirmation can also help you rebuild your credit because you are re-assuming personal liability for payments, and regular, timely payments usually will be reported as positive information to the credit bureaus.

On the other hand, when you reaffirm, you are re-obligating yourself personally to pay an installment note.  If you should default, you are fair game for all collection activities including wage garnishment.

Reaffirmation Must be in Writing, Signed by You and the Creditor and Approved by the Bankruptcy Judge

At least once or twice a month, I get an email from a frustrated individual who has received his bankruptcy discharge, and has continued to make monthly payments, but sees no mention at all about these payments on his credit report.

It is not enough that you checked the “reaffirm” box on your bankruptcy Statement of Intention.  You and your creditor have to complete a formal reaffirmation agreement.  These agreements usually consist of about 10 pages of legal speak and your attorney has to document that your budget can handle the reaffirmed payment.  Your attorney also has to sign the reaffirmation agreement and assert in writing that he thinks that reaffirmation is in your best interest.

Usually, reaffirmation agreements are prepared by the creditor or creditor’s attorney.   Sometimes lenders simply will not cooperate – they may not have any objection to accepting your payment and leaving you alone regarding possession, but they may forward a reaffirmation agreement to you.

I have also seen situations where lenders fail to file the signed reaffirmation documents on time and the reaffirmation agreement does not get court approval even though the debtor and his attorney did everything they were supposed to do.

If you and your attorney confer and decide that reaffirming a particular secured debt makes sense for you and that you can afford the reaffirmed payment, you should encourage your lawyer to quickly and aggressively request a reaffirmation agreement from your creditor.  Once your case is discharged and closed, it is difficult and expensive to try to re-open a closed case solely for the purpose of reaffirming a debt.

This past March, I discussed redemption of property in Chapter 7.   Redemption of property is a viable option but it is far less common than “reaffirmation” of debt.

Why Do You Need to Reaffirm?

Secured loans actually contain two different kinds of obligations.   On one hand, you obligate yourself personally to pay a particular debt.  This is typically in the form of a promissory note.  The second layer of obligation ties the specific item of property to the loan.  This is called a security agreement.

When you file a Chapter 7 and a discharge is issued by the judge, your personal liability on your secured debt is extinguished.  This is why payments on a non-reaffirmed car loan or home loan will not be reflected on your credit reports.  You have no personal obligation to pay.  However, a Chapter 7 discharge does not extinguish the lender’s security interest against property.  This is why a vehicle lender can repossess or a mortgage company may foreclose to recover property.   In such a situation you would not have any personal liability for any deficiency amount.

A reaffirmation serves two main purposes:

1. you will have the certainty of knowing that you are once again in a contractual relationship with the lender.  If you do not reaffirm, you could wake up one day to find that your vehicle has been repossessed or that you are being foreclosed upon.
2. secondly, payments on a reaffirmed debt will appear as positive information on your credit reports.  This means that your credit score will recover more quickly

Can You Negotiate Better Terms in a Reaffirmation?

Because a reaffirmation agreement is a new contract between you and your lender, you absolutely can negotiate different terms.  I have negotiated reduced payments, lower interest rates and reduced balances on furniture, electronics, and vehicles.  I have also negotiated lower payments on 2nd and 3rd mortgages.

It has been my experience that some lenders will just not play ball.   They would rather incur the expense of recovering, storing and reselling a used item.   I think this attitude of  “we do not negotiate with debtors” is silly and counterproductive, but some lenders take this position (I suspect that some of these lenders do not have the staff or protocol for handling a negotiated debt).

On the other hand, many lenders will agree to a deal with terms a lot better than the original contract.  But you do have to ask, and, of course, if you agree to any terms, you must live up to the deal.  Reaffirmation agreements can be canceled by the debtor within 60 days after the agreement is entered, or the case is closed, whichever comes first.

I have read your blog and you are very through so I write you with hopes that you might answer this question for me. I file Chapter 7  in 08, and did not reaffirm my loan. I am still living in the house and did make some payments. However, i have not for the last 8 months. It is my understanding that I must sign a document to reaffirm and that continuing payment in itself is not a reaffirmation…or?  Well it gets a little more complicated.  My house is valued at $410,000 and the bank has offered me a deal that is going to be hard to refuse. They have agreed to let me do a short re-fi in the amount of 180k.  If I agree to that is that in itself a reaffirmation?

Here is my response: in most cases, when you take out a mortgage loan, you are signing two different types of agreements.  The first type is a promissory note whereby you personally agree to make the payments.  The second type of obligation creates a property lien, meaning that you, as the owner of the property, pledges that property as collateral for the loan.

When you file a Chapter 7 and receive your discharge, your personal obligations are extinguished.  However, a Chapter 7 discharge does not eliminate the mortgage company’s lien against your property.  If you “reaffirm” your mortgage, you are actually reaffirming the promissory note and your personal obligations to pay.

For years, many bankruptcy attorneys advised their clients to avoid signing reaffirmation agreements for mortgages, car loans or any other secured debt.  The reasoning – even without a personal “guarantee” lenders are protected by the property lien.  If the lender is willing to accept payments (the so-called “stay and pay” option), the now discharged debtor keeps his property, keeps making payment, but does not have personal liability on the note.

If the debtor misses payments, the lender would still have the right to foreclose or repossess based on the property lien.  The debtor would not have personal liability for any foreclosure or repossession deficiency because his personal liability was extinguished in the bankruptcy.

There is a downside to this “stay and pay” strategy.  First, the debtor does not get any credit report benefit for making payments.  Because the debtor’s personal obligations have been extinguished, the lender no longer reports either a positive or a negative payment history.   A positive payment history from a mortgage company can be a good way to restore credit after bankruptcy, and if you do not reaffirm, you will not get this benefit.

Second, there is the “uncertainty factor” if you do not reaffirm.  Most mortgage or vehicle finance installment notes contain a default provision that includes bankruptcy as a default trigger.  In theory, at least, once your bankruptcy is closed (and the automatic stay of bankruptcy terminated), your lender could declare your loan in default and take action under State law to recover the collateral.  In my experience, lenders would much rather have monthly payments than your collateral but this risk does exist.

Finally, many of my readers have asked me if there is such a thing as “constructive reaffirmation” meaning that by making payments, are you in effect re-obligating yourself?  Are you creating a contractual obligation by your actions?

I think that the answer to this depends on State law but I would suspect that a mortgage or vehicle lender would have a hard time making this argument.  In many States (such as in Georgia) a financial obligation related to real estate must be written and they must have specific terms.  As a matter of general contract law, a contract usually will not be enforceable if its terms are not specified.   I would argue therefore that a debtor’s actions of simply making payments and the lenders actions of accepting such payments should not be enough to create personal liability on the part of the debtor.  I would be interested to know if any of the attorneys who read this blog have a different opinion or if anyone is aware of any case law that says otherwise.

At a minimum, if a lender tries to make the argument that you have somehow re-obligated yourself personally by your act of making payments, I would insist that the lender provide you with case law or other support for its position, and you should consult with a lawyer before agreeing to any payment or taking any action (like signing a new, valid contract) that could create personal liability.

My reader states that his lender has proposed a refinance for $180,000.   He did not say, but I presume that his prior (discharged) mortgage was much higher than this and that his current payments under the “stay and pay” are based on this higher balance.  If he enters into a mortgage contract for $180,000, that contract will function like any other mortgage – and include both personal liability under a promissory note as well as a property lien.   It is not a reaffirmation because the bankruptcy is over – instead, the proposed $180,000 loan deal is equivalent to a new mortgage.  This proposed deal could result in lower payments plus positive credit history, but it will also create personal liability that currently does not exist.  I would certainly advise my reader to discuss his options with an attorney so that he will fully understand the implications of his decision.

In those cases where a debtor does not reaffirm, there seems to be some confusion as to how this decision affects the debtor’s rights.  I received the following question from Heather, who asks the following:

Jonathan,
I claimed Chapter 7 bankruptcy back in 2004.  Sadly enough I just now looked closely at a credit report.  My mortgage wich I had maintained through the bankruptcy and have done so for the past 5.5 years said it was discharged on the bankruptcy.  Which rose many questions!  I called the mortgage holder and they said I never reaffirmed my mortgage.  I don’t know if I did or didn’t my original mortgage was with one company who sold it to another in 2006.  I no longer live in this house, it is an income property, which I also have on the market. Am I going to run into trouble selling this? And my mortgage is directly withdrawn out of my account each month if “technically” it was discharged are they able to continue to take that money every month?  I have sunk a lot of time and money into this property if it “technically” isn’t mine.  What would I lose by stopping payment on it.  I’ve already suffered the credit report deduction for 5.5 years and have managed to get my score to fair standard even with that on there.  what more can it do to me and where should I go from here.  Thanks

Here is my response: Not reaffirming a mortgage obligation means that you are not personally liable on the promissory note associated with the security agreement.   The property remains encumbered by the mortgage obligation and you continue to maintain and grow your equity interest in the property.  Your title interest does not change.

The biggest difference – you are no longer personally liable on the note.   This is a positive development in that you cannot be sued personally if you were to abandon the property and a foreclosure sale generated less than what was owed, or if the property burned down and there was no insurance.

The negative about not having personal liability – your credit report will not reflect any positives arising from the payments that you do make.  As you, personally have no obligation to make any payments, you are not personally accessing any credit.

If you were to pay off the mortgage, you would get the title just as you would otherwise.  You can still apply to reaffirm the debt and get back into a more traditional security note + promissory note situation.  You can also sell the property as you do have title interest.

As far as where to go – you will have to decide if the benefit of building credit through a positive mortgage payment history following a refinance outweighs the benefit of not having personal liability on a mortgage.

Scott points out that if Clayton County loses its accreditation, graduating students will not be eligible for Hope Scholarships (Hope Scholarships are lottery funded scholarships to schools in the Georgia university system and have offered a greatly reduced higher education costs to thousands of Georgia college students).  With a school system in a mess and eligibility for Hope Scholarships withdrawn, residential real estate prices will fall, home buyers with school age children will avoid Clayton County and the county’s tax base will fall.  Scott correctly advises:

If you are a homeowner in Clayton County and you find yourself in Bankruptcy, think twice before reaffirming your mortgage debt.  Even if you qualify for a reaffirmation and your home is worth the amount of debt, it might not be the case for long.  You might be signing up for post-petition personal liability for the mortgage on a home that decreases significantly in value in the coming months and years.  You could be locked into staying in Clayton because you cannot sell, selling your home at  discount and paying the difference, or a foreclosure. You will owe the full amount of your mortgage (including interest and fees) after your discharge.  Again, think twice.

While the Clayton County situation is somewhat unique, it does raise an important point about home reaffirmation in general.  It is not always a good idea to reaffirm a home or a car.  You should look forward, not backwards, when filing a bankruptcy.  Too many times I have heard the argument "I can’t give up that car because I have invested too much in it."   In my view, that kind of argument is ridiculous.  Bankruptcy should be used to eliminate obligations that you can’t afford, not validate bad decisions or purchases that you can no longer afford.

Yes, it would be a pain to file bankruptcy and give up the Clayton County home where you have settled and become comfortable.  However, if you have a chance to extricate yourself from an environment where housing prices will likely be depressed, and a place where hard working middle class families will avoid, you should use the bankruptcy process to better yourself and your future.

Jonathan Ginsberg responds:  Christina, thanks for your questions and the kind words about my Atlanta bankruptcy web site.  With regard to your car, in a Chapter 7, you can reaffirm your car note if (1) you are current on the note and the lender agrees to a reaffirmation and (2) you have less than $3,500 of equity in the vehicle.

Reaffirmation is a voluntary process most frequently used in the case of secured debt in which you keep your property and reassume full legal responsibility for the note.  If you are current and you have a source of funding for the payment, you should have no trouble reaffirming.

The $3,500 figure comes from Georgia’s exemption statute.  Under Georgia law (which applies to your bankruptcy case), you can shelter or "exempt" up to $3,500 of equity in your vehicle.  If you have more than $3,500 of equity, you would need to settle up with your Chapter 7 trustee and pay him the non-exempt portion of your equity – which he would use to pay creditors of your bankruptcy estate.

WIth regard to the lease, technically a rental contract is known as an "executory contract."  This means that its terms have not yet been fulfilled (the terms being your monthly lease obligations).  Until the October, 2005 changes to the law, most lawyers did not include current lease contracts in bankruptcy petitions.  Under the new law, however, an executory contract that is not "assumed" is deemed rejected.  So, it probably makes sense to include the lease contract on Schedule G of your petition and to assume the contract.   The potential problem with including the lease contract in your petition is the notice that will be given to the landlord.  Some large apartment complexes may be reluctant to give you a new lease if you have filed bankruptcy – this is rarely a problem with smaller ownership groups.

I would also note that if your only source of income is Social Security, and you have no assets, then you are basically judgment proof.  If you own only $25,000 and you are judgment proof, I wonder if filing Chapter 7 is really a good idea.

Jonathan Ginsberg responds:  Fana, the minute you file a bankruptcy, all creditor action stops because of something called the "automatic stay."   There are a few exceptions to the automatic stay (i.e. multiple filings, child support debt, and a few other limited categories), but as a rule, all creditor action stops the minute you file.

Chapter 7 is primarily designed to get rid of unsecured debts like credit cards and medical bills.  In a Chapter 7, secured debts must be either reaffirmed or the collateral must be surrendered to the secured creditor.

Automobile loans are considered secured debts because the vehicle you purchased serves as security for the loan.  If you want to keep your vehicle in a Chapter 7, you must reaffirm it.  Reaffirmation of a vehicle loan is voluntary on the part of the secured creditor.  Generally, most car lenders will reaffirm if:

you are current with your payments

you have enough income to pay for the reaffirmed debt in your budget

your are able to shelter (exempt) your equity, if any, as part of your Chapter 7 petition

If the creditor refuses to reaffirm your choices are to surrender the vehicle or to convert to Chapter 13 where you can try to force a repayment down the lender’s throat.

If you do nothing – do not reaffirm and do not state any intention, the Bankruptcy Code will presume that your intention was to surrender and after the bankruptcy is over, the secured lender can repossess the vehicle.  Note that in this situation you would have no personal liability for a repossession deficiency – the Chapter 7 discharge serves to wipe out your personal liability.  However, the lien (in rem jurisdiction) that encumbers the vehicle remains and survives the bankruptcy.

So, if you are financing a vehicle and you file Chapter 7, there is a good chance that you can keep your vehicle if you qualify for a reaffirmation.

Chapter 13 now provides that debtors may include "adequate protection" payments to vehicle lenders such that the lenders receive payments prior to the confirmation of a Chapter 13 case.  These adequate protection payments can be made directly by the debtor to the lender or, as is the case most often, through the trustee’s office from the trustee payment receipts.

For example, a debtor may owe $25,000 on a vehicle purchase in which the contract payment is $450 per month.   His Chapter 13 trustee payment may be $550 per month with $400 of that payment payable to the lender prior to confirmation as an adquate protection payment.  Such an arrangement seems reasonable, but is it really?

Here is the ethical issue that debtors’ lawyers face.   Individuals facing bankruptcy – whether Chapter 7 or Chapter 13 – usually have very little cash on hand.   The filng fee for Chapter 13 in particular is now $274 and further increases are predicted.   Debtors’ lawyers therefore usually collect the filing fee and some small payment towards the attorney’s fees prior to filing a case.  In my office, for example, I usually ask for at least $600 in up front attorney’s fees + the filing fee for a total of $874.  My experience has been that most debtors have to struggle to come up with $874.  Then there is the $50 that the debtor has to pay for pre-bankruptcy counseling.  Many lawyers charge the filing fee only or perhaps the filing fee and $200 or $300.

The Chapter 13 plan used in the Northern District of Georgia allows attorneys to set a "reasonable fee" both for cases that are confirmed and for cases that are dismissed prior to confirmation.  A plan may provide for $4,500 or $5,000 in fees if the case is confirmed and, say, $3,500 if the case is dismissed.   The fees charged in your case may be higher or lower depending on the complexity of your case and the lawyer you choose.

As Chapter 13 debtors’ lawyers well know, much of the work done in a Chapter 13 case occurs prior to confirmation.  In the current climate, cases may be reset two or three times and plans and petitions may be amended repeatedly.

If most of the money being paid in to a plan ends up in the hands of vehicle lenders, very little remains to pay a lawyer who may have expended fifteen or twenty hours, only to see his client’s case fail because of a job loss, an illness or circumstances beyond the lawyer’s control.  On the other hand, if the lawyer sets the adequate protection payment very low, the lender may object and the debtor may not have the option of converting his case to Chapter 7.   Secured lenders in Chapter 7 will usually refuse to reaffirm secured debt claims if the debtor is delinquent.  Six months of a low adequate protection payment will result in several hundred to several thousands of dollars in payment delinquencies, leaving the debtor at risk for repossession.

To put this another way, this adequate protection provision forces debtors’ lawyers to choose between getting paid a fair fee for their work or maximizing the adequate protection payment to preserve their client’s ability to convert to Chapter 7 or to dismiss the Chapter 13 case without drastic consequences.

Now, a cynic would argue that lawyers are free to charge a higher up front payment – it is there decision to charge little or nothing up front.   Unfortunately, the marketplace says otherwise.   What is happening and will continue to happen is that solo practitioners and small firms are being driven from the market.   High volume filers will be the only ones left who can take the risk of filing Chapter 13′s.   With no disrespect directed to high volume filers who certainly have their place in the market, there are many complex Chapter 13 cases that need personalized attention.

In my view this adequate protection procedure has the (un)intended consequence of further closing the door to debt relief under Chapter 13.

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