Reaffirmation Agreements In Chapter 7 Cases: What it means for the Debtor

Chapter 7 bankruptcy allows a consumer to eliminate (“discharge”) their unsecured debt, subject to certain exceptions. [1]  With respect to a secured debt, such as a home mortgage or auto loan, the consumer has three options.  The first option is that they may “surrender” the collateral in full satisfaction of the debt.  For instance, the auto lender would have the right to repossess the vehicle and sell it at public auction.  However, if the proceeds of the sale are insufficient to pay off the loan balance, the lender is prohibited from attempting to collect the difference from the debtor.  The second option is that the debtor may “redeem” the collateral which is the subject of the loan.  This allows the debtor to make a lump-sum payment to the creditor, based upon the value of the collateral, which satisfies the indebtedness.[2]  The third option available to the Chapter 7 debtor is to reaffirm on the secured debt.  Reaffirming a secured debt basically restores the relationship between the debtor and the lender going forward, after the bankruptcy case is discharged.

When a debtor files a bankruptcy petition, they are required to include a “Statement of Intentions”, which informs the secured creditors as to which of the above three options that a debtor has chosen for that particular debt.  Debtors are required to perform their intentions within a specified time period.  If a debtor intends to “reaffirm” on a debt, that will be set forth on the Statement of Intentions, and the creditor will be on notice.  However, indicating the “intent” to reaffirm does not actually reaffirm the secured debt.  The creditor must prepare a reaffirmation agreement which contains mandatory disclosures about the loan, including the balance, monthly payment, interest rate, and description of the collateral.  This can only be prepared by the creditor, as neither the debtor nor the debtor’s attorney will have access to the loan information necessary to prepare an accurate reaffirmation agreement.  Once the reaffirmation agreement is signed by all parties (the debtor, debtor’s attorney and a creditor representative), it is then filed with the court.  The parties are not bound by the terms of the reaffirmation agreement until it is signed and filed.[3] Unless agreed to by the parties, all of the original loan terms remain the same.

The reaffirmation agreement is for the creditor’s protection, as it restores the debtor’s personal liability on the debt.  If the debtor defaults in the future, the lender has the right to repossess/foreclose their collateral, and pursue the debtor for any deficiency claim which may exist after the collateral is sold.  It is for this reason that the reaffirmation of a debt should be carefully considered, and the ability to pay the debt in the future is so important.  The benefit to the debtor is that the lender should report the timeliness of payments and loan status on the debtor’s credit report.  Likewise, many creditors will refuse to send billing statements or allow online payments in the absence of a reaffirmation agreement.  Finally, some creditors may not permit a loan modification if the secured debt has not been reaffirmed.  Contrary to the information often provided by secured creditors, the Bankruptcy Code does not prohibit accurate credit reporting or normal payment collection in the absence of a reaffirmation agreement.  But many creditors will impose those conditions to compel a reaffirmation agreement, in order to make sure that their interests are protected.

Unfortunately, there is a lot of misinformation about reaffirmation agreements and their purpose, primarily coming from the creditor side.  For several years, many of the larger mortgage lenders did not provide reaffirmation agreements – even when requested – because they were not confident that their loan records were accurate.  In other instances, creditors would simply ignore or disregard debtor requests for reaffirmation agreements.  On other occasions, the terms of the reaffirmation agreement would be incorrect, and by the time that the corrections were made, the case was already discharged.[4]  Regardless of the reason, the debt was not reaffirmed.  While this may work in the debtor’s favor if they decide to change their mind and surrender the collateral, it may compromise their ability to rebuild their credit in the future.

For instance, if the debtor stated their intention to reaffirm on the debt, and continued to make the payments just like normal, their credit report should reflect those payments.  However, they will be penalized by the failure of the secured creditor to timely provide and/or file a correct reaffirmation agreement.  This usually shows up when a debtor attempts to refinance a loan or obtain a payoff, and the credit report indicates that the debt has been discharged.  This is exceptionally frustrating for a discharged debtor who has faithfully managed their mortgage payments for several years, with no acknowledgement by the creditor.  Whether due to lack of understanding, or purposeful shifting of the blame, the secured creditor’s response to a debtor’s inquiry about their payment history is almost always to blame the bankruptcy attorney for the failure to file the reaffirmation agreement.  There are certainly going to be instances where a reaffirmation agreement was provided, but not completed by the debtor or debtor’s attorney.  But neither can be blamed for not signing an agreement that was never provided in the first place, as is most often the case.

The law clearly requires the participation of all parties in the filing of a reaffirmation agreement.  It is not something that can be prepared and filed without the creditor’s cooperation, especially given the fact that it is primarily for the creditor’s benefit.  Ideally, the secured creditor will promptly provide the reaffirmation agreement, and allow the discharged debtor to rebuild their credit and confidence as they move forward.