Debt Treatment Under Chapter 7
1.0 How is Priority Debt Handled?
1.1 In General
Most priority debt is non-dischargeable, meaning that it does not go away after the filing of a chapter 7. There are some important exceptions, however. These include taxes and student loans.
1.2 What is the Effect of a Chapter 7 on My Tax Liability?
All business taxes are non-dischargeable as are unfiled tax liabilities and timely filed tax obligations that are less than three years old. In the event that you owe personal income taxes on returns that have been filed, and more than three years have passed since the filing and assessment of your tax liability, you have not signed a voluntary extension of the collection period with the IRS, and the IRS has not filed a lien; those taxes may be discharged.
1.3 Is it Possible to Discharge Student Loans?
The general rule is that student loans are non-dischargeable. However, if you can prove to the bankruptcy court that repayment of the loan would create an “undue hardship” your student loans may be discharged. It is very difficult to show undue hardship. You must prove that you lack the physical or mental ability to earn sufficient funds to repay the debt. The discharge of student loans in a chapter 7 requires a special addition legal proceeding called an adversary proceeding that must be filed separate and apart from the bankruptcy. Our office does not handle adversary proceedings.
It may be possible for you to seek discharge of your student loans outside of bankruptcy. In limited situations which may include: the closure of the school you were attending while still enrolled, the school’s false certification of your eligibility, the schools failure to pay a refund owed to you, or your permanent and total disability; it may be possible to have the debt forgiven or discharged. If you think you might qualify under one of these grounds you should visit the department of educations web site at www.ed.gov and download the appropriate application forms.
It should also be noted that under the new law it appears that all student loans are non-dischargeable. Under prior law loans that were not “made, insured or guaranteed by a governmental unity” or funded in “whole or in part by a governmental unit or nonprofit institution” were dischargeable.
1.4 Are Post-Dated Check Loans Priority Debts?
Most Post-Dated Check Loan agreements have language in them stating that you may not file bankruptcy on them. This is incorrect. You must list all of your debts on your bankruptcy including check loans. Further, these loans are usually considered to be unsecured and will be discharged unless they were made or renewed in the last 90 days and the balance was over $500.00.
1.5 Consumer Debt
If you have made large credit charges in the six months prior to filing and have made very small payments or no payments, the credit card company may ask that these debts be declared non-dischargeable because of a demonstrated lack of intent to repay. If you are in this situation, you can minimize your chances of being sued by making the regular monthly payments for at least three months. The longer you make regular payments the less your chances of being sued. The larger the single charge the longer the time which must pass.
2.0 What Happens to Secured Debt?
2.1 In General
Debtors generally have three options in connection with secured debt. They are surrender, reaffirmation, and redemption.
2.2 What is Surrender?
Surrender occurs when you return to a creditor the property which secures its claim. If you surrender property to a secured creditor, the entire debt is discharged. There is no deficiency as in the case of a repossession or foreclosure.
In cases where you surrender the collateral, the creditor will eventually dispose of it. They will often send you letters indicating an intent to sell the collateral and/or that they have sold the collateral. These letters will often indicate that you are responsible for the balance. If the collateral was timely returned to the creditor and was not damaged post petition prior to repossession, you can ignore these documents. You are not responsible for any deficiency after sale. The one exception being Federally Guaranteed Mortgages, where you will receive a 1099 that shows amounts (the deficiency) that must be included on your next years taxes as income.
2.3 When Should I Surrender Property?
It is generally better to surrender property to a creditor after the filing of a bankruptcy. If the property is surrendered prior to filing, an adverse notation such as a repossession will be added to your credit report. Such notations are usually not added to your credit report if the property is surrendered post filing. Although some creditors will report post filing seizures as repossessions.
A creditor is not allowed to retake their collateral under State Law without a court Order of Replevin unless (a) you voluntarily allow them to take the property or (b) they can repossess it without “breaching the peace” (meaning quietly or without injury to person or property). If you are concerned about a repossession you should not leave the vehicle where it can be taken without your knowledge. Further, if a creditor asks you to voluntarily allow repossession you are not required to consent. You should call the police if they become belligerent. If a creditor provides you with a Writ and Order of Replevin you must immediately give them the motor vehicle.
If you are delinquent in payments on a motor vehicle you should immediately remove all of your personal items from the vehicle so they are not lost in a repossession. The creditor is supposed to contact you and allow you to collect your items, but many do not. If you leave your work tools in a vehicle it may be several days or months before you can recover them. Sometimes you will never get them back.
As a final note, bankruptcy should not be used as a tool to unnecessarily delay the return of secured property to a creditor when you are behind in your payments. If you wish to retain the collateral after bankruptcy you must be current on your payments. A creditor may not be willing to reaffirm if you (a) have intentionally avoided repossession when behind or (b) have a very poor payment history.
After the filing of a Bankruptcy you should immediately return any property that you intend to surrender. Under the new law, you must surrender the property within 30 days of your first meeting of creditors). If you retain property after the date of filing you should maintain insurance on it since you will be responsible for any damages that take place between the date of filing and when the creditor takes possession.
2.4 What is Reaffirmation?
Reaffirmation is an agreement with a creditor that you wish to retain the collateral and continue making your regular monthly payments. Reaffirmation most often occurs in connection with homes and cars. In each case in which a client indicates a desire to retain an item of secured property a letter is sent by the attorney to the creditor requesting a reaffirmation agreement. Under 524(c) the reaffirmation agreement must be signed (by debtor and creditor) and filed with the court before the case is discharged (usually 60 days after the first meeting of creditors). Unfortunately, many creditors do not respond. In fact, many creditors (including those you wish to continue to pay) will not send you monthly statements after you file.
This creates a dilemma under the new law. New section 521(a) states that you must reaffirm on all property within 30 days of the first meeting of creditors, which is contrary to the 60 day limit of 524(c). Further, section 362(h) states (with one limitation that will be mentioned below) that if a debt on personal property is not reaffirmed within 30 days of the first meeting of creditors the stay is automatically lifted as to that property. A third date is found in new section 521(a)(6) which requires a debtor to surrender personal property that has not been reaffirmed or redeemed within 45 days of filing. The same section indicates that if you have not complied with this provision the stay is lifted and “the creditor may take whatever action ... is permitted by applicable nonbankruptcy law ...” Nonbankruptcy law says that a creditor cannot repossess or foreclose property unless (1) you are behind in your payments, (2) the contract includes a “bankruptcy” termination clause, or (3) the contract includes an “insolvency” termination clause. Under the old law you could retain the collateral without a formal reaffirmation as long as you continued to make your payments since “bankruptcy” and “insolvency” clauses were deemed void. The new law over rules the Lowry case. Thus a creditor can refuse reaffirmation and take back collateral if you are current on payments but your contract includes a “bankruptcy” or “insolvency” clause. Section 362(h) seems to state that the stay is not lifted if a debtor attempts to reaffirm before the 30 day deadline “on the original contract terms and the creditor refuses to agree to the reaffirmation on such terms.” However, only sections 521(a) and 524(c) apply to real property.
If you find yourself in this situation post-filing with an uncooperative creditor who will not prepare or sign a reaffirmation agreement and you wish to retain the collateral, you should continue to make your regular monthly payments. However, you must be very careful. If you ever get behind on your payments or your insurance lapses they can immediately take back the property. They will not work with you to catch up payments if you get behind and they may actually refuse to speak to you about your account.
As an additional barrier to reaffirmation, if you are represented by counsel, section 524(c)(3) requires the attorney to certify that the repayment “does not impose an undue hardship” on the debtor or a dependent of the debtor. What this means is that if your post-filing budget does not show sufficient funds to pay the normal and recommended living expenses of a family your size (including alimony or support obligations), the debt you wish to reaffirm, and any debt that is non-dischargeable; the attorney cannot sign it.
The new law in 524(k) provides new disclosures that must be given to debtors who reaffirm. For example, the agreement must disclose (1) the amount being reaffirmed, (2) any costs and fees accrued as part of the debt being reaffirmed, (3) that additional amounts may come due after signing, (4) the annual and simple interest rate(s) you are being charged, (5) if you have a variable rate the fact that your interest rate may go up or down, (6) each of the items that exist as collateral for the reaffirmation, and (7)a statement of your repayment schedule. In addition, you must be provided the following disclosures:
Note: When this disclosure refers to what a creditor ‘may’ do, it does not use the word ‘may’ to give the creditor specific permission. The word ‘may’ is used to tell you what might occur if the law permits the creditor to take the action. If you have questions about your reaffirming a debt or what the law requires, consult with the attorney who helped you negotiate this agreement reaffirming a debt. ...
Reaffirming a debt is a serious financial decision. The law requires you to take certain steps to make sure the decision is in your best interest. If these steps are not completed, the reaffirmation agreement is not effective, even though you have signed it.
1. Read the disclosures in this Part A carefully. Consider the decision to reaffirm carefully. The , if you want to reaffirm, sign the reaffirmation agreement in Part B (or you may use a separate agreement you and your creditor agree on).
2. Complete and sign Part D and be sure you can afford to make the payments you are agreeing to make and have received a copy of the disclosure statement and a completed and signed reaffirmation agreement.
3. If you were represented by an attorney during the negotiation of your reaffirmation agreement, the attorney must have signed the certification in Part C. ...
5. The original of this disclosure must be filed with the court by you or your creditor. If a separate reaffirmation agreement (other than the one in Part B) has been signed, it must be attached.
6. If you were represented by an attorney during the negotiation of your reaffirmation agreement, your reaffirmation agreement becomes effective upon filing with the court ...
 Your right to rescind (cancel) your reaffirmation agreement. You may rescind (cancel) your reaffirmation agreement at any time before the bankruptcy court enters a discharge order, or before the expiration of the 60-day period that begins on the date your reaffirmation agreement is filed with the court, whichever occurs later. To rescind (cancel) your reaffirmation agreement, you must notify the creditor that your reaffirmation agreement is rescinded (or canceled).
 What are your obligations if you reaffirm the debt? A reaffirmed debt remains your personal legal obligation. It is not discharged in your bankruptcy case. That means that if you default on your reaffirmed debt after your bankruptcy case is over, your creditor may be able to take your property or your wages. Otherwise, your obligations will be determined by the reaffirmation agreement which may have changed the terms of the original agreement. For example, if you are reaffirming an open end credit agreement, the creditor may be permitted by that agreement or applicable law to change the terms of that agreement in the future under certain conditions.
 Are you required to enter into a reaffirmation agreement by any law? No, you are not required to reaffirm a debt by any law. Only agree to reaffirm a debt if it is in your best interest. Be sure you can afford the payments you agree to make.
 What if your creditor has a security interest or lien? Your bankruptcy discharge does not eliminate any lien on your property. A ‘lien’ is often referred to as a security interest, deed of trust, mortgage or security deed. Even if you do not reaffirm and your personal liability on the debt is discharged, because of the lien your creditor may still have the right to take the security property if you do not pay the debt or default on it. If the lien is on an item of personal property that is exempt under your State’s law or that the trustee has abandoned, you may be able to redeem the item rather than reaffirm the debt. To redeem, you make a single payment to the creditor equal to the current value of the security property, as agreed by the parties or determined by the court.
Next, you must make either of the following statements as part of the reaffirmation agreement:
I believe this reaffirmation agreement will not impose an undue hardship on my dependents or me. I can afford to make the payments on the reaffirmed debt because my monthly income (take home pay plus any other income received) is $_____, and my actual current monthly expenses including monthly payments on post-bankruptcy debt and other reaffirmation agreements total $_____, leaving $_____ to make the required payments on this reaffirmed debt. I understand that if my income less my monthly expenses does not leave enough to make the payments, this reaffirmation agreement is presumed to be an undue hardship on me ...
I believe this reaffirmation agreement is in my financial interest. I can afford to make the payments on the reaffirmed debt. I received a copy of the Reaffirmation Disclosure Statement in Part A and a completed and signed reaffirmation agreement.
It is also important to understand that if you reaffirm a debt and later default on your payments, the bankruptcy will offer you no protection and the creditor will be entitled to sue you to collect the balance of the loan after disposing of the collateral.
2.5 What is Redemption?
Some creditors, such as those selling household furnishings and consumer electronics, know that the value of their collateral is substantially less than the amount you owe them. As a result many may allow you to make payment on a reduced balance. The bankruptcy code also provides that if you can make a lump sum payment to a creditor of the current fair market value of their collateral they must give you clear title to the property. This is also called redemption. Redemption is subject to the same time limits as reaffirmation. Redemption may also be affect by changes to section 506(a) which states that the secured value of personal property is it’s “replacement value” or the amount you would pay a “retail merchant” for the same item “without deduction for costs of sale or marketing” rather than it’s “fair market value”.
Some creditors such as RC Willey, will allow you to pay the redemption amount in installment payments. Other companies will require you to pay it in a lump sum. If a creditor will not voluntarily enter into a lump sum redemption , a court hearing can be scheduled before a judge to force them to do so. If you elect to do this, you should be prepared to hire an expert witness to testify as to the properties value. While the court will base its decision on whatever evidence is presented to it, it will prefer competent testimony by a professional. Hearsay or your own personal opinion may be objected to by the opposing side during a valuation hearing. You should be aware, that there will be an additional charge for such a motion. Further, if the motion is granted you must pay in cash the amount determined by the judge within 48 hours of the hearing.
2.6 Cross Collateralized Debts
A concept that you need to understand in connection with reaffirmation is cross collateralization. Most Credit Union’s have you sign an agreement pledging any collateral they may have for any debt as collateral or all other debts that you may have with their institution. What this means in practical terms is that if you wish to reaffirm on a car loan with a Credit Union, you will also have to reaffirm on any credit cards, overdraft accounts, or unsecured notes that you have with them.
2.7 Cosigned Debt
If you do not reaffirm on cosigned debt your cosigner remains liable for the debt. If you redeem your cosigner will owe the difference.
2.8 Debts That Survive Bankruptcy
There are a number of types of debt which attach to real property. These include mortgage obligations, trust deeds, tax liens, mechanics liens, and judgement liens. Each of these obligations survive bankruptcy and remain an obligation against the real property. Certain creditors may not be able to pursue you individually after the filing of a bankruptcy (such as judgement creditors in a chapter 7) but they are still entitled to pursue the property to satisfy their debt. Thus, if the property is not surrendered you may have to reaffirm the obligation, bear the risk that the creditor will eventually foreclose against the property, or if the property is ever sold, the debt will need to be payed at closing.
There is one exception to the above general rules. In the event that the non-consensual debt (tax liens and judgement liens) interfere with the homestead exemption that you might otherwise be able to claim in the property, the bankruptcy court may be willing to remove or reduce the amount of the lien. For example, lets say that you have a home valued at $100,000, it has a first mortgage of $60,000 dollars, a tax lien of $10,000 and a judgement lien of $5,000 dollars. Further assume that you would be entitled to a $40,000 homestead exemption in that home. Because of the tax lien and the judgement lien, your equity in the home is approximately $25,000 dollars. Without these liens your equity would be $40,000 which is the amount of the homestead exemption. As a result, if the attorney were to file a motion under 11 U.S.C. 522 the judge could set aside the judgement lien. It should also be noted that if a lien is not removed, it continues to accrue interest and costs.
3.0 What Happens to Executory Contracts?
There are two basic options in connection with executory contracts. You may accept the contract, meaning that you either retain the property (or continue receiving the service) and continue to make each of the regular payments as they come due. Alternately you may reject the executory contract which means you cancel the service and return the property if any. Executory contracts are automatically rejected if they are not accepted within 60 days of bankruptcy filing and the stay is lifted as to the property involved. Under former law you could not force acceptance of an executory contract unless the account was current.
The new law also adds confusion to executory contracts. Section 362(h) states that if the contract is not assumed within 30 days after the first meeting of creditors the stay is lifted. This can be more than 60 days after filing as required by 365(d) and (p)(1). Further 365(p)(2) seems to give the creditor the right to reject an executory contract even if you are current and wish to keep the contract. Finally, 365(p)(2) may require one notice to the creditor of your intent to accept the contract and a second notice within 30 days of the first that “the lease is assumed”. The new law also states that it is not a violation of the automatic stay for a creditor to contact you if you are behind on your contract payments in an attempt to negotiate a cure when you wish to reaffirm.
4.0 What Happens to Unsecured Debt?
Unsecured debt is discharged, meaning that you no longer have a legal obligation to pay it. However, many individuals who file chapter 7 have a desire to repay one or more of their unsecured creditors. It is perfectly legal to do so, and making payment on a debt which has been discharged in bankruptcy does not re-obligate you on that debt. The creditor may accept whatever payments you choose to make but may not force you to continue making such payments. This can be extremely helpful in those situations where you wish to repay a debt, begin making payments, but then encounter an unforseen problem which prevents you from continuing to pay.