Debtors who file for protection under the Bankruptcy Code are specifically permitted, despite the automatic stay and the discharge injunction, to repay voluntarily any portion or all of a discharged debt. 11 U.S.C. §524(f); see Matter of Heller, 123 B.R. 782 (Bankr. S.D. Ohio 1991); In re Brown, 49 B.R. 558, 560-61 (Bankr. M.D. Pa. 1985) (noting that debtors often voluntarily pay institutions so they can re-establish credit).

Voluntary post-petition payments do not reobligate a debtor on the original debt, and the debtor can cease payments at any time without penalty. Hudson v. Central Bank (In re Hudson), 168 B.R. 368, 371 [fn1] (Bankr. S.D. Ill. 1994). When debtors execute a valid reaffirmation agreement, however, their personal obligation is reinstated to the extent of the terms of the reaffirmation agreement itself and the validity of the obligation under state law. 11 U.S.C. §524 (c) and (d); In re Hotujac, 102 B.R. 733 (Bankr. W.D. Mo. 1989); see, also, In re Moore, 50 B.R. 301 (Bankr. D. Ohio 1985) (terms and conditions of new contract control rights of parties).

Studies suggest that from 19-42 percent of debtors seek to reaffirm at least one pre-petition debt. In re Turner, 156 F.3d 713, 715 (7th cir. 1998), citing Gross, Karen, "Perceptions and Misperceptions of Reaffirmation Agreements," 102 Com. L. J. 339, 346-47 (1997). While debtors may have many reasons for agreeing to reaffirm personal liability on an otherwise dischargeable debt, by far the most common reason in our experience is the debtor's desire to maintain possession of the property that secures the debt. Since a debtor cannot unilaterally force a reaffirmation agreement on a creditor (In re Turner, 156 F.3d at 718), in those jurisdictions that do not permit the debtor to continue making payments under the original contract without a reaffirmation agreement (the so-called "fourth option"), the debtor who is unwilling to surrender the collateral but cannot pay its full redemption value in one lump sum must reaffirm the debt.

The Bankruptcy Code provides specific requirements for the creation of a valid reaffirmation agreement. 11 U.S.C. §524(c) These requirements are mandatory and cannot be waived. In re Turner, 156 F.3d at 718 (citing In re Duke, 79 F.3d 43, 44 (7th Cir. 1996)). Recently, some bankruptcy courts have attempted to exercise greater control over the reaffirmation process. Courts in Massachusetts (In re Melendez, 235 B.R. 173 (Bankr. D. Mass. 1999)), New York (In re Bruzzese, 214 B.R. 444 (Bankr. E.D.N.Y 1997)), California (In re Kamps, 217 B.R. 836 (Bankr. C.D. Cal. 1998)) and Texas (In re Smith; In re Mullins, 223 B.R. 108 (Bankr. N.D. Tex. 1998)) have imposed stringent, sometimes inconsistent, requirements on a debtor's right to reaffirm a debt. Sometimes these new "rules" have been applied to the detriment of creditors, even when the creditor has been without fault. In re Melendez, 235 B.R. 173 (debtor's attorney was determined to have failed in his duties to fully inform debtor, but result was nullification of reaffirmation agreement, depriving creditor of enforceable obligation).

Protection of the Creditor's Reaffirmation Rights

Within the last few months, the Fifth Circuit Court of Appeals has twice reviewed the application of a Northern District of Texas local rule that, in effect, prohibited reaffirmation of unsecured debt and prevented post-discharge enforcement of a creditor's security interest, unless the bankruptcy court had reviewed and approved the security interest before discharge.¹ In the Matter of Stephen Dale Smith, et al. (Creditors Bankruptcy Service, et al. v. Smith), No. 5:98-CV-243, Feb. 11, 2000 (appealed from In re Smith; In re Mullins, 223 B.R. 108 (Bankr. N.D. Tex., 1998) but not designated for publication) and In the Matter Of Melvin Dale Kinion, et. al. (Chase Automotive Finance Inc. v. Kinion), ___ F.3d. ____ (5th Cir. 2000) (No. 99-10826, March 24, 2000).

In re Smith: An Effort to Exercise Jurisdiction Over All Lien Issues

In re Smith; In re Mullins, 223 B.R. 108 (Bankr. N.D. Tex., 1998), illustrates how the Northern District of Texas bankruptcy court applied the local rule. In Smith, the creditor sent the debtor's attorney a letter asserting a purchase money security interest in durable goods and asking if the creditor's debt was scheduled in the statement of intentions (11 U.S.C. §521(2)) to be reaffirmed or the collateral surrendered or redeemed. The bankruptcy judge allowed the debtor's counsel, without prior notice to the creditor, to file the letter at the discharge hearing. The court then asserted jurisdiction over the creditor's security interest based on the debtor's unilateral filing of the creditor's inquiry letter and noted that there was insufficient evidence of a security interest. The bankruptcy court then issued the "standard order," which (i) denied the "reaffirmation agreement," (ii) declared the debt unsecured, (iii) enjoined the creditor from taking any action post-discharge to enforce the claimed lien and (iv) gave the creditor 30 days to file a motion for rehearing.

According to the transcript from the hearing on the creditor's motion for rehearing, the bankruptcy judge's stated purpose for designing the "standard order" and following this procedure was to require all "questions about whether creditors hold liens on property" to be resolved in the bankruptcy court and to prohibit post-bankruptcy foreclosure actions by secured creditors. In re Smith; In re Mullins, 223 B.R. 108. The bankruptcy judge stated at the creditor's motion for rehearing:

[T]hat is exactly why I designed the order that was signed, so that we settle, once and for all, whether they have a lien and whether they can come out after these debtors post-bankruptcy...It's also why I give 30 days for creditors to have a motion for rehearing...I want the creditor to have time to come in if, indeed, it does prove that it has a lien. But if it doesn't, or doesn't care to, then I don't want the debtors to have to face a problem down the road...

In an unpublished opinion, the Fifth Circuit Court of Appeals reversed, holding, "Assuming, without deciding, that in a proper case a bankruptcy court can adjudicate the existence of a lien ancillary to its order denying reaffirmation, the court plainly cannot do so unless it is presented with a valid reaffirmation agreement. In the instant case, no colorable reaffirmation agreement was presented for the bankruptcy court to approve or disapprove. As such, the bankruptcy court had no authority to enter the order."

Chase Automotive Finance: Applying the Plain Language of the Code

Subsequently, the Fifth Circuit Court of Appeals considered a second case from the same bankruptcy court in Chase Automotive Finance Inc. v. Kinion, ___ F.3d. ____ (5th Cir. 2000). Chase Automotive Finance squarely presented the issue of the bankruptcy court's reliance on the local rule to adjudicate the existence of a lien ancillary to an order denying reaffirmation. The Fifth Circuit Court of Appeals, applying the plain language of the Code, held that the bankruptcy court could not take that action and determined that the local rule, "apparently predicated on the assumption that only secured debt should be reaffirmed" and "designed in part to limit reaffirmations to secured debt," was "plainly inconsistent with the Code and invalid."

The Kinions financed the purchase of a $25,000 Cadillac through Chase in October 1996. Less than a year later, the Kinions filed a voluntary chapter 7 no-asset case. Chase forwarded a proposed reaffirmation agreement to the debtors, who signed and returned it to Chase. Counsel for the Kinions, on receipt of the executed agreement, was to see that it was filed with the bankruptcy court.

The local rule required that the finance contract and title be attached to a motion for reaffirmation. The Kinions' attorney wrote Chase twice seeking copies of the documents, but they did not arrive before the discharge hearing. At the discharge hearing, the bankruptcy court was informed by debtor's counsel of the reaffirmation agreement and of the absence of security documents concerning the Cadillac. Although the Kinions did not dispute the secured status of the debt on the Cadillac and had listed Chase on their bankruptcy schedules as a secured creditor, they nevertheless asked the court to permit them to file the reaffirmation agreement so the court could then enter its order that (i) denied the reaffirmation agreement, (ii) declared the debt unsecured, (iii) enjoined the creditor from taking any action post-discharge to enforce the claimed lien and (iv) gave the creditor 30 days to file a motion for rehearing.

Only three days later, Chase furnished the Kinions with the necessary security documents. Debtors' counsel did not turn those documents over to the court. Instead, after the bankruptcy case had been closed, the Kinions filed the reaffirmation agreement with the denial order. The bankruptcy court then reopened the case sua sponte, pursuant to 11 U.S.C. §350, and signed the order. The Kinions then sent the 30-day notice to file a motion for rehearing to Chase at an address different from the one to which their previous correspondence had been directed.

The Fifth Circuit held, "The actions that occurred here do not survive scrutiny under a cursory analysis of applicable bankruptcy law. To the extent that these events were set in motion by the local rule of the Amarillo division, a rule designed in part to limit reaffirmations to secured debt, the rule is plainly inconsistent with the Code and invalid." The court relied upon the plain language of the Bankruptcy Code in rejecting the bankruptcy court's blanket prohibition against reaffirmation of unsecured debt. The Chase court stated:

First, to the extent that the local bankruptcy rule, applicable only in the Amarillo division in the Northern District of Texas, implies that reaffirmations can only be approved for secured indebtedness, it is contrary to the Bankruptcy Code. The Code permits reaffirmations of unsecured as well as secured debt. The Amarillo division's local rule may not impose a requirement of secured status upon a creditor seeking court filing of a reaffirmation agreement. Moreover, the Code requires neither a court hearing nor court approval if the debtor is represented by counsel.

11 U.S.C. §524(c) and (d).

The court acknowledged that security-interest information could well be important, particularly with regard to a debtor's attorney's statutory and ethical duties to approve a proposed reaffirmation or to the bankruptcy court's obligation to admonish an unrepresented debtor, but plainly stated, "...the unsecured status of the debt may not in and of itself prevent a debtor from agreeing to reaffirm."

The court then addressed the bankruptcy court's position that lien issues should be resolved in the bankruptcy court rather than be post-discharge in rem enforcement. The court confirmed the long-standing rule that liens and other secured interests ordinarily survive bankruptcy. In order for the bankruptcy court to have jurisdiction to decide the validity of a lien, the court held that the debtor was required to initiate an adversary proceeding, with all the procedural safeguards required by the Bankruptcy Rules and their incorporation of the Federal Rules of Civil Procedure.

Finally, the Kinion court confirmed that creditors' rights as well as debtors' rights are entitled to the bankruptcy court's protection. Although Chase did not file a motion for rehearing within the 30 days permitted by the bankruptcy court's "standard order," the Fifth Circuit held:

[T]he bankruptcy court abused its discretion in failing to grant Chase's motion to reconsider. Whether reconsideration was authorized under 11 U.S.C. §350, Bankruptcy Rule 8015 or by some other device, it should have been granted to correct the procedural errors that led to the unauthorized stripping of Chase's valid lien.

Conclusion

A bankruptcy court's zeal to furnish debtors with a "fresh start" cannot be used to limit creditors' statutory protections. The Amarillo Division local rule, as applied, had two deficiencies: It ipso facto denied reaffirmation of unsecured debt, and it deprived secured creditors of the right to stand aloof and pursue their liens post-discharge. The Fifth Circuit confirmed both rights. Ancillary requirements that, in effect, prohibit reaffirmation of unsecured debt are plainly inconsistent with the Bankruptcy Code and are invalid. Creditors' liens, unless properly challenged by an adversary proceeding with appropriate procedural safeguards, should pass through the bankruptcy unaffected.

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Footnotes

¹ The local rules can be found at http://www.txnb.uscourts.gov/m_judge-info.htm. Return to article