The consumer creditor community recently received a gift from an unlikely source—the First Circuit Court of Appeals. In the case of Jamo v. Katahdin Federal Credit Union (In re Jamo),¹ the appeals court set aside the holding of the bankruptcy court and the First Circuit Bankruptcy Appellate Panel (BAP) and held that §362 does not preclude a creditor from requiring the reaffirmation of unsecured debt as a prerequisite to reaffirming a residential mortgage loan.

Background

Mr. and Mrs. Jamo filed chapter 7 on March 18, 1999, in Maine. Their statement of intention indicated a desire to reaffirm their mortgage loan. There is no indication that the Jamos were delinquent in their payments under the mortgage loan at the time they filed bankruptcy. Nonetheless, because the First Circuit requires chapter 7 debtors to declare whether their secured consumer loans will be redeemed, reaffirmed or surrendered,² the Jamos had no choice but to specify their desire to reaffirm.³

When initially advised of the debtor's intent to reaffirm, their credit union advised that its policy was to maintain lending relationships with only those members who honored all their credit obligations. The Jamos' unsecured indebtedness to the credit union, composed of signature loans and credit cards, totaled approximately $24,000. The credit union offered to rewrite the mortgage loan to include the unsecured debt and to reduce the related monthly mortgage payment from $1,116 to $514. The debtors reluctantly agreed to the terms, but their counsel refused to endorse the reaffirmation agreements.⁴ The various related reaffirmation agreements were filed with the bankruptcy court 18 days after the issue of discharge. The bankruptcy court refused to approve the reaffirmation agreements as filed.

The debtors ultimately agreed to instead reaffirm their unsecured debt through payments over 10 years at no interest, with their mortgage payments to be affirmed under the original terms and with the monthly payment obligation to be reduced from $1,116 to $479. The debtors simultaneously filed an adversary proceeding asking the bankruptcy court to determine that the credit union's refusal to reaffirm their home mortgage loan without a reaffirmation of all unsecured claims violated §362 of the Bankruptcy Code.

Bankruptcy Court Decision

Treating the reaffirmation agreement hearing and adversary proceeding on a consolidated basis, the bankruptcy court distilled the issue before it as "whether, when the credit union implemented its policy by conditioning reaffirmation [of] its secured claim (viz. the home mortgage) on the reaffirmation of all its claims (approximately $24,000 in unsecured debt), it committed an "act" proscribed under §362(6)."⁵

Before evaluating the three related opinions, it is helpful to review the applicable statutory authority. First, §362(a)(6) provides:

Except as provided in subsection (b) of this section, a petition filed under §301, 302 or 303 of this title, or an application filed under §5(a)(3) of the Securities Investor Protection Act of 1970, operates as a stay, applicable to all entities, of—

(6) any act to collect, assess or recover a claim against the debtor that arose before the commencement of the case under this title.

Secondly, §524(c) provides:

An agreement between a holder of a claim and the debtor, the consideration for which, in whole or in part, is based on a debt that is dischargeable in a case under this title is enforceable only to any extent enforceable under applicable non-bankruptcy law, whether or not discharge of such debt is waived, only if—

(1) such agreement was made before the granting of the discharge under §727, 1141, 1228 or 1328 of this title;
(2)(A) such agreement contains a clear and conspicuous statement which advises the debtor that the agreement may be rescinded at any time prior to discharge or within 60 days after such agreement is filed with the court, whichever occurs later, by giving notice of rescission to the holder of such claim; and

(B) such agreement contains a clear and conspicuous statement which advises the debtor that such agreement is not required under this title, under non-bankruptcy law, or under any agreement not in accordance with the provisions of this subsection;

(3) such agreement has been filed with the court and, if applicable, accompanied by a declaration or an affidavit of the attorney that represented the debtor during the course of negotiating an agreement under this subsection, which states that—

(A) such agreement represents a fully informed and voluntary agreement by the debtor;
(B) such agreement does not impose an undue hardship on the debtor or a dependent of the debtor; and
(C) the attorney fully advised the debtor of the legal effect and consequences of—

(i) an agreement of the kind specified in this subsection; and
(ii) any default under such an agreement;

(4) the debtor has not rescinded such agreement at any time prior to discharge or within 60 days after such agreement is filed with the court, whichever occurs later, by giving notice of rescission to the holder of such claim;
(5) the provisions of subsection (d) of this section have been complied with; and
(6)(A) in a case concerning an individual who was not represented by an attorney during the course of negotiating an agreement under this subsection, the court approves such agreement as—

(i) not imposing an undue hardship on the debtor or a dependent of the debtor; and
(ii) in the best interest of the debtor.

(B) Subparagraph (A) shall not apply to the extent that such debt is a consumer debt secured by real property.

Finally, §521(a)(2)(A) of the Bankruptcy Code provides:

The debtor shall—

(2) if an individual debtor's schedule of assets and liabilities includes consumer debts which are secured by property of the estate—

(A) within 30 days after the date of the filing of a petition under chapter 7 of this title or on or before the date of the meeting of creditors, whichever is earlier, or within such additional time as the court, for cause, within such period fixes, the debtor shall file with the clerk a statement of his intention with respect to the retention or surrender of such property and, if applicable, specifying that such property is claimed as exempt, that the debtor intends to redeem such property, or that the debtor intends to reaffirm debts secured by such property... (emphasis added)

Judge James Haines recognized that the presence of §524 contemplated post-petition contact between creditor and debtor for the purpose of exploring the possibility of and the terms of a reaffirmation agreement, notwithstanding the seeming prohibition within §362(a)(6). However, the court found that the credit union had crossed the thin line between reaffirmation agreement negotiation and the type of coercion prohibited under the automatic stay. Judge Haines concluded that the credit union violated the stay by refusing to entertain a request that the debtors be permitted to reaffirm their home mortgage loan because they did not propose to reaffirm their unsecured obligations.

In support of this conclusion, the court pointed out that during the course of negotiations, the credit union often referred to the likelihood of foreclosure in the event that the debtors refused to accept the terms offered by the credit union. In addition, the court found no support for the credit union's position in those cases where courts required a debtor to reaffirm an undersecured loan in full.⁶ To quote Judge Haines:

There is a broad distinction between a debtor's attempt to retain a creditor's collateral via partial reaffirmation of an undersecured claim and a creditor's conditioning the reaffirmation of a secured loan on the reaffirmation of separate, unsecured loans. The first instance is an example of bargaining for the terms of reaffirmation; in the course the creditor may insist on its rights under the original contract. The second, like the scenario before me, presents a creditor doubly employing the leverage of its collateral: once (legitimately) regarding terms for reaffirming the secured transaction, a second time (unlawfully) to gain reaffirmation of independent obligations.⁷

In essence, the court was clearly disturbed by what it viewed as the credit union's attempt to boot-strap its position into one that arguably was superior to that which it occupied prior to the filing of the chapter 7. As a result, the bankruptcy court enjoined the credit union from (a) foreclosing its mortgage on the plaintiff's residence for any reason associated with this litigation, the plaintiff's filing of a voluntary chapter 7 bankruptcy petition in 1999, the discharge of any debts pursuant to the plaintiffs' 1999 bankruptcy case, or any change in the plaintiff's union membership status that resulted from bankruptcy or discharge; (b) foreclosing its mortgage on the plaintiffs' residence because of any asserted payment default to date, provided, however, that the plaintiffs bring current their mortgage obligation (less interest and late charges accrued due to tardiness to date) under the terms of the original mortgage note within 12 months of the date of this order; (c) collecting or attempting to collect any collection costs or attorneys' fees to which it may claim entitlement under the plaintiffs' mortgage note to the extent those fees accrued prior to the entry of this order, or to the extent those fees relate to the plaintiff's bankruptcy case or this litigation; and (d) withholding its consent to the plaintiffs' reaffirmation of their mortgage obligation on its original terms on account of the plaintiffs' failure to reaffirm other pre-bankruptcy debts due to the credit union.

BAP Decision

The credit union appealed to the First Circuit BAP, asking the court to consider whether the bankruptcy court had committed an error in holding that the credit union violated the automatic stay by "linking" its consent to reaffirm its secured claim with the debtor's consent to reaffirm unsecured claims. Additionally, the court was asked to consider whether the bankruptcy court had exceeded its authority in granting relief in the form of approving a reaffirmation agreement on terms not consented to by the credit union and in granting conjunctive relief.⁸ The BAP agreed with the bankruptcy court on the issue of "linking" and held that the action of the credit union conditioning reaffirmation of a residential mortgage loan upon reaffirmation of other unsecured obligations, and representing that should the reaffirmation package not be approved, it would foreclose on the debtors' home, is both threatening and coercive, and therefore a willful violation of the automatic stay.⁹ Although clearly troubled with the far-reaching nature of the sanctions imposed by the lower court, the BAP upheld the sanctions on the basis that they effectively reimposed the status quo ante as to the mortgage, which both protected the rights of the debtors and left the credit union in the same position that it would have held if the debtors had never filed for relief under chapter 7.¹⁰

The reasoning of the bankruptcy court and the BAP is not unsound. In requiring a chapter 7 debtor to reaffirm a secured consumer obligation, certainly there is nothing in the statutory language of §521 or 524 to indicate that anything other than the secured loan must be reaffirmed. Indeed, §521 refers to the reaffirmation of "debts secured by such property." While it seems well-established that reaffirmation terms are subject to negotiation, it requires a fairly significant leap to require a debtor to reaffirm a number of loans, rather than just those debts secured at the time the case was filed. If a debtor is prepared to resume the contract's terms of the secured loan, it would logically appear that the only remaining points of negotiation would be the basis upon which any outstanding arrearage would be paid.

First Circuit Permits Linking

The First Circuit refused to recognize any of the negotiation constraints identified above. Noting that §524(c) envisions reaffirmation agreements as the product of fully voluntary negotiations by all parties, the court ruled that the interplay between the automatic stay and the many detailed prerequisites for approval of a reaffirmation agreement generally protect a debtor from the superior negotiating position of a creditor. Indeed, the appeals court endorsed a bright-line rule that a creditor may discuss and negotiate terms for reaffirmation with the debtor without violating the automatic stay as long as the creditor refrains from coercion or harassment.¹¹

The court then specifically considered the issue of linking reaffirmation of unsecured debt with reaffirmation of secured debt. The court refused to adopt a "per se rule" in the nature of that adopted by the bankruptcy and BAP courts. In support of its position, the court pointed out that a debtor who persists in travelling the chapter 7 route knows that reaffirmation depends entirely on the ability to come to terms with a secured creditor.¹² The court also pointed out that the Bankruptcy Code does not prohibit such a linkage in the negotiation of reaffirmation agreements. The court then re-examined the record for the actions and negotiations of the parties. It found that while the credit union may have possessed a superior bargaining position, this did not, in and of itself, mandate a finding of coercion or harassment with respect to the reaffirmation negotiations. With respect to the so-called threats of foreclosure, the court viewed the lower court's reliance on such threats as laughable. In essence, the credit union had only memorialized its alternatives to concluding a reaffirmation agreement with the debtor, and in one instance was only responding to a letter by the debtor's counsel referring to its intent to aggressively oppose any foreclosure action. "Because the credit union's passing references to foreclosure cannot reasonably be construed as threatening 'immediate action' against the debtors, those references were not impermissibly coercive for the purpose of finding a violation of the automatic stay."¹³

The court then found that although the bankruptcy court erred in finding a violation of the automatic stay, its disapproval of the related reaffirmation agreements could be justified within the court's discretion as not being within the debtors' best interests. However, the imposition of injunctive relief, attorneys' fees and costs against the credit union constituted an abuse of discretion. Such wide-ranging relief issued pursuant to §105(a) of the Code was impermissible since the authority bestowed pursuant to §105(a) is only properly invoked if and to the extent that the equitable remedy dispensed by the court is necessary to preserve an identifiable right conferred elsewhere in the Bankruptcy Code.¹⁴

Conclusion

The appeals court's opinion paints with a very broad brush. The court states there is no statutory prohibition to the linkage utilized by the credit union in its negotiations with Mr. and Mrs. Jamo. However, the language of §521 arguably limits reaffirmation to those consumer debts secured by property of the estate. If the indebtedness is not secured by property of the estate at the time the debtor files chapter 7, how can its repayment be required as part of the reaffirmation process contemplated under §521? Moreover, one cannot help but speculate whether the appeals court would have reached the same result had the credit union gone forward and continued to insist on the collateralization of the unsecured debt as a prerequisite to reaffirmation of the secured debt. There can be no question that consumer creditors within the First Circuit will attempt to exact such a requirement, as the opinion does nothing to discourage such an approach.

Alternatively, does this decision stand only for the proposition that reaffirmation of a secured consumer loan may be linked with reaffirmation of unsecured debt provided that all loans are reaffirmed on fundamentally the same terms as those in place prior to chapter 7? Did the court feel that the 'linkage" between unsecured and secured loans was justified because the credit union reduced the monthly payments that would be due under the mortgage? Unfortunately, the appeals court will almost certainly be required to face these and other similar issues in the near future. Notwithstanding my general allegiance to the creditor's side of the table, it is impossible to ignore the likelihood that abuses and harsh terms will be visited upon chapter 7 debtors seeking to reaffirm their loans under the guise of "reaffirmation negotiations" and the broad breadth of this opinion.

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Footnotes

¹ 283 F.3d 392 (2002). Return to article

² See Bank of Boston v. Burr (In re Burr), 160 F.3d 843 (1st Cir. 1998). Return to article

³ This specification would not be necessary in those jurisdictions recognizing the "fourth option," such as the Fourth Circuit Court of Appeals. In re Belanger, 962 F2d 345 (1992). Return to article

⁴ There were nine in all. Return to article

⁵ Jamo v. Katahdin Federal Credit Union (In re Jamo), 253 B.R. 115 (Bankr. D. Maine 2000). Return to article

⁶ See In re Greer, 189 B.R. 219 (Bankr. S.D. Fla. 1995); In re Brady, 171 B.R. 635 (Bankr. N.D. Ind. 1994). Return to article

⁷ 253 B.R. at 129. Return to article

⁸ In re Jamo, 262 B.R. 159, 162-163 (1st Cir. BAP 2001). Return to article

⁹ Id. at 165. Return to article

¹⁰ Id. at 168. Return to article

¹¹ Id. at 399, citing Cox v. Zale Del. Inc., 239 F.3d 910 (7th Cir. 2001); Pertuso v. Ford Motor Credit Co., 233 F.3d 417 (6th Cir. 2000). Return to article

¹² 283 F.3d at 400. Return to article

¹³ Id. at 402. Return to article

¹⁴ Id. at 403. Return to article