While the National Bankruptcy Review Commission (NBRC) is considering wholesale changes to reaffirmation procedures, including what debts can be reaffirmed,^[1] it is imperative that Congress resolve a split among the circuits over the issue of whether the debtor can retain collateral without either reaffirming the indebtedness or redeeming the collateral. The issue arises as a result of the provisions in §521(2)(A) that require the debtor to execute a statement setting forth his or her intention with regard to secured consumer debts to either reaffirm the debt or to redeem the property.^[2]

There is a significant split among the Courts of Appeal over whether the debtor is required to reaffirm an indebtedness in order to retain collateral or whether the debtor can retain the property and continue making the installment payments. The Fourth ^[3] and Tenth Circuits ^[4] have held that the debtor has another option of retaining the collateral and keeping the payments current. The Fifth,^[5] Seventh ^[6] and Eleventh Circuits ^[7] have concluded that the only options for the debtor under §521(2)(A) are to either reaffirm the debt or redeem or abandon the collateral.

The courts which hold that the debtor must either redeem or reaffirm reason that effectively allowing the debtor to convert his secured indebtedness to a non-recourse debt gives the debtor not a "fresh start" but a "head start"^[8] and the "clear language of §521(2)" requires the debtor to elect one of the three statutory options: reaffirmation, which requires creditor consent; redemption, which requires payment in full of the allowed secured claim; or abandonment of the collateral.^[9]

The courts holding that the debtor also has the option of continuing to make installment payments on secured obligations without the necessity of reaffirmation or redemption reason that while the provisions of §521(2) are mandatory, the consequence of the debtor's failure to comply does not enhance or diminish the creditor's rights to demand redemption or reaffirmation ^[10] and that §521(2) affects "only procedure, and not substantive rights of the debtor."^[11]

In support of this interpretation, other courts have cited §521(2)(C), which states as follows:

Nothing in subparagraphs (A) and (B) of this paragraph shall alter the debtor's or the trustee's rights with regard to such property under this title.^[12]

There is no "clear rule" from the cases interpreting §521(2).^[13]

One underlying problem for the debtor who seeks to retain the collateral without reaffirmation is the presence in many loan agreements of an ipso facto clause which renders the loan in default upon the filing of a bankruptcy proceeding irrespective of the status of loan payments. Such provisions in executory contracts are invalid.^[14] No similar provision exists as to loan agreements. As a result, several courts have held that, upon entry of the discharge and the failure of the debtor to reaffirm the collateral, the secured creditor would have all of its remedies under state law including the right to enforce the provisions of the loan agreement.^[15]

Commission Proposal

A corollary to the NBRC recommendation to limit the availability of reaffirmations is the proposal to permit the debtor to retain the property while making payments under the secured contract following bankruptcy, assuming that the debtor meets all other contract terms and ultimately pays the secured loan in full. The NBRC thus supports the "ride through" approach permitted in the Fourth and Fifth Circuits, while noting that because the proposal would not prohibit a creditor from contacting a debtor directly regarding post-petition contract defaults, there is some risk that a new form of unmonitored reaffirmation would reemerge.

Conclusion

The issue of whether the debtor can retain property subject to a security interest by merely continuing to make the installment payments is subject to great conflict in the interpretation of the provisions of §521(2)(A) and (C). The provisions of §521(2)(A) only apply to consumer debts. None of the cases discuss the differentiation between consumer and business loans with regard to the right to retain property without reaffirmation or redemption. Further, the cases are split on whether §521(2) is merely a procedural statute or affects substantive rights. The argument that the statute grants substantive rights to creditors by limiting the debtor's options appears to be negated by the plain language of §521(2)(C).

Nevertheless, any changes by Congress to the reaffirmation provisions should be accompanied by changes to clarify the rights of the debtor and the obligation of creditors with regard to the issue of the retention or redemption of collateral.

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Footnotes

^[1] The Commission recently amended the Consumer Framework Proposal to allow reaffirmations upon approval by the court but only to the extent of an allowed secured claim. See ABI Journal, Vol. XVI, No. 7 at p. 6 (Sept. 1997).[RETURN TO TEXT]

^[2] Section 521(2)(A) provides as follows:

(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.[RETURN TO TEXT]

^[3]In re Belanger, 962 F.2d 345 (4th Cir. 1992).[RETURN TO TEXT]

^[4]Lowry Federal Credit Union v. West, 882 F.2d 1543 (10th Cir. 1989).[RETURN TO TEXT]

^[5]Matter of Johnson, 89 F.3d 249 (5th Cir. 1996).[RETURN TO TEXT]

^[6]In re Edwards, 901 F.2d 1383 (7th Cir. 1990).[RETURN TO TEXT]

^[7]In re Taylor, 3 F.3d 1512 (11th Cir. 1993), reh'g denied, 11 F.3d 163.[RETURN TO TEXT]

^[8]In re Taylor, 3 F.3d at 1516 (11th Cir. 1993).[RETURN TO TEXT]

^[9]Matter of Johnson, 89 F.3d at 252 (5th Cir. 1996).[RETURN TO TEXT]

^[10]Lowry Federal Credit Union v. West, 882 F.2d at 1546 (10th Cir. 1989).[RETURN TO TEXT]

^[11]In re Belanger, 962 F.2d at 347 (4th Cir. 1992).[RETURN TO TEXT]

^[12]In re Belanger, 962 F.2d at 347; In re Carpinella, 201 B.R. 34 (Bankr. Conn. 1996) ("once a debtor's discharge is entered and the subject collateral ceases to be property of the bankruptcy estate, the secured creditor can freely exercise the same rights against its collateral that it possessed prior to the bankruptcy filing; i.e., if the debtor defaults under the relevant loan and/or security agreement, the secured creditor can move against the collateral in accordance with those agreements and applicable non-bankruptcy law").[RETURN TO TEXT]

^[13]In re Castillo, 209 B.R. 59, 67 (Bankr. W.D. Tex. 1997) (holding that §521(2) is a procedural statute and does not require the debtor to perform only in the manner specified in that section); In re Ogando, 23 B.R. 14 (Bankr. Mass. 1996) ("in sum, §521(2) is merely a procedural statute which by its own terms in not intended to infringe upon any rights the debtor otherwise has with respect to secured consumer debt or the underlying collateral."); In re Parlato, 185 B.R. 413 (Bankr. Conn. 1995) (collecting the cases on both sides of the issue); In re Gerling, 175 B.R. 295 (Bankr. W.D. Mo. 1994) (the use of chapter 7 to modify a debtor's deal with a secured creditor is not proper such that the debtor should use one of the reorganization chapters in order to retain the collateral if he declines to reaffirm).[RETURN TO TEXT]

^[14] Section 365(e).[RETURN TO TEXT]

^[15]In re Bell, 700 F.2d 1053, 1058 (6th Cir. 1983); In re Gerling, 175 B.R. at 298 (Bankr. W.D. Mo. 1994); In re Castillo, 209 B.R. at 75 (Bankr. W.D. Tex. 1997), contra Riggs National Bank v. Perry, 729 F.2d 982 (4th Cir. 1984) and In re Belanger, 962 F.2d at 348 (4th Cir. 1992) (holding that as a matter of law, ipso facto clauses in loan agreements are unenforceable).[RETURN TO TEXT]