How should a secured lender or lessor react when a borrower or lessee files a chapter 7 bankruptcy but continues to make payments? The creditor whose customer "rides through"—making payments and keeping the collateral or leased personalty, but not reaffirming the debt—is increasingly subjected to conflicting and what some would call unreasonable demands imposed by the bankruptcy courts. A number of circuit courts of appeal now require a secured creditor to accept a "ride through."¹ At the same time, at least one bankruptcy court has suggested that if a secured creditor "induces" a debtor in any way to make payments on the secured debt, the creditor violates the post-discharge injunction.

Taking these cases at face value, a secured creditor seems to be limited to passively awaiting payment. If the payment is not received, the secured creditor is limited to foreclosing or repossessing. Even that gives no comfort to a creditor owed a secured revolving credit obligation like a home equity line of credit. Federal and often state regulation requires that creditor to send periodic billing statements to the debtor. If that is done, does the creditor "induce" payment?

But the view that secured creditors' post-filing rights are restricted to complete passivity is questionable. When carefully considered, the Bankruptcy Code permits a secured creditor to do considerably more than merely await payment and, failing receipt, start repossession. Any other result would interfere with the debtor's "fresh start" by encouraging rapid repossession and refusals to reinstate by a creditor whose discharged chapter 7 debtor is slow in making payments or misses a payment.

At first blush the automatic stay and the post-discharge injunction seem to impose a very significant degree of passivity upon a secured creditor. Section 362(a) stays the creditor from taking any action to collect on a debt or realize on collateral during a case without court permission. Similarly, after discharge, the injunction imposed by §524(a)(2) bars actions taken to collect a debt as a personal liability of the debtor, subject to §524(f)'s authorization of "voluntary" repayment of discharged debts. How much passivity do these provisions impose? It is often difficult to answer that question in the context of the actual day-to-day situations secured creditors face. For example, perhaps the purest situation is one in which the debtor continues to pay on time without any billing from the creditor. The creditor appears to be fully passive. But if the automatic stay is read literally, creditors cannot take "any" action to collect a debt. Is accepting payment, which usually includes opening a payment envelope, removing the check, recording the payment in the creditor's records and depositing the check in the bank, action to collect a debt? It is if the literal reading of the statute is the test, ridiculous as that may seem. Since, however, some circuit courts of appeal have required the creditor to accept "ride throughs" implicitly, accepting payment cannot violate the stay. That conclusion is buttressed by the fact that some courts have recognized that the literal meaning of §362(a) is in some contexts unreasonably broad, and have tempered its application with a reasonable effort to accommodate the interest of the creditor when the debtor is not harmed. Cases such as those where the debtor is making payments to assure he or she can keep the collateral appear to be appropriate ones in which a court should relax the literal application of the stay.

After the post-discharge injunction comes into effect, the analysis of this situation changes. Unlike the automatic stay, the post-discharge injunction by its terms excepts both (1) acts of a creditor that are not to collect the debt as a personal liability of the debtor, and (2) voluntary payments. The example of creditor acceptance and processing of a debtor payment can be easily justified under the post-discharge injunction as acceptance of a voluntary payment.

But much more difficult practical cases arise in the day-to-day interaction between creditors and debtors. For example, can a mortgage creditor continue to service a fully current post-discharge mortgage in the same way as one owed by someone who has not filed for bankruptcy? In normal mortgage servicing, regular monthly bills or annual coupon books are sent to the mortgage debtor. Can they continue to be sent post-discharge? Federal and some state laws require that an annual escrow analysis, as well as notices if adjustable interest rates or other terms change, be sent to the debtor. Can those notices be sent? What do you do if a debtor misses a payment? Can someone call to find out if there is a lost payment? If the debtor has defaulted, can the creditor permit reinstatement?

Common sense suggests that the conduct described above should be permissible. However, recent bankruptcy cases suggest the contrary. In In re Latanowich² (the "Sears case"), the court suggested that Sears' practice of sending billing statements post-discharge violated the injunction. Leaving aside the difficulties of the court's analysis in that case, the case also was clouded by the fact that the debtor had been allegedly deceived into believing, falsely, that a valid reaffirmation agreement had been obtained. Sears' bills may have been viewed as part of the continuing alleged deception. Moreover, the credit involved in that case was predominantly unsecured, and the underlying policy concerns are different when secured credit is involved because of the policy favoring the "fresh start." It is arguably different to send a bill to a debtor to urge a voluntary payment of unsecured debt than to send a bill to remind the debtor to make payments on a mortgage that will be foreclosed if payment is not received. In the latter case, if the debtor forgets to make a payment and the creditor cannot send a bill, the debtor can be seriously harmed by the commencement of foreclosure, more or less out of the blue.

Yet in In re Armstead,³ Hon. Diane Weiss Sigmund faced a situation involving secured credit and ignored the differences between secured and unsecured credit.⁴ There, a creditor had made three separate secured loans, one secured by the debtor's residence, one by furniture purchased with the second loan, and one by carpet purchased with the third loan. As part of a post-discharge refinance by an entirely different creditor, the mortgage loan was paid in full, and the furniture and carpet loans were paid in part, with the creditor's agreement. After payoff, the debtor argued that the payments on the debtor's furniture and carpet loans violated the post-discharge injunction.

Judge Sigmund started her analysis of the debtor's claim by asking whether the payments were voluntary under §522(f). She then concluded that payments were only voluntary if not "in any manner induced by acts of the creditor." Ultimately, she decided that the payoff of the carpet and furniture loans were not "voluntarily" made, and the post-discharge injunction was violated. The debtor apparently conceded that the payoff of the mortgage loan was voluntary, and so the opinion does not discuss it.

The conduct of the creditor that Judge Sigmund viewed as improper was not extreme. The creditor early on "wrote off" the loan, a step which suggested to Judge Sigmund that the creditor had "forgotten about" the collateral. However, no one claimed that the collateral had been released, or that the security interest was invalid. "Writing off" a loan is usually recognized as an internal decision, motivated by regulatory, accounting and tax concerns, and having no impact on the creditor's and debtor's legal relation. Certainly, it does not result in release of a valid security interest. In addition, Judge Sigmund, with regard to behavior that made the debtor's payment involuntary, mentioned that the creditor tried to get the debtor to pay the secured debt, negotiated at the debtor's request a partial payoff of the debt, and sent bills for the installments of the payoff. In addition, when there was some money left over from the payoff of the mortgage loan, the creditor apparently applied that to the unpaid balance of the furniture loan. The carpet loan was somewhat complicated by the refinancing home equity lender requiring that the underlying lien be relinquished as a condition of the loan. In that situation, the creditor agreed to accept a partial payoff and, at the debtor's request, inform the refinancing lender that the debt was paid off. Judge Sigmund ultimately found that the creditor's insistence upon payment as a condition of so informing the refinancing lender was also wrongful.

As far as one can tell from the opinion, the creditor retained the right to repossess the furniture and the carpet. If so, Judge Sigmund's decision seems to stand for the proposition that a creditor's efforts to get a secured debt paid after discharge, and its insistence on payment as a precondition to relinquishing a security interest, is improper, presumably because it makes the debtor's payments "involuntary." But the judge's analysis is incomplete and wrong, because the analysis focuses solely upon the voluntariness of the debtor's conduct in making the payments and because it sets an unrealistic standard for determining voluntariness. The analysis easily turned in the direction of voluntariness, since the debtor had subsequently become annoyed with the creditor and demanded repayment of some of the payoff money previously paid. It was clear by the time the case got to Judge Sigmund that the debtor in hindsight did not want to pay off the furniture or carpet loans. But that fact should be irrelevant to an analysis based on "voluntariness." Only the debtor's voluntariness when the payment was made should be considered.

A more fundamental problem with the analysis is its incompleteness. Under §524(a), logically prior to the question of whether the debtor acted voluntarily, is whether the creditor's conduct violated the post-discharge injunction in the first place. Of course, §524(a)(2) extends the injunction only to actions to collect a debt as a "personal liability" of the debtor. That standard clearly prevents an unsecured creditor from taking any significant action that impacts a debtor adversely. But under that standard a secured creditor or lessor clearly retains its secured or lease rights. Since 1984, §524(a)(2) has excepted from the discharge injunction a secured creditor's right to enforce its lien and a lessor's rights to repossess if lease payment and covenant requirements are not observed. If a secured creditor can still enforce its lien or a lessor can still repossess, it also has the right to receive payments and require the performance of the other covenants in the lease or security agreement. By extension, it can bill, talk to the debtor about non-payment, negotiate payoffs, and otherwise do normal pre-foreclosure or repossession servicing and collection, as well as foreclose or repossess, because all of that activity is in the nature of enforcement of the security interest or lease. None of it is an attempt to collect a debt as a personal liability, unless the creditor makes the mistake of telling the debtor as part of the activity to enforce the security interest or lease that the debtor is personally liable for a deficiency.

At the same time, efforts of the secured creditor to improve its position post-discharge are clearly different from the conduct described above. A secured creditor's insistence on the debtor entering into a new payment obligation to repay the old that is different from that which was secured pre-bankruptcy should not be successful.⁵

Judge Sigmund's broad statement that any payments that are induced by the acts of a creditor are not "voluntary" should at the least be limited to cases of unsecured credit where the creditor does not retain the rights of a secured creditor or lessor. When secured credit or a lease is involved, concluding that the post-discharge injunction only permits debtor repayment that is not motivated by creditor or lessor inducement, or the pressure created by the continuing right of the secured creditor or lessor to receive payment or enforce its foreclosure or repossession rights, sets an extreme and unrealistic standard. The Bankruptcy Code allows a degree of coercion of the debtor to continue to exist in the context of secured credit or a lease because it preserves the creditor's right to enforce the security interest or lease. Secured creditor and lessor actions consistent with the creditor's or lessor's in rem rights are not barred even by literal reading of the Code, nor should they be. The debtor decided to retain the collateral, with the consequence that the payments and other obligations secured by the collateral must be performed. In that context, billing reminders, follow-up calls after missed payments, negotiations of cure of default, payoff arrangements and other actions consistent with the secured creditors' or lessors' rights are excepted from the post-discharge injunction. Any other result is inconsistent with the post-discharge preservation of secured creditor and lessor rights Congress clearly intended.

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Footnotes

¹ See, e.g., In re Parker, 139 F.3d 668 (9th Cir. 1998); In re Boodrow, 126 F.3d 43 (2d Cir. 1997). Return to article

² 207 B.R. 326 (Bankr. D. Mass. 1997). Return to article

³ 215 B. R. 97 (Bankr. E.D. Pa. 1997). Return to article

⁴ A decision indicating in dicta a somewhat similar result is In re Knight, 211 B.R. 747 (Bankr. D. Ore. 1997). Return to article

⁵ See Matter of Arnold, 206 B.R. 560 (Bankr. N.D. Ala. 1997) (credit union cannot use denial of membership as a lever to obtain post-discharge payment of discharged debt). Return to article

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Journal Date:  Thursday, October 1, 1998 © American Bankruptcy Institute. All rights reserved. ABI is a (501)(c)(3) non-profit business (52-1295453)