A bankruptcy discharge releases the debtor from personal liability for most types of debts incurred prior to the filing of the bankruptcy case, meaning that the debtor is no longer legally obligated to repay these debts. However, if a debtor signs a reaffirmation agreement for a particular debt, the discharge will not apply to that debt and the debtor will remain personally liable for payment of the debt.
What is a reaffirmation agreement? A reaffirmation agreement is an agreement wherein the debtor promises to repay a debt that would otherwise be discharged in the bankruptcy case. Reaffirmation agreements are generally only used for secured debts, in particular, automobile loans where the loan was incurred for the purchase of the vehicle.
Reaffirmation Agreements and Automobile Loans
Why would a debtor sign a reaffirmation agreement? The main reason is that, in the case of automobile loans, the loan agreement will provide that the filing of a bankruptcy case is considered to be a default under the loan, even if the debtor is current with the loan payments. This is known as a “bankruptcy clause” and is contained in almost every loan agreement. The Bankruptcy Code permits a secured lender, in a Chapter 7 case, to repossess the collateral if the financing agreement contains such a clause, and the debtor fails to sign a reaffirmation agreement or redeem the property. However, state law must permit the lender to repossess the vehicle in the absence of a monetary default. New York State law permits a lender to do so.
Most lenders will not enforce the bankruptcy default clause, even if the debtor does not sign a reaffirmation agreement. It usually makes more sense to continue to accept payments for the loan and allow the debtor to retain possession of the vehicle. However, there is no guarantee that a lender will not repossess the vehicle and, for that reason, many debtors sign reaffirmation agreements to avoid the possibility of this happening.
Another consequence of not signing a reaffirmation agreement is that the lender will usually no longer accept electronic payments, will no longer send statements to the debtor, and will not report the loan as being current on the debtor’s credit report, even if the debtor remains current with the loan payments.
The Consequences of Signing a Reaffirmation Agreement
Keeping the above in mind, it is often not in the debtor’s best interests to sign a reaffirmation agreement, because it takes away the protection afforded the debtor by the bankruptcy discharge. By signing a reaffirmation agreement, a debtor remains liable for payment of the debt, and must continue to pay the balance due to the creditor. If the debtor fails to do so, then the vehicle can be repossessed and the debtor will be liable for any deficiency owed. A deficiency is the difference between the balance due on the loan and what the secured creditor receives for the vehicle at auction.
By contrast, a debtor that does not sign a reaffirmation agreement, and then for some reason does not pay the loan off in full, is not liable for any remaining amounts due on the loan. The vehicle will simply be repossessed or surrendered, and the debtor will not be liable for any further payment.
Reaffirmation of Mortgages
The above discussion, concerning a secured lender’s right to repossess collateral if the debtor does not sign a reaffirmation agreement, does not apply to loans secured by real property, including mortgages and home equity loans. That is, the failure of the debtor to sign a reaffirmation agreement does not give the mortgage lender the right to foreclose, assuming the borrower is current with the loan payments. It is almost never advisable for a debtor to sign a reaffirmation agreement for a mortgage. Doing so makes the debtor personally liable for repayment of the loan. In the case of a mortgage, this can make the debtor liable for a deficiency judgment after a foreclosure sale of a home. However, it should be noted that lenders rarely pursue deficiency judgments in New York State.
In the case of second mortgages, including home equity loans, lenders often bring a money action against the homeowner for payment of the promissory note, instead of a foreclosure action. If the borrower had filed for bankruptcy, and did not reaffirm the loan, then the lender would be prevented from suing the borrower for money. The lender’s only recourse would be a foreclosure action. Second mortgage holders rarely bring foreclosure actions, unless there is sufficient equity in the property to pay off the first mortgage and at least a portion of the second mortgage.
Requirements for a Reaffirmation Agreement
If a debtor is represented by an attorney, the attorney must certify that the reaffirmation agreement does not create an undue hardship for the debtor. If the attorney is unwilling to do so, or if the debtor is not represented by an attorney, then the reaffirmation agreement must be approved by a bankruptcy judge. An attorney may be unwilling to sign a reaffirmation agreement for a client if the attorney believes that it would not be in the debtor’s best interests, or that it would create an undue hardship for the debtor, if, for instance, the debtor does not have a steady job.
For a reaffirmation agreement to be enforceable, the debtor must also receive the disclosures required by 11 U.S.C. § 524(k) before signing the agreement. These disclosures include:
- A written disclosure statement with the amount of the reaffirmed debt and the annual percentage rate
- The reaffirmation agreement
- A declaration of certification by the debtor’s attorney
- A signed statement by the debtor in support of the reaffirmation agreement
- A motion for the court’s approval (only if no certification by debtor’s attorney)
The reaffirmation agreement must be signed and filed with the Bankruptcy Court before the debtor receives a discharge. The debtor may rescind a reaffirmation agreement within sixty days from when the agreement is filed with the court, or at any time prior to discharge, whichever is later.
Whether or not a debtor should sign a reaffirmation agreement is an important decision and will depend, most importantly, on the debtor’s ability to repay the loan. Every bankruptcy client of Andrew M. Doktofsky is given a thorough explanation of the consequences of signing a reaffirmation agreement.