The Journal of The DuPage County Bar Association

Back Issues > Vol. 26 (2013-14)

A Beginners Guide to Secured Debt in Chapter 7 Bankruptcy Cases: Surrender, Redemption, and Reaffirmation
By Dennise L. McCann And Jane E. Penley

The purpose of a Chapter 7 bankruptcy is to discharge as much debt as is possible while maintaining as much of the debtor’s property, both real and personal, as possible. Nevertheless, the manner in which secured debt is treated does not always provide the debtor with a completely fresh start. Oftentimes, the debtor will either have to seek funds to redeem property subject to a security interest or reaffirm a debt in order to maintain his home, car, furniture, or other property. This article will address the options available to the debtor when handling debt secured by real or personal property.

Options for treatment of real and personal property in bankruptcy. The debtor’s decision as to how he wishes to proceed with respect to the treatment of his property in bankruptcy must be made early on in the process. Within thirty days of filing for Chapter 7 bankruptcy relief, or on or before the first meeting of the creditors,1 a debtor must file a statement of intention with the bankruptcy court indicating whether he intends to surrender or retain his property that is subject to a security interest.2 A debtor can manage his property during a bankruptcy in one of three ways, depending on what his ultimate goals may be.3

First, the debtor may elect to simply surrender his property, real or personal, that is subject to a valid security interest. Second, the debtor who desires to retain his personal property subject to a security interest can elect to redeem the property. Third, the debtor who desires to retain his real or personal property subject to a security interest can elect to reaffirm the debt associated with said property.

While surrender may appeal to the debtor and assist him in obtaining his true fresh start, for the practical purposes of day-to-day living, the debtor will often need to maintain an automobile to commute to and from work as well as other personal property, such as appliances or furniture for use by the debtor’s family. As such, because the debtor cannot afford to surrender these basic necessities, he is left with two remaining options in bankruptcy with respect to these items—redemption or reaffirmation. Pursuant to Section 521(a)(6) of the United States Bankruptcy Code (the “Code”), which pertains only to personal and not real property, if the debtor seeks to retain possession of personal property subject to a security interest, the debtor must either redeem the property in accordance with Section 722 of the Code or reaffirm the debt in accordance with Section 524(c) of the Code.4 Thus, with respect to personal property subject to a security interest, a debtor may surrender, redeem, or reaffirm the debt associated with the property. In contrast, if the debtor seeks to retain real property, his only option is to reaffirm the debt. Redemption of real property is not an option.5

Each option is complex and should be discussed in depth between the debtor and his attorney prior to making a decision on the treatment of the property. If the debtor does not timely redeem or reaffirm, the Code provides that the Automatic Stay6 may be lifted and the secured creditor allowed to exercise its rights under non-bankruptcy law, including foreclosure and repossession.7 Due to the bankruptcy protection, however, the debtor will not be personally liable on the debt including any deficiency judgment that may arise from the state court sale of the property. Essentially, this means that if a debtor does not timely decide how he wishes to proceed with respect to his property, the default option of surrender is effectively chosen for him. Thus, it is critical that the debtor discuss these options early in the process to ensure that the debtor can remain in control of his financial condition.

Surrender of real or personal property. If the debtor no longer wishes to retain possession of his real or personal property that is subject to a security interest, the debtor simply surrenders or gives up that property. Upon the surrender, the debtor no longer owns the property and is not personally liable on the debt going forward. The debtor, or the debtor’s attorney, should contact the secured creditor to arrange for the return of the property. If the debtor surrenders his real property, the automatic stay will be lifted to allow the secured creditor to foreclose on the property. Until such time as the foreclosure process is complete, the debtor may continue to live on the property while not making mortgage payments.8

Redemption of personal property. A debtor may redeem personal property intended primarily for personal family or household9 use by paying the creditor a lump-sum payment. To redeem personal property, the debtor pays the lesser of the secured claim or the value of the property. Value, for purposes of redemption, is defined in Section 506(a)(2) of the Code as the price a retail merchant would charge for property of that kind, considering the age and condition of the property at the time the value is determined.10 Once the debtor redeems the property, he owns it free and clear. Redemption is rarely utilized as a method of retaining personal property because Chapter 7 debtors generally do not have sufficient funds on hand to pay the creditor. In instances in which a debtor does redeem his personal property, the debtor typically seeks another loan, through family, friends, or a company that specializes in redemption loans, to obtain funds for redemption. The debtor, however, is then merely trading his original debt for a lesser debt that may eventually jeopardize his fresh start.

Reaffirmation of debt associated with real or personal property. If the debtor is unable to redeem personal property and wishes to retain it, or if the debtor wishes to retain real property, his remaining option is to enter into a reaffirmation agreement with the creditor in accordance with Section 524(c) of the Code.11 By reaffirming a debt, the debtor agrees to remain personally liable on the debt in the event of a default post-petition. The debt, in essence, survives the bankruptcy, and in the event of a later default, the creditor can utilize its state-court remedies to seek the return and sale of the property and to seek a deficiency judgment against the debtor and its enforcement.

From a practice standpoint, during or shortly after the initial consultation with the debtor, the attorney should determine what debts, if any, the debtor seeks to reaffirm, whether reaffirming the debt is truly in the debtor’s best interests, and whether the debtor can truly afford to pay the reaffirmed amount. The debtor and his attorney must discuss what property is a necessity that should be retained and what property should be surrendered. For example, a debtor’s automobile that he uses to commute to and from work is a necessity and it may be in the debtor’s best interest to reaffirm its debt, however, a luxury yacht may not. It is imperative that the debtor’s attorney explain the consequences of reaffirming the debt; that if the debtor cannot make the reaffirmed debt payment in the future, he will remain liable for the debt, despite having filed for Chapter 7 bankruptcy relief.12

Timing is critical with respect to reaffirmation agreements.13 Historically, secured lenders would routinely generate reaffirmation agreements pertaining to their loans with the debtor and send them to the debtor’s attorney upon learning of the bankruptcy. Then the attorney would complete the agreement and send it back to the lender who would then file it with the bankruptcy court. More recently, however, lenders (particularly mortgage lenders) place the burden of drafting, submitting, and ultimately filing the approved reaffirmation agreements with the bankruptcy court on the debtor’s attorney. The debtor’s attorney should obtain the reaffirmation agreement in a timely fashion because certain lenders take in excess of sixty days to generate the agreement. In these instances, it may mean that if the debtor’s attorney does not act quickly, the reaffirmation agreement cannot possibly be filed with the court prior to discharge of the bankruptcy, which will have the unintended result of the surrender of the property if the attorney cannot obtain an extension to file.14

The former “ride through”—a potential grey area in real property foreclosures. Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”),15 some circuits permitted a fourth option with respect to the treatment of property subject to a security interest aptly called a “ride through.”16 This particular scenario arose when the debtor neither redeemed nor reaffirmed the property and simply remained current on the payments and kept the property without ever signing a reaffirmation agreement. Courts that recognized the “ride through” would not allow the secured creditor to foreclose on or repossess the property in this instance. Post-BAPCPA, however, Section 524 clearly states that a debtor must sign a reaffirmation agreement in order to keep the property. If a debtor fails to sign a reaffirmation agreement yet is current with payments, the secured creditor is still free to pursue its state-court remedies. Whether a foreclosure court will allow a lender to proceed to sale when a debtor is current in payments but has not signed a reaffirmation agreement remains to be seen. Theoretically, even absent the “ride through” option, a debtor could continue to remain current with payments and take a wait-and-see approach to determine whether the creditor will force the issue and proceed to foreclose on or repossess the property. It is important for the attorney to advise the debtor that certain lenders have internal policies stating that absent proof that mortgage debt was reaffirmed in a Chapter 7 bankruptcy or a court order stating that a refinance will not violate the discharge injunction of Section 524 of the Code, the debtor will be barred from being able to refinance post-petition.

Conclusion. When representing a debtor in a Chapter 7 bankruptcy, the attorney must be aware of the debtor’s secured debt and must discuss the available options relating to treatment of said debt with the debtor at the outset of the case. If the debtor cannot afford the property, it should be surrendered. If the debtor wishes to retain personal property subject to a security interest, the debtor can redeem the property or can reaffirm the debt; however, he may end up with a new loan, which can jeopardize his fresh start. If the debtor wishes to retain real property, and he is current in his payments, he may enter into a reaffirmation agreement with the creditor, which will ensure that he remains personally liable on the debt despite having filed for Chapter 7 bankruptcy relief. When reaffirming a debt, the debtor must be made aware of his obligations and responsibilities under the reaffirmation agreement and the hardship it may impose if he subsequently defaults. After all, the goal of Chapter 7 bankruptcy is to obtain a fresh start and free the debtor from as much debt as possible. 

1 Section 341(a), (b) of the United States Bankruptcy Code provides that within a reasonable time after the order for relief in a case under this title, the United States trustee shall convene and preside at a meeting of creditors consisting of any equity security holders. 11 U.S.C.A. § 341(a), (b).

2 11 U.S.C.A. § 521.

3 See, In re Collmar, 417 B.R. 920 (N.D. Ind. 2009).

4 11 U.S.C.A. § 521(a)(6).

5 In re Amoakohene, 299 B.R. 196 (N.D. Ill. 2003).

6 Section 362(a) provides that when the debtor files his petition, creditors cannot take action to collect on or enforce any security interest. See, 11 U.S.C.A. § 362(a).

7 See 11 U.S.C. § 521(a)(6).

8 In Illinois, a homeowner is not subject to eviction until thirty (30) days after the sale is confirmed. 735 ILCS 5/15-1509, 15-1701(d).

9 Courts define personal property for personal, family, or household use broadly. See, In re Walker, 173 B.R. 512 (M.D.N.C. 1994); In re Hall, 11 B.R. 3 (W.D. Mo. 1980).

10 See, 11 U.S.C A. § 506 (2012).

11 11 U.S.C.A. § 524(c).

12 In re Golladay, 391 B.R. 417 (C.D. Ill. 2008) (the reaffirmation rules are intended to protect debtors from compromising their fresh start by entering into unwise agreements to pay dischargeable debts). See, 11 U.S.C.A § 524(c).

13 In re Boliaux, 422 B.R. 125 (N.D. Ill. 2010) (the purpose of the sixty (60) day deadline to file a reaffirmation agreement is to ensure it is filed before discharge is entered to that the court can review and proceed with discharge when required).

14 F. R. B. P. 4008.

15 The BAPCPA was enacted in 2005 and changed many of the bankruptcy rules, including the discontinuance of “a ride-through.”

16 The Second, Third, Fourth, Ninth, and Tenth Circuits recognized this alternative to redemption and reaffirmation. Sonnenborn, Melanie, Reaffirmation Agreements: Basic Practice Tips and Pitfalls, 6 ABI 4 (Nov. 4, 2008).

Dennise L. McCann is a senior attorney with the law firm of Anderson & Associates, P.C., and for over twenty five years has concentrated her practice in bankruptcy, creditor negotiations and family law. She was the judicial law clerk for the Honorable Susan Pierson Sonderby, U.S. Bankruptcy Judge, from 1988 to 1992. She received her J.D. from the John Marshall Law School in 1988, and she graduated summa cum laude from the University of Wisconsin-White Water. 

Jane E. Penley is an attorney with the law firm of Anderson & Associates, P.C. She is a member of the DuPage County Bar Associates and the DuPage Association of Women Lawyers. She received her Juris Doctor from DePaul University College of Law in May 2012 and received her Bachelor of Arts in International Studies and Spanish from Indiana University-Bloomington in 2006.

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