The Bizarre World of Reaffirmation

reaffirmation car loan


One of the most difficult tasks attorneys often face is explaining aspects of the law that, when you come right down to it, don’t make any sense.  As my friend and colleague Kenneth Sanders often says, “It’s not logical, it’s not ethical, and it’s not fair: it’s just bankruptcy!”

Reaffirmation agreements, and the legal significance of signing or refusing to sign the agreement, is one of the best examples of the disconnect between common sense, and the law.

I wrote an earlier post about the automatic stay, and why car statements often stop coming.  The automatic stay is a powerful tool, and during your bankruptcy case, it will stop creditors from taking actions to collect the debt.  This includes repossessing your car.  They might, however, send your attorney a reaffirmation agreement, and you should understand the legal consequences of signing- or refusing to sign- this document.

A reaffirmation, simply put, is an agreement to keep your obligation to repay the loan, despite the bankruptcy.  To illustrate the potential risk, let’s use the following example:  You have a car worth $5,000, and you owe $7,500 on it.  After the bankruptcy, you can’t afford to keep making payments.  The car company can repossess the car, and sell it.

If the court approved a reaffirmation agreement, you are still on the hook for the remaining balance.  If there was no reaffirmation, the car company cannot come after you, since you no longer owe the remaining debt.

There is also a risk to NOT signing a reaffirmation agreement.  If you do not sign, the car company can repossess the vehicle after bankruptcy, even if you remain current.  Most vehicle lenders do not exercise this option, but some do.

There is, however, a middle ground that provides the best of both worlds.  For a reaffirmation agreement to become effective, two things need to happen.  The debtor needs to sign it, and the court has to approve it.  Courts generally either defer to the debtor’s attorney, or hold a hearing to let the debtor explain why they want to reaffirm the loan.

As an attorney, I cannot sign off on a car loan if I don’t think it is in your best interest, or if it presents an undue hardship. If your bankruptcy schedules show that you do not have enough money to afford the payment, I cannot in good conscience sign off on the reaffirmation, since we have already shown the court that the payment is an undue hardship.

And THAT is where logic ends and the vagaries of the law take over.  Under an emerging line of cases, if the debtor signs the reaffirmation but the court does not approve it, the debtor gets to have their cake, and eat it, too: they can keep the car as long as they stay current on payments, but if the vehicle is repossessed, the lender cannot pursue the remaining balance.

This “best of both worlds” approach is called a “ride through,” and used to be the norm. The reasoning is that the debtor has done everything they were required to do under the code, and should not be punished because the mean ol’ attorney or the mean ol’ judge refused to ratify the agreement.

As with any emerging issue of the law, your mileage may vary depending on how your district’s judges view the issue. You should definitely talk to your attorney before agreeing to sign- or refusing to sign- any reaffirmation agreement.  In our district, very few reaffirmation agreements are approved by the court, and we see precious few repossessions for debtors who remain current on their payments.



Why did my car payment bills stop coming?

car vehicle payment reaffirmation

For many of my clients, filing bankruptcy is designed to wipe out personal debt, deal with lawsuits or medical bills, or to stave off foreclosure.  It is seldom because of their car payments.

However, many of them do have loans on their cars, loans for which they are current, and for vehicles they intend to keep.  I will post a future entry on reaffirmation, the strange and confusing process by which car loans can be “ridden through” (pardon the pun) the bankruptcy.

It is very surprising for these clients when their monthly car loan statements simply…stop. It is as though the vehicle lender is no longer interested in receiving payment!

Of course, if you want to keep your car, you will need to keep making payments.  The reason the finance companies stop sending statements is not because they don’t want to get paid; it is because of a special bankruptcy rule called the Automatic Stay.

This rule is the powerful shield provided by a bankruptcy.  It provides that creditors may take no action to collect a pre-petition debt during the bankruptcy process.  A dunning letter (like collection demands), a billing statement, or a phone call from a creditor may violate this rule, and can lead to hefty sanctions.

To avoid violating the Automatic Stay, lenders usually cease sending statements, or send special statements reading “for informational purposes only.”  As a corollary to this, automatic debits often stop.

To avoid delinquency on the car loan, you should contact the lender and arrange to continue making “voluntary” payments.  The payments are “voluntary” because they have no right to bill you or to collect money.  However, if you do not make the payments, as soon as the bankruptcy ends the lender can repossess the vehicle.

If you file for bankruptcy protection and want to keep your car, you should talk to your attorney.  You may qualify to redeem the vehicle, or it might be in your best interest to reaffirm the debt.  In most cases, you will need to make arrangements with the finance company to continue making payments, or you may find yourself without transportation when your bankruptcy ends.


The Myth of Perfect Credit

credit score myths

When I meet for the first time with a person in financial distress, one of the things they are most likely to mention is how they “used to have such good credit!”  I find it remarkable that out of all the negative consequences living with debt can bring- family trouble, tough budget decisions, foregoing vacations and holiday celebrations, putting off retirement- the loss of credit is one of the foremost things on consumers’ minds.

Here’s the thing about credit: it has no intrinsic value.  If you have a perfect credit score, they do not send you a plaque to hang on your wall.  You do not get better parking spaces, or the choicest tables at restaurants.  Having good credit just means that businesses will be more likely to lend you more money, on better terms.

To be sure, having good credit is a positive thing; I’m certainly not suggesting that credit doesn’t matter.  It does not, however, reflect on your moral worth as a human being, and is not a precursor to happiness.  If I were offered five thousand bucks for fifty points off my credit score, I would take the deal.  The importance of your credit depends entirely on what you need it for.

Let me say that again, because it is important: the importance of your credit depends entirely on what you need it for.

If you plan to finance a vehicle in the near future, having a good credit score can save you a few hundred, or even a few thousand, dollars.  While the math is tricky, it can be calculated- your credit has monetary worth in this situation.  If you are financially independent, your ability to borrow may be irrelevant- if so, your good credit score is worthless, or your bad credit does not matter.

Many folks I meet have added “having good credit” to their definition of the American Dream.  I think this importance is largely misplaced.  Approach your finances holistically, and figure out what the economic value of credit it based on your particular situation, not some perceived value based on nothing more than social norms.  This will help you make good decisions about your finances in general, about your debt in particular, and may also help you avoid some of the stress that comes with economic hardship.

One final note: while I believe that the credit score is overblown, credit fraud is a different thing entirely, and should be taken seriously.  If you believe you are the victim of credit fraud, contact these three credit bureaus, and report the suspicious activity immediately.


Protecting Assets in Bankruptcy

bankruptcy assets exemption

One of the most common myths about bankruptcy is that you will lose everything you own if you file.  In fact, most people do not lose anything.

Here is how assets work in bankruptcy: the moment you file a petition for relief, a legal fiction takes place.  All the property you own on the date of filing becomes a part of the “bankruptcy estate.”  The trustee has control of this estate.

Along with your petition for relief, you file a number of supplemental documents known as “Schedules.”  These are usually prepared by your attorney.  In these schedules, you list all of your assets, and use a state-by-state system called exemptions to protect those assets from the trustee.

The exemptions you are permitted to use is based on where you live, how long you have lived there, and how your state has set up its exemption system.  Some states have their own exemptions.  Some allow you to use the federal exemptions.  Still others, like California, let you choose from multiple options.

When an asset is not exempted, or if the full amount is not exempted, the consequence depends on the type of bankruptcy filing.  In chapter 7, that may mean the trustee will sell the asset, pay you the value of any exemption you did use on it, and will divide the rest of the money among your creditors based on the type of debt, and the amount owed.  In chapter 13, your plan will need to pay unsecured creditors at least as much money during the plan as they would have gotten from the sale of your non-exempt assets.  This is a complicated calculation, and one you should discuss with a bankruptcy specialist prior to filing.

In the great majority of cases we file, our clients are able to protect all of their assets.  In other cases, there are simple steps the clients can take prior to filing to make sure they get the best result possible, and protect as much of their property as they can.  The myth of going bankrupt and losing your shirt is just that: a myth.


Step One: The Initial Consultation

In this post I want to talk a little bit about the first step for someone considering a bankruptcy filing: the initial consultation with an attorney.  This takes place before you hire an attorney or any money changes hands.  Most attorneys, including our office, do not charge for the initial bankruptcy consultation.

The purpose of the consultation is not just to figure out if you qualify for bankruptcy.  That is a part of the meeting, no doubt, but the bigger question we try to answer is “what options do you have available?”  Usually, bankruptcy is but one of several options, and we can discuss the pros and cons of each approach.

When you have an initial consultation with an attorney, you are protected by attorney-client privilege.  This is a two-sided coin: everything you say will be kept confidential, but at the same time, you absolutely need to tell the truth to the attorney.  We can’t give good advice without accurate information, so it is vitally important that you disclose everything relevant to your situation, and answer our questions honestly.

Different firms vary on what documents and information they require in advance of an initial consultation.  While our office tries not to demand too much up front, it is always helpful if you have a recent pay stub, a tax return, a copy of your credit report, and information about any lawsuits or foreclosure activity.  As a general rule, bring what you can easily locate; we would much rather have a document and not need it, than need it and not have it.

The length of the consultation depends on the complexity of the situation.  For a very simple case, in which you have low income, few assets, and no prior bankruptcy, the consultation may take less than an hour.  More typical consultations last between one hour and ninety minutes.  Very complex cases involving businesses, multiple properties, or other sticky issues can take several hours to fully discuss.

When you have an initial consultation with a bankruptcy attorney, be aware that the meeting is also a two-way interview.  You are interviewing the attorney, and figuring out if you have the comfort level needed to permit him or her to represent you.  The attorney is determining whether your case is one he or she wants to take.  Most bankruptcy attorneys I know are in the field because they enjoy helping people, so they can be picky about which clients they represent; our firm agrees to represent about half of the people with whom we have initial consults.

After your initial consultation, be sure to get the attorney’s card, and ask how they prefer to be contacted with follow-up questions.  In my experience, most clients think of a few questions within the 24 to 48 hours after their appointment, and it is important that you ask how to get in touch with your attorney to get those follow-up questions answered.

The initial consultation is probably the most important step in debt resolution.  It sets the tone for representation, and gives you a chance to ask questions and explore potential solutions.


The Self-Employment Problem

Small business owners are, by nature, risk-takers.  For every business that succeeds, there are several that never get off the ground, and wind up with more debt than they can repay.

For those who are self-employed and need bankruptcy protection, a unique problem arises.  Under the Chapter 7 bankruptcy rules, only the trustee may operate an “estate business,” which often includes a self-employed debtor’s livelihood.  This applies to handymen, attorneys, shops, and restaurants.  In other words, the moment the bankruptcy petition is filed, the business must stop operating, even if it is profitable.

Fortunately, there are several way to fix this problem for self-employed debtors.

First, before filing the petition, the business owner can convert the self-employment into a business entity.  In California, we tend to prefer LLCs for small businesses.  They are relatively inexpensive to form, flexible in their rules, and most importantly, they can continue to operate even if the owner files for bankruptcy.

Second, the owner can file a motion with the bankruptcy court to “compel abandonment” of the business.  Essentially, this takes the business out of the bankruptcy estate, allowing the owner to resume operations.  The down-side is that, depending on the court’s local rules, it may take several weeks to obtain this relief, and in the meantime, the business cannot operate.  In the Sacramento region, these motions can be set on 14-days notice.

Third, the owner can close the business prior to filing, and after filing can start a new business.  The new business can be in the same line of work, as long as it does not make use of the old business’ property.  This can be a tricky analysis, since many business owners rely on certain assets, such as bank accounts, customer lists, and equipment.  However, for small businesses in the service industry, this can sometimes be a viable option.

For any of these three approaches, you should consult with a bankruptcy attorney to discuss the pros and cons, and which solution is best suited to your particular circumstances.  What you should NOT do is break the rules by continuing to operate your business while in bankruptcy without taking the appropriate steps to ensure you are complying with the law.


BAPCPA reaches its 7 year milestone

Seven years ago, Congress made some significant changes to the Bankruptcy Code in a law called the Bankruptcy Abuse Prevention and Consumer Protection Act, or BAPCPA.

This law dramatically altered the landscape of bankruptcy by, among other things, imposing a means test to prevent some high-income families from filing for relief.  It forced many people seeking protection from their creditors into a repayment plan under Chapter 13 by “disqualifying” them for Chapter 7 protection.

In the months after BAPCPA passed, but before it came into effect, there was an immense surge of filings as people tried to get their cases opened before the new standards made it more difficult to do so.  There were so many new filings that the Court Clerk had to open extra space for the overflow traffic of debtors filing for relief.

Of course, nobody knew at the time that we were in for the worst recession since the great depression of the 1930s just a few short years later.  It turns out a housing bubble and financial shenanigans were the real cause of economic trouble, not abusive bankruptcy filings.

However, for the folks who filed for bankruptcy back in 2005, there was a new dilemma.  Just like other people, they often got hit by job loss, income reduction, foreclosure, and the other trappings of the economic downturn.  Unfortunately, they were not always able to discharge their debts in bankruptcy, since the code only permits one chapter 7 discharge every eight years.

Over the coming twelve months, those original filers will once again be eligible for relief. I expect to see a large up-tick in filings as those who patiently waited for the time period to run once again seek relief from their debts.