Occasionally a client is under a misconception that a Chapter 7 bankruptcy discharge will erase all creditor interests in secured property. In other words, after the bankruptcy there is no house loan or car loan, and the debtor is able to keep the house or car.
A Chapter 7 discharge acts as a permanent court injunction prohibiting the collection of debts incurred prior to filing the bankruptcy case. The discharge order stops creditor action against the debtor personally – no more lawsuits, phone calls, or collection letters. However, the creditor may pursue any legal claim against a debtor’s property.
To understand a collection action against a debtor’s property (called an "in rem" action), let’s examine a typical auto loan. The creditor and the debtor enter into a contract wherein the debtor personally promises to make payments on the loan and the creditor promises to not repossess the car as long as these payments are made. The loan is secured by the auto and a lien is recorded with the state. When a debtor receives a bankruptcy discharge, the creditor is prohibited from collecting on the contract, but the discharge does not (generally) extinguish the lien. Consequently, the creditor can repossess the auto at the end of the bankruptcy case when done in accordance with state law. The creditor may not sue the debtor to recover money on the contract.
The general rule is that secured property must be paid for or returned to the creditor. For this reason a reaffirmation agreement is often used during a Chapter 7 bankruptcy case. A reaffirmation agreement is a new contract in which the debtor agrees to continue personal liability on a secured loan and the creditor agrees to not repossess the property. The reaffirmation agreement continues the personal liability of the debtor, despite the bankruptcy discharge. Reaffirmation agreements are only available to Chapter 7 debtors and the agreement must be executed before the bankruptcy discharge is entered. The debtor can revoke the agreement with 60 days after the agreement is signed.
Failure to timely execute a reaffirmation agreement causes the automatic stay to be lifted and the property is longer a part of the bankruptcy case. The property then be repossessed by the creditor, even though you are current on the loan. This situation recently was discussed last year in the Ninth Circuit Court of Appeals case Dumont v. Ford Motor Credit Company
If you have an auto loan, home loan, or other secured property you want to keep after your Chapter 7 bankruptcy, discuss your options with an experienced attorney. The federal bankruptcy laws offer many options for protecting property and your attorney can help you select the right decision for you and your family.
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