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Lose in Court, Drive Happily into Sunset

By Cathy Moran, California Bankruptcy Lawyer

Growing case law suggests that debtors should hope the bankruptcy court does not approve their car reaffirmation agreement.

Huh?, you say.  If you’ve agreed to reaffirm, and essentially waive the bankruptcy discharge as to the car loan in order to keep the car, why would you want the court to find that the car loan represents a hardship to you or your family?  Because pay and drive lives on if you are willing to reaffirm,  even though the reaffirmation agreement is disapproved, according to a growing number of bankruptcy judges.

Reaffirmation before reform

Here’s the back story.  Before BAPCPA became law in 2005, the Bankruptcy Code included a provision that said that merely filing bankruptcy was not a default on a loan if you were otherwise performing.  That is, the “ipso facto” clause in the contract that made filing bankruptcy an event of default wasn’t enforceable.

So, after a bankruptcy filing, the debtor could simply continue to make the payments on time and keep the car.  If, in the future, he couldn’t pay, the lender was limited to picking up the car.  No deficiency judgment was available to the lender.  Bankruptcy lawyers called this “keep and pay” , or “pay and drive”.

Car buyers squeezed by new law

Then the lobbyists for the car companies got their goodies inserted in bankruptcy reform, including removing the “bankruptcy isn’t a default” provision.  So, someone who was absolutely current on their car payments, but filed bankruptcy to deal with some other debt issue had just defaulted on the car loan, and was in danger of having the car repossessed, unless they reaffirmed the loan.

Reaffirmation agreements were historically seen as points of possible abuse and the Code provided that judges must oversee whether the debtor was making a sound and well informed decision when he agreed to resume the liability for a debt.  In the car context, reaffirming a car loan meant that, if the debtor later on couldn’t make the payments agreed upon, the lender could not only repossess the car, but also sue the debtor for the difference between what the car brought at auction and the contract price.

Between the right to a deficiency judgment and the fact that lenders could insist that a reaffirmation agreement contain the same expensive terms as the original agreement, debtors were over a barrel after BAPCPA.

Courts find the old route

Enter bankruptcy judges who were called on to review reaffirmation agreements and the debtor’s budget.  They were to determine if the debtor had enough income to make payments under the reaffirmed car loan and cover all the other necessary expenses of family living.

If the numbers didn’t pencil out, lots of judges held that they could not find that reaffirming was in the debtor’s best interest.  (There’s a story there, too, for how does a judge think a debtor just emerging from bankruptcy is going to replace a repossessed car, or get to work in most places without one?)

But judges, bless their hearts, read the (poorly written) provisions of the “bankruptcy reform” legislation and said, whoa!  All the law requires the debtor to do it to timely sign and file the reaffirmation agreement.  If he does that, and the court disapproves the agreement, the lender can’t repossess the car so long as the debtor makes the payments on time and keeps the car insured.

Pay and drive lives on if the debtor goes through the motions of reaffirmation!

Some of the cases finding “ride through” available when reaffirmations not approved:

Husain 364 B.R. 211

Moustafi 371 B.R. 434

Hinson 352 B.R. 48

Quintero Bankr. N.D. CA

Image courtesy of Eduardo Deboni

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Full post as published by Bankruptcy Law Network on October 10, 2010 (boomark / email).