A Bay Area Bankruptcy Attorney's Perspective on Auto Loan Reaffirmation Agreements in Chapter 7 Bankruptcy
A Word of Warning from the Experienced Bankruptcy Lawyers at the Law Offices of Jon G. Brooks in San Jose, CAThe purpose of this article is to explain "reaffirmation agreements" in plain terms so that our Chapter 7 bankruptcy clients can readily understand what a bankruptcy reaffirmation agreement is, why their car loan lender may require one, and what the consequences of signing (or refusing to sign) a reaffirmation agreement will be both during their case and long after their Chapter 7 bankruptcy case has closed. Note that reaffirmation agreements must be approved by a Bankruptcy Court, and in the San Jose Bankruptcy Court, that will require a separate court hearing. For additional information about auto loan reaffirmation agreements in bankruptcy, see my recent blog post “Can I Still Return My Car After My Bankruptcy Case Has Discharged?”
In order to understand what a reaffirmation agreement is and why your lender wants you to sign one, let's first suppose you are not in bankruptcy. You're struggling along, making your car payments, and then BAM, you're laid off. Or you're not laid off, but for reasons beyond your control, you simply cannot afford your car payments, and you have fallen behind. A month or two goes by with no payment, and your lender notifies you that you are in default on your car payments, and they intend to repossess the vehicle. In short order, the lender sends someone who looks like they walked off the set of a reality show to repossess your car.
In all likelihood, at the time of the repossession you owe the bank or credit union or auto finance company thousands of dollars more than the car is worth. Because after all, cars depreciate steeply immediately after you purchase one. And worse, the lender typically won't even attempt to get fair market value for the car. Instead, they'll usually sell your repossessed car at an auction for far less than it would be worth in a private party sale.
What you may not know is that in California the lender can now sue you for the difference. That's right. If you owed $23,000 on the car, and the bank sells the car for only $12,000, then under the law you have a "deficiency" of $11,000. That is the difference between what they got for the car at auction and the amount you currently owed on the car. What is worse, the lender can now sue you for that $11,000 PLUS accrued interest, PLUS tow truck, repossession, auction, impound lot, and other fees. Additionally, they'll add on top of that their attorneys' fees and court costs when they sue you. Now you've lost your vehicle, and, according to our example above, the lender is now suing you for, say, $18,000 or so. And believe us, the auto lenders nearly always sue borrowers after repossessing a vehicle.
When all is said and done, a vehicle repossession usually ends up with a judgment against you for many thousand dollars. Once they have a judgment, that means they'll garnish your wages until the full judgment is paid off (again, with interest) and your bank accounts can be emptied by them, and they can record liens against your home or other real estate.
Reaffirmation Agreements on Car Loans in Chapter 7 Bankruptcy
Now we understand that OUTSIDE of bankruptcy, if your car is repossessed, your car loan lender is very likely to sue you even after the repossession. But what happens when you file Chapter 7 Bankruptcy?
As with other secured debts, the Bankruptcy Code (in Section 362(h)(1)(A)) requires that in filing a Chapter 7 bankruptcy petition, you choose one of three alternatives: (1) surrender [the car], (2) redeem [the car] (which literally means, pay it off in full), or (3) reaffirm the debt for the car. Now here is where we get into "reaffirmation agreements" on car loans.
So, what is a "reaffirmation agreement" anyway? Essentially, a reaffirmation agreement creates a new binding contract in the place of the original car loan. The reason that a reaffirmation agreement is such a potentially disastrous contract for the Chapter 7 debtor is simply this: in the absence of a reaffirmation agreement, if you fell on hard times after your Chapter 7 bankruptcy case closed and defaulted on your car payments, then sure, the lender could repossess the car. But, importantly, they could not sue you for the "deficiency" between what you then owed and the value of the car (plus interest, attorneys' fees, impound fees, etc., as we saw above). But if a Chapter 7 debtor signs a reaffirmation agreement, then that creates a brand new, post-bankruptcy binding contract, which allows the lender to sue the bankruptcy debtor in the event of a repossession subsequent to his or her bankruptcy. And, one must remember, you can only obtain a Chapter 7 discharge once every 8 years! Hence, if the Chapter 7 debtor were to lose his or her job, say, one year after receiving a Chapter 7 bankruptcy discharge, and as a result default on the reaffirmed car loan, then the lender can not only repossess the car, but also sue the debtor, and he or she will not be able to discharge that new lawsuit in bankruptcy.
It used to be, prior to the 2005 Bankruptcy law changes known as the BAPCPA, that in a Chapter 7 Bankruptcy, a debtor who desired to keep a vehicle could simply keep the auto so long as he or she continued to make the payments after the Chapter 7 bankruptcy case was resolved. This was commonly called a "drive through." As long as you made the payments post bankruptcy, you could keep the car. Sounds fair enough, right? It was precisely this legal right to sue the borrower after bankruptcy -- for the difference between the depreciated value of a vehicle and the then outstanding balance of a vehicle loan -- that the banks fought so hard for in the 2005 BAPCPA law. Our 9th Circuit Court of Appeals has held that the new law does not allow for "drive throughs." In other words, if a debtor refuses to sign a reaffirmation agreement, EVEN IF, he or she remains current on his or her car payments, then the lender is within their legal rights under the 2005 BAPCPA to repossess the car! Yes, really!
But that's not really the end of the story.
The Bankruptcy Code as amended by 2005 BAPCPA, does indeed require that the Chapter 7 debtor "surrender, redeem, or reaffirm." But it merely requires that the debtor attempt to "reaffirm." How does this actually play out day to day? In practice, we see auto loan lenders prepare and send reaffirmation agreements in nearly every Chapter 7 case we file in which the debtor has a secured auto loan. We review these reaffirmation agreements carefully, and, if our Chapter 7 client has stated a desire to keep the vehicle post bankruptcy, then, not only is that client required to sign the reaffirmation agreement, but we are also required to sign it, stating our belief that the ongoing car payment will or will not impose an "undue hardship" on the client. In a significant number of cases, such a car payment will, in fact, impose an undue hardship.
As debtors' bankruptcy attorneys in San Jose, California, we deal with hundreds of auto loan reaffirmation agreements every year. These are the source of much confusion on the part of debtors and, well, let's be honest, the source of significant annoyance, by our San Jose bankruptcy judges. Some of our bankruptcy judges will, whenever a Chapter 7 debtor signs a reaffirmation agreement for an auto loan, require a special court hearing to decide whether the Bankruptcy Court itself will approve or disapprove the reaffirmation agreement. Bankruptcy judges who do require this hearing do so because they intend to hold a formal inquiry into whether this new reaffirmation agreement is truly in the Chapter 7 debtor's best interest or not.
If the Court does require such a hearing, then here is what is likely to happen: if you want to keep your car after bankruptcy, and you sign a reaffirmation agreement, that judge will require that you, your attorney, and a lawyer or representative from the auto lender appear at the hearing. At the hearing, the judge will consider your ability to make payments on the reaffirmed auto loan after your bankruptcy, and MOST IMPORTANTLY, if the judge determines that the new reaffirmation agreement may impose an undue hardship on you, the judge will require the representative of the lender to state on the record in open court whether that lender is in the practice of repossessing vehicles in the absence of a reaffirmation agreement. In other words, the judge will ask the lender pointedly: Do you allow debtors to keep their cars as long as they remain current on their payments even if the Court does not approve a reaffirmation agreement? Very, very few lenders will typically be so brazen as to answer the Court with a "no." In our experience the only lenders that do routinely repossess cars without a reaffirmation agreement post bankruptcy despite the fact that the borrower is current are Ford Motor Credit and Chrysler Financial.
Our perspective on reaffirmation agreements is simple: the lenders want them for good reason because they benefit the auto lenders only. Bankruptcy debtors should try to avoid them if possible because reaffirmation agreements, by and large, do not benefit the reaffirming debtor. Instead they set up the reaffirming debtor for a law suit later if he or she defaults.
To further discuss the meaning and consequences of a car loan reaffirmation agreement in bankruptcy and to schedule a free consultation with an experienced bankruptcy lawyer at the Law Offices of Jon Brooks in San Jose, CA, please call us at 408.286.2766. Prior to our appointment, we ask that you download our Personal Bankruptcy Questionnaire, fill it out to the best of your ability, and bring this information with you to your meeting.
By Jon G. Brooks