The Advantages under Chapter 13 of Dealing with Creditors Secured by Personal Property Collateral
This last summer I wrote in this Bankruptcy Blog about “Reaffirming Personal Property Other Than Your Vehicle.” It was about how to file bankruptcy and yet be allowed to keep the furniture, appliances, electronics, and anything else you bought on time or gave as collateral on a loan. That blog post focused on how this works in a Chapter 7 “straight bankruptcy” case.
The bottom line was that if a debt was legally “secured” by the items purchased or the collateral given, then you’d have to pay all or part of the debt to be able to keep what you bought or gave as collateral. If the debt was not “secured,” the debt would be legally written off—”discharged”—and you wouldn’t need to pay anything for the right to keep what you bought or gave as collateral.
However, if a debt was in fact secured and you did not agree to pay to keep what you bought or gave as collateral, you would risk having those repossessed by the creditor after your Chapter 7 case was over.
The problem is that it’s not always easy to know whether a debt is actually legally secured by the purchased items/the collateral. And even if the debt IS secured, sometimes creditors don’t bother to pursue what they might be legally entitled to, especially if the items/collateral do not have much resale value.
You’re left with a practical dilemma under Chapter 7. On one hand you don’t want to pay for the right to keep something if you aren’t legally obligated to, or to pay more than you should. On the other hand, you don’t want to have something repossessed that you would have wanted to keep.
THE LEVERAGE PROBLEM UNDER CHAPTER 7
The heart of the problem under Chapter 7 case is that the creditor has most of the leverage. Under the law you can always surrender the purchased items or collateral and owe nothing on the debt. But that’s essentially your only leverage. If you want to keep what you bought or used as collateral, the lender can demand that you legally commit to pay the full debt (“reaffirm”). If you really need or want the stuff, you will likely be willing to pay the debt, even if the stuff is not worth as much as the debt. At the very least, you’ll likely be willing to pay a premium.
Given that the items at issue are usually worth relatively little monetarily (excluding vehicles, which are not being discussed here today), it’s not worth a lot of attorney time (and fees) to determine for sure whether a debt is or is not secured, or to negotiate back and forth over how much it’s worth. So, practically speaking, the creditor can pressure you to pay to keep something you need, and probably to pay more than it is really worth.
Although they have this leverage, in many cases the creditor will not pursue repossession of small valued items. The costs involved in repossession and selling items with little value is not worth the creditor’s time. In California the creditor would have to seek a replevin action if you did not voluntarily turn over the personal item.
CHAPTER 13 SHIFTS THE LEVERAGE IN YOUR FAVOR
Chapter 13 shifts a great deal of that leverage into your hands because of how the procedure works. It allows—indeed it requires—you and your attorney to propose whether a debt is secured or not, and if so how much the collateral is worth. These assertions are incorporated into the formal Chapter 13 plan that your attorney prepares and you sign, and is then filed at the bankruptcy court. That proposed plan acts as a package offer to all of the creditors, which then have only a few weeks to dispute how they are to be treated in the plan.
This puts the burden on the creditors to object. If a creditor does not object or does not do so before the time the bankruptcy judge reviews and “confirms” the plan, the creditor is largely stuck with what the plan said.
As to a debt that that plan says is secured up to a certain dollar amount, once you pay that amount through your plan, the debt is no longer secured by the now-paid-off collateral. It’s free and clear.
And as to a debt that your plan asserts to be unsecured altogether, if the creditor does not object in time it has to go through additional legal steps to be treated as a secured creditor. It has to ask for court permission to pursue the collateral. At that point it has to prove the debt is indeed legally secured by the collateral. If it does, you and your attorney can then amend your plan to pay the fair market value of the collateral, and protect it.
And if the creditor does not assert its right to the collateral during the Chapter 13 case at all, it may still be able to pursue the collateral after the case is over. But by that time whatever collateral survives will likely have depreciated to the point of not being worth repossessing.
THE PRACTICAL REALITY IS IN YOUR FAVOR
The reality is that creditors not secured by real estate, vehicles, or other expensive collateral seldom object to how we propose to treat their collateral in a Chapter 13 plan. They don’t mostly because there is just not enough money in it to be worthwhile for them to do so. And if they do object, usually the the matter can be settled quite quickly and favorably.
THE “AUTOMATIC STAY” AS THE GREAT EQUALIZER
One big reason for the shift in leverage is the practical difference under Chapter 7 and Chapter 13 in the “automatic stay,” the law that prevents creditors from pursuing you and your property during a bankruptcy case. Under Chapter 7, the “automatic stay” is in force only during the three or so months that the case usually takes to complete. Under Chapter 13, that protection lasts for the three-to-five-years that those cases usually take. So instead of a creditor leveraging you into paying, and into paying more, in order for you to avoid a repossession a few months later as would happen under Chapter 7, under Chapter 13 you don’t have that fear. And so the creditor has much less leverage.
THE EFFICIENT, EFFECTIVE, AND DOWNRIGHT ELEGANT CHAPTER 13 SOLUTION
This combination—the extended protection of the “automatic stay” under Chapter 13, plus an efficient mechanism for determining whether a debt is secured or not, and if so to what dollar amount—gives you a safer and cheaper way to keep what you need. The “automatic stay” reduces your fear of repossession, improving your negotiating leverage. And the plan proposal and court confirmation process is efficient because there is either little objection to what you propose in your plan (assuming it’s reasonable) or else the objection can usually be resolved quickly.
THE “CRAMDOWN” EXCEPTION
Be aware that there is one situation under Chapter 13 in which you cannot propose to pay only the value of whatever was purchased but instead must pay the full balance on a debt to keep what you purchased. This happens if the purchase was made less than one year before the Chapter 13 case was filed.
In that case the secured debt is “non-modifiable”—you have to pay the debt in full through paying the monthly payments as required by the contract, if you want to keep what you bought.
This one-year period is relatively short—with vehicles you can’t do a “cramdown” to reduce monthly payments and to reduce how much you pay overall until the vehicle loan is more than two and a half years old. And if you’re close to a year, you can wait to file until that one-year mark passes. So this exception does not come into play often, but you do need to be aware of it if you’ve made any secured purchases within the last year.