Interviewer: I know you’ve provided advice to thousands of bankruptcy clients in your 20+ year career. Can you tell us what is one of the greatest concerns that your clients have when they walk through your door to consult with you about bankruptcy?
John’s Answer: The effect of bankruptcy on their vehicle is among their greatest concerns because their vehicle is often essential to keep their job. Fortunately, almost all clients get to keep their vehicle, and some clients will even obtain a great financial advantage relating to their vehicle by filing for bankruptcy. More rare is another subgroup of clients that will have an issue with their vehicle in a bankruptcy because it has equity. Even those in this third group will often end up keeping their vehicle and, of course, I would identify and discuss this issue with the client thoroughly, well before the petition is filed.
Interviewer: I didn’t realize that there were these three groups. So please elaborate. Let’s say that I am the owner of a five-year-old vehicle having a market value of $10,000 with a lien in favor of Chrysler in the amount of $14,000. Will I be able to keep that vehicle, and what exactly will happen to the balance due to the creditor?
John’s Answer: You can choose to keep the vehicle in either Chapter in this scenario, but the treatment of the vehicle will differ depending on if you file a Chapter 7 or a Chapter 13 case. Lets look first at Chapter 7.
Chapter 7- Reaffirmation Agreement
Under Chapter 7, most clients in the situation which you’ve proposed would sign a Reaffirmation Agreement by which you “reaffirm” the debt, if keeping the car were important. “Reaffirming” is an important concept in Chapter 7 and means that you sign a “reaffirmation agreement” after the petition is filed in which you agree to be personally responsible to pay back the original promissory note on this vehicle. That is, you are now reaffirming the obligation on the same note that you originally signed when obtaining the credit for the vehicle. Of course the amount reaffirmed will be the amount due on the loan to Chrysler as of the date of the filing of the Chapter 7 (or whatever lesser amount can be negotiated). If you intend to keep the vehicle, signing the reaffirmation is generally fine as long as you can afford the vehicle debt you are agreeing to take on.
If you sign the reaffirmation agreement and later find that you cannot afford the vehicle, you have a very limited opportunity to cancel the reaffirmation agreement. If you did not cancel timely, that means that you will be responsible for the vehicle debt. If you find that you can no longer afford this vehicle debt and its too late to cancel the reaffirmation agreement, you face the risk of a repossession and, after the sale of the vehicle by Chrysler, a deficiency balance will likely come back on you. The “deficiency balance” is that portion of the balance owed on the vehicle that the creditor did not obtain from the sale of the vehicle to another after repossession.
Of course, all this deficiency risk may be avoided if the client does not sign the reaffirmation agreement and, instead, chooses to make regular payments to Chrysler. In fact, under the bankruptcy law prior to the changes of 2005, a lot of my clients did exactly that. Specifically, they would continue to make regular monthly vehicle payments, but not sign the reaffirmation agreement in case they got into financial trouble and were not able to pay for the vehicle. Then, in the event they could later not afford (or didn’t want) the vehicle, they would stop making the regular payments and just give the vehicle back to Chrysler. Chrysler would not be able to come back on the client for any deficiency on the vehicle, if any existed. In 2005 the law was changed to provide the creditor protection in such a situation. Specifically, if the reaffirmation agreement is not signed by the client and filed before the discharge is granted in the Chapter 7 case, the car creditor can take back the vehicle (with Court permission if the Chapter 7 case is not yet closed). What this means is that the creditor has the vehicle, can sell it, but cannot come after the client for any portion of the debt. Therefore, most of my clients now sign the reaffirmation agreement to avoid the possibility that the creditor may take the vehicle back if the reaffirmation agreement is not signed.
However, there are some instances, in which our office is very reluctant to have a client sign a reaffirmation agreement, including if the amount of the debt is much greater than the value of the vehicle, if the interest rate is very high on the promissory note to be reaffirmed and we anticipate a high probability of eventual default, or if there is a question about if the client can really afford all of the required payments.
One solution is to try to negotiate better terms. In the example you posed, the amount of the debt was well above the value of the vehicle. Perhaps the terms can be negotiated where the debt amount is at or below the value of the vehicle. There is room to negotiate because both you and the vehicle creditor may be better off with a negotiation rather than surrendering and auctioning off of the vehicle.
For the creditor this might be a wise negotiation because it will avoid the possibility that the client may elect to surrender the vehicle. A surrender would result in an eventual sale at auction and, thus, the creditor would likely get less funds from an auction than it could have gotten from a reasonable negotiation with client. Also, the creditor cannot pursue the client because the reaffirmation agreement was not signed. Of course, Chrysler may not agree to a negotiation if they question the client’s ability to obtain an alternative car on credit. A lot of this will depend on the negotiations involved and what resources the client actually has available to buy (or obtain possession of) another vehicle, if necessary.
Chapter 7- Redeem
One option for the Chapter 7 client is to redeem the vehicle. This involves paying the vehicle creditor less than the full amount of the vehicle debt by paying a lump sum amount(s) to the creditor up to the trade-in value of the vehicle. For example, if the vehicle is worth $7,000 at trade-in prices, and $13,000 is owed on the debt, you pay only $7,000 to redeem, and the difference not paid ($6,000) would be forgiven with the bankruptcy discharge. Significantly, the $7,000. redemption amount would need to be paid promptly (generally within a few months). It’s a great deal if you have the money.
Interviewer: What about in a Chapter 13 case?
Chapter 13 – “Strip Down” Lien
John’s Answer: Chapter 13 provides simple, powerful benefits to the client to help them keep their vehicle. In the situation where one is “upside down” on the vehicle, the Chapter 13 law will permit the payment of the claim on the vehicle through the Chapter 13 plan. Knowing this, we obtain the fair market value of the vehicle, and compare it to the amount owed to the vehicle creditor, such as Ford or GMAC. For example, if the fair market value is $10,000 and the amount owed to Ford is $14,000, we can sometimes take the full claim and split it into two parts for the benefit of the client. Because the vehicle is only worth $10,000, $10,000 of the claim would be considered secured by the value of the vehicle, but the balance of the claim to be payed as a general unsecured debt (at the same rate which is determined by the court to be paid to all other general unsecured creditors, including any credit card debt). So, if the court determines that a 5% repayment to general unsecured creditors is what is required then that $4,000 general unsecured claim will be paid in the amount of only $200 (ie $4,000.00 x .05), as distinct from the full $4,000. Thus, the difference of $3,800.00 ($4,000 general unsecured claim less $200 payable on that claim) is forgiven with the Chapter 13 discharge. An additional benefit is that no part of this unsecured claim of the vehicle creditor will need to be paid interest. The secured claim ($10,000.00) will need to be paid interest, although generally at a greatly reduced amount compared to the interest set on the contract of the creditor.
This is one way that the bankruptcy code helps clients to reorganize their finances while also keeping their vehicles. The ability to divide the claim into two parts in this manner is called a “strip down” of the vehicle claim and it is only available on vehicles which are financed more than 910 days before the filing of the bankruptcy case. It appears that the 910-day rule was imposed because Congress did not want debtors to file bankruptcy and “strip down” a vehicle shortly after they financed the vehicle. Obviously, doing so would hurt the vehicle creditor and may not be fair to the vehicle creditor if it is too soon after the purchase and financing of the vehicle.
Interviewer: What if the client’s vehicle is about to be repossessed for non-payment (or has just been repossessed and the client needs that vehicle back)?
John’s Answer: Some clients have not made payments in the last 2 or 3 months (or more) and they are unable to work out a payment arrangement with the vehicle creditor or they have other overwhelming debt to address as well. In this case, Chapter 13 can be very helpful, as a Chapter 13 plan will allow those missed payments to be placed into a plan in which the client pays money to a Chapter 13 trustee who then distributes the money under a court-supervised distribution to various creditors, including the vehicle creditor.
It is possible to both treat the arrears in this manner and, if the market value of the vehicle is less than the balance owed on the vehicle, also have the vehicle creditor’s claim “stripped down” if the debt is more than 910 days old. This provides two benefits: first, the arrears are paid and second the amount paid for the vehicle is less than the balance owed.
Chapter 7 would not be very helpful, as the arrears would not be addressed adequately. The creditor would likely ask for and receive permission from bankruptcy court to repossess and sell the vehicle on which the creditor is owed payments.
Interviewer: What if the vehicle is burdensome and I don’t want to keep it or its related debt? Can I just give it back to the creditor and not have to pay for it?
John’s Answer: Yes, this is called “surrendering” a vehicle to the secured creditor (or lease creditor). This is done in Chapter 7 or Chapter 13, typically when the vehicle is burdensome, such as when the debt is higher than the value of the vehicle, or if the vehicle is not affordable, or if one has too many vehicles and does not need the vehicle being surrendered.
In Chapter 7, you can inform the vehicle creditor that you wish to give up the vehicle and stop making payments on the vehicle. Eventually the vehicle creditor will take steps, with the consent of the Bankruptcy Court, to get possession of the vehicle and sell it. Because a Chapter 7 client will receive a discharge in a Chapter 7 case, any deficiency on a vehicle after it is sold will be erased in a bankruptcy case, just like the credit cards. After the bankruptcy is filed, the client would not sign a Reaffirmation Agreement because that would personally obligate the client on this vehicle.
Chapter 13 is a bit different because in chapter 13 there is some percentage being paid back to general unsecured creditors, perhaps 5% or 30% or some other percentage. After the repossession, the vehicle creditor could file a deficiency claim to receive that percentage. If the percentage repayment is high, e.g., 100%, then the surrender may be problematic as the client no longer has the vehicle and the deficiency will then need to be repaid back at this high percentage — possibly even requiring full repayment.
Hyperlink: Voluntary Surrender of the Vehicle: Effect of Chapter 7 & Chapter 13
Interviewer: What if the client has some equity in the vehicle, but still owes money on it, and also wants to surrender it? Does the client get to keep the equity after the vehicle is sold?
John’s Answer: Well, that’s a good question. The answer depends on whom the vehicle is being surrendered to: A Chapter 7 Trustee or the Creditor?
Chapter 7- Surrender with Equity
In Chapter 7, there is a trustee appointed to look out for the benefit of unsecured creditors. The trustee is appointed because often creditors don’t have a sufficient stake in any one case to warrant hiring their own attorneys to closely monitor the case. The Chapter 7 trustee will look for equity in various assets and sometimes will be able to obtain funds from that equity for the benefit of the general unsecured creditors.
With respect to the vehicle, a client can typically protect some of the equity by asserting a vehicle exemption under state or federal law that allows a client to protect, approximately $3,000 to $4,000. Or sometimes under the federal wildcard law, the client can protect an additional $11,000 of equity. So to answer your question, if the Chapter 7 Trustee is selling the vehicle, the Trustee will pay off any lien of the creditor, then will pay the client his exempt portion based on the state or federal exemptions that a client selects upon filing a petition. The Trustee will use the rest of the funds to pay unsecured creditors.
On the other hand, if the vehicle creditor sells the vehicle, then the client gets back all funds received after the vehicle creditor is paid in full with the associated costs.
If it’s only partially protected under those exemptions, the vehicle creditor will be paid in full, then the client will get his protected portion, then the trustee stands in line to get any anticipated leftover portion. If this leftover portion is too small to justify distribution, the trustee would not sell the vehicle in the first place. In this instance, the vehicle creditor would sell the vehicle and get as much as it can at auction. An auction is a distress sale, thus client will only get proceeds back under its exemption if there are sufficient proceeds to cover the balance owed to the car creditor.
Also if there were a significant amount of leftover equity in the vehicle, this would likely be known before filing the case. It may be easier for the client to simply sell the vehicle before filing at market price (not a bankruptcy related distress sale) and use any proceeds (after paying off the creditor balance) for client’s regular monthly expenses. A sale of the vehicle at market price prior to filing bankruptcy will avoid the lower distress sale prices often associated with bankruptcy sales and may mean the difference between the client receiving funds or not related to this vehicle. To reduce your risk of having later problems with the Trustee for selling before you file the petition, this sale should only be done with the advice from an experienced Bankruptcy Attorney.
Interviewer: What other issues do you see with vehicles in Chapter 7 or in Chapter 13?
John’s Answer: In Chapter 13, we sometimes see clients that want to keep a vehicle with a large balance due (e.g. $17,000 or more under the plan) with a low percentage of repayment (e.g. 5%) to general unsecured creditors. In this kind of situation, the Trustee and/or the Judge might offer resistance because the client is keeping a very expensive car and in the absence of that car the other creditors might receive a higher distribution than the 5% provided in the proposed plan. If the vehicle debt which is being repaid in the plan is not extremely outrageous, offering to pay a somewhat higher percentage to general unsecured creditors may be viewed as fair and will probably get approved by the Court. Where a higher percentage to general unsecured creditors is not possible because the vehicle debt is so high — for example I have seen clients with monthly vehicle debts of $600. or more — then consideration should be given to surrendering the vehicle or possibly to Chapter 7 relief and trying to keep the vehicle. The standards are different in Chapter 7 and, thus, keeping a vehicle with a large debt balance is generally less of a concern in Chapter 7. More discretion is given to the client to make lifestyle choices in Chapter 7, such as how large a vehicle debt balance the client can pay monthly.
Interviewer: If the client has a leased vehicle, what happens to that leased vehicle in bankruptcy?
John’s Answer: To keep in good standing with the lease creditor if you wish to keep your vehicle, you can file a motion to assume the lease. The vehicle creditor will get notice of your intention and would have an opportunity to object, but that would be unexpected. The alternative is that you do nothing and you simply continue to make the lease payments. It is possible in that instance to lose the vehicle since there is no Order assuming the lease.
If one rejects the lease (without having assumed it during the bankruptcy case), then the lease creditor (in either Chapter 7 or Chapter 13) will have a claim to be paid as a general unsecured creditor. Just as with the vehicle ownership situation with a burdensome balance, a client should reject the lease if it is burdensome. For example, a client may have purchased a Hummer when he was making $100,000 a year but now is making only $30,000 as the result of a layoff from a long-standing job. Thus he can no longer afford the Hummer, but needs Chapter 13 for other reasons such as to catch up on missed mortgage payments. In that case the rejection of the lease would be a good choice and the client would pay the amount owed the lease creditor, if they file a claim, to the same extent that the client would pay to general unsecured creditors, often 5% repayment with 95% of their debt forgiven with the Chapter 13 discharge.
A more complex situation to address with your attorney before filing bankruptcy involves assuming the lease in Chapter 13 and later defaulting. Is the lease creditor now allowed 100% repayment through the plan as an administrative priority claimant or should their creditor be treated as though the default had occurred prior to bankruptcy, and, thus, is not entitled to 100% repayment as an administrative priority creditor?
Interviewer: Well, that’s all very interesting information on vehicles. I didn’t realize there are so many issues and nuances on vehicles in bankruptcy. If you had to summarize in one or two sentences the topic of vehicles in bankruptcy, what would you say?
John’s Answer: In almost all Chapter 7 and Chapter 13 bankruptcy cases, the client is able to keep the vehicle on terms as good as or better than those initially agreed to at the time of financing his vehicle. Sometimes the benefits can be exceptionally good with respect to the vehicle and significantly aid in the fresh start objectives of the Chapter 7 client or the reorganization objectives of the Chapter 13 client.
The best option will depend on all the facts presented and the client’s particular goals. The treatment of the vehicle is one important factor that will drive the decisions to be made in bankruptcy, but will not be the sole or most important factor in many cases.