Dealing with Secured Creditors
Dealing with Secured Creditors
I’m sure you have heard the terms Secured Debt and Unsecured Debt. In this article, I am going to focus on Secured Creditors and how they are handled in a bankruptcy case but I will spend a moment to discuss the difference between the two different types of debt.
When you purchase something on credit, such as a car or a piece of jewelry, you enter into a Secure Loan because the item you’ve purchased secures the creditor because it automatically becomes collateral. Collateral is something that can be taken away, from the borrower, by the lender, if the debt is not paid.
Unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. In an unsecured loan situation, there is no item that can be taken back, thus leaving the creditor not secured. Examples of unsecured debt would be medical bills, credit card debt and utility bills. These types of debts present a higher risk for lenders because in order for them to receive what is owed to them, if the borrower fails to pay, would be to sue for repayment.
Allowed Secured Claim
Under the old Bankruptcy Act, little could be done to protect debtors from the holders of secured claims. Now, under the Bankruptcy Code, nearly every type of secured claim can be, at least, altered in some way through bankruptcy and often with significant benefits for the debtor.
Code section 506(a) provides that every claim filed which is secured by a lien on property (a secured debt), or subject to a setoff (A setoff is a claim made by someone, who owes money, that the amount owed should be reduced because someone else also owes the claimant money), is an allowed secured claim to the extent of the creditor’s interest in the estate’s interest in such property or in the amount subject to setoff.
To the extent that the creditor’s interest, or the amount subject to setoff, is less than the total amount of the claim. The claim is an allowed unsecured claim.
An unsecured claim which is filed and allowed is therefore divided (or bifurcated) into two parts:
1. An allowed secured claim in an amount equal to the value of the collateral, and
2. An allowed unsecured claim for any excess of the total claim over the value of the collateral
In other words, in a debt which is not subject to defenses or set offs, in the amount of $2000 which is secured by a car which is worth $500, the debtor could request a determination that the claim be bifurcated into an allowed secured claim of $500 and an allowed unsecured claim of $1500.
This concept looks to the actual interests of the parties existing at the time of the bankruptcy to determine their rights . A secured creditor’s interest is measured by what it would receive at that time through the enforcement of the lien and that amount would bet he value of the collateral.
By treating the amount of the claim which is in excess of the value of the collateral as an unsecured claim, the Code prevents the secured creditor from getting an unfair advantage in the bankruptcy case over the unsecured creditors.
The value of the property is based on the replacement value as of the date of filing your bankruptcy petition, without deducting any costs for selling or marketing the property. If the property is personal, family, or household property, the replacement value is the price a retail merchant would charge for the same kind of item taking into consideration the age and condition of the property.
The reason for this kind of change with regard to secured loans on property is so that the bankruptcy laws reflect the actuals rights of each party. A creditor would not get more than the value of the property. Using our previous example, if you default on a car loan and the car would get the creditor $500 after being repossessed and sold, the creditor has the right to a secured claim of $500 in the bankruptcy process. The other $1500 would get lumped into all the other unsecured claims. This prevents a secured creditor from having an unfair advantage in the bankruptcy process. If the laws allowed a secured creditor to get more, then it would mean that the secured creditor has a right to other property beyond that used as collateral for the original car loan.
There are some limitations that have been placed on splitting a secured loan into two parts by the Supreme Court in a chapter 7 bankruptcy. However, in a chapter 13 bankruptcy (and other chapters) the ability to split into an allowed secured and allowed unsecured claims is important for many of our clients.
The Process for Determining the Allowed Secured Claim
The question of determining which debts are allowed secured claims, usually arises in the form of an objection filed by the debtor after the creditor has filed its claim. If the secured creditor does not file proof of claim, the debtor may file a claim in the amounts the debtor believes to be secured and the amounts they believe to be unsecured. The creditor then has the opportunity to respond, seeking to amend the claim. The debtor may then initiate a proceeding against the creditor by complaint or by motion, seeking a court order determining the amount of the claim.
In other words, after filing your bankruptcy petition, the trustee will notify all of your creditors. Creditors are given a set period of time to file claims. If a creditor doesn’t file a claim, you can file one on their behalf to ensure the debt is included in the bankruptcy process. You have the right to file the amounts or portions of the debt that are secured and unsecured. No matter who files the claim, you as the debtor or your creditor, there is an opportunity to dispute the value of the property used as collateral for the loan in question. If you no longer have the property because it was lost, stolen, or transferred, the creditor does not have a secured claim.
A creditor is required to provide evidence of their interest in the property used as collateral. To be safe, we may file a motion to object to the creditors secured claim to ensure the court specifically determines the value of the secured claim and the creditor has been notified that the court will determine the value.
Valuation means to estimate the value of something’s worth. In order to determine how to divide claims, we first must determine the value of an item’s worth. Sometimes the date the property is valued becomes important. For example, cars will often depreciate in value quickly, or in a volatile real estate market, values could change rapidly as well. For personal, family or household property, the value is determined based on the age and condition at the time of valuation (as opposed to date of filing).
Creditors Attempts to Obtain Security After Bankruptcy
The first potential problem for debtors with secured creditors is that the creditors may attempt to seize or foreclose on collateral. There are a few different avenues which a creditor might take to do this.
The first is the creditor’s motion for relief from the automatic stay. This is a request for permission from the bankruptcy court to take action against the debtor outside the bankruptcy forum. One seeking relief from the stay to go forward against the debtor or his property must show the bankruptcy judge, after a hearing, that there is “cause” for the granting of relief ( which might include showing that the creditor’s interest in particular property is not “adequately protected”) , or showing that the debtor has no equity in the property and that the property is not needed for a reorganization.
Most often, it is the secured creditor who wants relief from stay to foreclose on real estate or to repossess a car. Creditors can frequently get relief from the stay to foreclose on property in which the debtor has no equity or where the property is not insured. Where the equity cushion (the difference between the creditor’s claim and the value of the property) is small, the debtor may have to make “adequate protection payments” to the creditor to preserve the equity cushion for the creditor’s benefit as a condition of the stay remaining in effect.
When relief from stay is granted, it does not remove the property from the estate or grant the creditor ownership of the property. It simply removes the stay and restores the parties to their state law rights and permits the creditor to enforce those rights to the extent that the relief from stay order permits. Thus, if a mortgage holder gets relief from stay, it doesn’t grant the creditor ownership of the collateral, it just frees the creditor to exercise whatever remedies the creditor had outside of bankruptcy.
Sometimes creditors will try to use the bankruptcy court to reclaim the property by having the trustee abandon the property. Creditors may try to convince the trustee that you do not have any equity in the secured property that you have claimed exempt. It may be that the property doesn’t have monetary value for the trustee, but that it is necessary for you to complete your chapter 13 plan. Typically abandonment happens after the end of the case unless there is notice and hearing in front of the court.
There are times when it may be to your advantage for the trustee to “dispose” or sell property. We have clients who will be facing foreclosure on their home even though they are going through bankruptcy to get their financial life back on track. If there will be foreclosure, having the trustee sell the property can sometimes avoid capital gains taxes. If the trustee sells the property the bankruptcy estate will have to pay the taxes as opposed to you paying them. As your attorneys we will review the specific circumstances regarding your property in order to serve your best interests.
Secured debt on vehicles
I’ve discussed in earlier articles the requirement in a chapter 7 bankruptcy for providing a statement of intention with regard to property used as collateral. In general, you decide whether or not you will keep or give up the property and whether it is exempt or non-exempt. The other decision you make is whether or not you intend to reaffirm the debt. Some lenders will agree to let you continue to make payments on the loan and keep the property without having to reaffirm the debt.
The deadline to file this statement is the earliest of 30 days after filing or by the time of the meeting of creditors. If you are leasing property, such as a car, you will also include a statement as to what you intend to do with the leased personal property. The statement of intention is given to the trustee and all of the creditors listed in the statement. If there is a need to change your plans about the property listed in your statement of intention, we can discuss your options. As a statement of your intent, you are not necessarily bound by what you originally submitted and we can discuss the best options for you with regard to property that is used as collateral.
These issues are complicated, and only an experienced bankruptcy attorney can answer your questions fully. Speak to a professional about your specific circumstances before you make any decisions about your bankruptcy case. The process of Arizona bankruptcy can be difficult and unique for each situation. If you are looking into filing for bankruptcy, it is in your best interest to consult with a competent Tucson bankruptcy attorney before taking any action. I am one of Tucson’s most prolific filers of bankruptcy petitions. That didn’t just happen by luck. My staff and I work hard to make sure our clients have a superior experience with our firm. If you are considering filing for bankruptcy in Arizona, contact us for a free consultation to find out how we can help.