Reaffirming a Debt in Bankruptcy
There are times when clients who have filed chapter 7 or 13 bankruptcy will ask whether or not they should reaffirm a debt that would otherwise be discharged in their bankruptcy. Reaffirmation is an agreement made with a creditor to continue paying off a debt even after bankruptcy. There may be legitimate reasons for wanting to reaffirm a debt or loan. However, before the changes in bankruptcy law in 2005, it was not uncommon for creditors to use coercive methods to try and get debtors to reaffirm a loan. Reaffirming a debt means that you will be legally responsible for repaying the debt after your bankruptcy even though the bankruptcy would have released you of any legal responsibility to pay it back.
Protecting the Debtor
Because of the previous coercive tactics used by creditors, Congress put into place various protections when the 2005 changes were enacted. For example, in Senate reports on potential changes to bankruptcy laws in 1998, there was evidence that Sears had 2,733 illegal reaffirmation agreements that had been entered into without complying with the law at the time. Over a two-year period, more than 80,000 people were affected by abusive reaffirmations.
According to committee reports of the 105th U.S. Congress, “The U.S. Attorney in Boston filed suit alleging that Sears had committed mail and wire fraud in its reaffirmation practices. He commented that `In obtaining these agreements, Sears deceived debtors into thinking they were obligated to pay back debts which had already been discharged by the Bankruptcy Court.’ The attorneys general in 40 states also began investigations into reaffirmation practices. And, as a result, Sears was forced to agree to pay $165 million to consumers and the attorney general is looking into these practices. In Illinois, for example, almost 2,300 residents were affected and Sears reimbursed them nearly $2 million.”
These practices contributed to significant problems in the bankruptcy system. Creditors would even use the threat of repossession of household goods knowing that debtors would succumb to the pressure of such threats given the enormous financial stress they were under. Because of the documentation of such abuses, there are now specific requirements for reaffirmation agreements as part of the bankruptcy process. The protections set in place will depend on the circumstances of the reaffirmation. But on the whole, they were enacted to ensure that debtors understand that they are under no legal obligation to enter into a reaffirmation agreement with a creditor.
There are times when a debtor will sign a reaffirmation agreement when not represented by an attorney. Other debtors will have their attorney negotiate the reaffirmation agreement. The requirements for reaffirmation in the bankruptcy process take into account both situations.
There are several requirements that were put in place in 2005 for reaffirmation agreements. At a basic level the reaffirmation agreements must be enforceable under non-bankruptcy law. This means the agreement must be legal outside of the bankruptcy process. Reaffirmation agreements must also be in writing and signed and dated by the debtor and the creditor. The agreement must also be made before the discharge. A discharge cannot be revoked in order to enter into a reaffirmation agreement. The law also has provisions for ensuring that the debtor is aware that they right to not sign a reaffirmation agreement.
Before the discharge is entered, the bankruptcy court will make sure that the debtor knows that they are not required to reaffirm a dischargeable debt. If the debtor was represented by an attorney, the court will ensure that the attorney has informed the debtor. Alternatively, if there was not an attorney negotiating the reaffirmation agreement, the court must inform the debtor at the discharge hearing of their rights.
The agreement must be filed with the court. If the debtor was not represented by an attorney in negotiating the reaffirmation, the court reviews all of the information and then will make a decision about whether or not to approve the reaffirmation.
Part of the paperwork required when reaffirming a debt includes a calculation showing that there is enough disposable income to pay the debt. The income needed can come from the debtor or if there are other sources of income that will pay for the reaffirmed debt, those sources must be shown. If an attorney negotiates the reaffirmation, she or he must sign an affidavit that states that the agreement was voluntary and fully informed and will not impose undue hardship on the debtor or their dependents.
If not represented by an attorney, the court will hold a discharge and reaffirmation hearing before approving the agreement. Even if the debtor was represented by an attorney, if the debtor’s budget does not show sufficient funds to make payments, the court is required to review the agreement. And as mentioned before, the court and the attorney are both required to ensure that the agreement does not impose an undue hardship on the debtor and his or her dependents and the agreement must be in the best interests of the debtor.
When deciding whether to approve a reaffirmation agreement, the court must determine what is in the best interests of the debtor and whether or not there is undue hardship. One way the courts have tried to determine this is to look at the reasons behind the reaffirmation agreement. As mentioned earlier, individuals might choose to reaffirm debt for a number of reasons. These reasons will often play an important part in the court deciding whether or not to approve the agreement.
For example, sometimes a debtor might wish to keep a line of credit open with a credit card company. The court may decide that maintaining a small amount of credit is not in the best interests of the debtor, especially if the credit card debt is a much larger proportion of the amount of available credit. Or perhaps the debtor is trying to protect an extended family member who co-signed for a loan by reaffirming the debt. The court’s responsibility is to look at the best interests of the individual filing bankruptcy and if it is not in that person’s best interests and the court will not approve the agreement.
Even without the reaffirmation agreement, the debtor also has the option to voluntarily pay the debt after discharge without having to sign a reaffirmation agreement. This option is often lost on a debtor especially if there is pressure coming from the creditor to sign a reaffirmation agreement. Paying the debt voluntarily preserves the power of the discharge and allows the debtor to fulfill an obligation that he or she may feel is important.
When the debt is secured by property the courts will look at additional factors in deciding whether or not to approve the agreement. For example, if the value of the property is higher than the amount to be paid under the reaffirmation agreement, it is likely that the court will not approve the agreement. The court might look at whether the property is necessary for the debtor. For example, a car would likely be considered a necessity, but expensive electronic equipment might not be considered necessary for the debtor to get a fresh start after the bankruptcy discharge.
Discrimination Based on Bankruptcy
One of the concerns clients have regarding bankruptcy is the possibility that they could face discrimination because they have a bankruptcy on their record. The bankruptcy laws contain specific language barring government agencies from discriminating against individuals who have filed for bankruptcy.
According to the law, governmental units or agencies may not “deny, revoke, suspend, or refuse to renew a license, permit, charter, franchise, or deny employment, terminate employment or discriminate with respect to employment.” Additionally, individuals who are seeking student loans or grants cannot be discriminated against. This also means that you cannot be denied a license, such as a driver’s license, as a result of a bankruptcy.
Private employers can refuse to hire someone because of a bankruptcy, however, they cannot fire someone solely because they filed for and received a bankruptcy discharge. Private landlords can decide to deny your rental application because of a bankruptcy. Because the majority of landlords or rental companies require a credit check, they will know of the bankruptcy and may make the decision to not rent to an individual who has received a discharge.
Beyond the possibility of being turned down when applying for housing, bankruptcy clients must also deal with their current landlord when going through the bankruptcy process. As I have discussed in other articles, the automatic stay that is put in place as soon as we file bankruptcy puts a hold on any eviction process. If the landlord has already received a judgment for eviction prior to the filing date, the stay automatically ends 30 days after the filing date. However, the landlord can request permission from the bankruptcy court to lift the automatic stay and proceed with the eviction. There are ways for us to challenge the end of the automatic stay under certain circumstances. For example, if the debtor is able to show that the entire amount owed to the landlord has been paid within 30 days then the landlord cannot evict.
If the debtor is filing a chapter 7 bankruptcy, the bankruptcy trustee has 60 days after the bankruptcy is filed to decide whether or not assume the lease or reject the rental agreement or lease. In a chapter 13 bankruptcy, the debtor may decide to include their rent in the payment plan. If the debtor owes back rent to the landlord, the debtor pay any back rent and have enough income to continue to pay their monthly rent. Once an individual has received a bankruptcy discharge, private landlords do not have an obligation to renew a lease. And as I mentioned before, private landlords can also reject housing applicants because of a bankruptcy discharge.
Some clients will be receiving government benefits such as social security retirement or disability insurance, supplemental security income, workers’ compensation, social welfare benefits, veteran’s benefits, and/or unemployment insurance. When they receive a notice from the government about overpayment and are required to repay some portion of those benefits, it can make a difficult financial situation even more desperate. This debt owed to the government is generally dischargeable.
The primary exception to the discharge of these debts is when there has been some kind of fraud or deception involved in receiving the benefit payments. By filing for bankruptcy, the debts can be discharged. And if the client is facing wage garnishment as a result of benefits that need to be repayed, filing bankruptcy will stop the garnishment process.
Taxes After Bankruptcy Discharge
A common question from many clients comes up around tax time after the individual has received their bankruptcy discharge. Creditors will send to the debtor receiving the discharge a 1099-C form. When a debt is cancelled or forgiven outside of the bankruptcy process or insolvency, the debtor is generally required to include the cancelled amount in their gross income when preparing tax returns.
However, the IRS excludes from gross income any debt that has been cancelled when
- The cancellation takes place in a bankruptcy case under the Bankruptcy Code,
- The cancellation takes place when the debtor is insolvent, and the amount excluded is not more than the amount by which the debtor is insolvent,
- The canceled debt is qualified farm debt (debt incurred in operating a farm). See Cancellation of Debt in chapter 3 of Publication 225, or
- The canceled debt is qualified real property business indebtedness (certain debt connected with business real property). From IRS Publication 908
Some tax preparers, unfamiliar with bankruptcy issues, will automatically include discharged bankruptcy debt reported on the 1099-C in the gross income of the debtor. When preparing the tax return for the year during which the bankruptcy discharge was granted, it is important to pay close attention to this issue. It is also possible IRS might mistakenly look to collect taxes on the 1099-C forms. Remaining vigilant to these tax issues the year following your bankruptcy discharge is important to protecting your rights under the bankruptcy laws.