The Reaffirmation Trap — for Debtor and for Debtor’s Counsel

12 Sep The Reaffirmation Trap — for Debtor and for Debtor’s Counsel

I deeply respect Jed Berliner and his contributions to the Bankruptcy Law Network, and read with interest his recent post Affirm or Reaffirm After Bankruptcy, It’s Trouble Whatever It’s Called. You’ll notice a lot more posts now about reaffirmation such as Russ DeMott’s series beginning with Reaffirmation Agreements: “Let Them Eat Steel! (Part One).

The problem is, there are real, practical problems for a debtor and her attorney concerning reaffirmations. If you don’t have one — a reaffirmed contract, that is — there’s a risk that your house or car might be taken from you after the bankruptcy. It can be a calculated risk — simply put, depending on where you live, most creditors probably won’t seek to take your house or car from you if you are current on your payments even if there is not a reaffirmation agreement. If you can bear the uncertainty, not reaffirming might well be your best choice.

But what if you have negotiated a modification to the agreement that lowers your interest rate or otherwise really gives you a better deal on your house or car? If the new proposed agreement is truly in your best interest, getting a reaffirmation might well be your best choice, even if the creditor tells you they’ll accept your signature alone and don’t need the bankruptcy court’s approval. This is because that agreement, if it is not reaffirmed within the bankruptcy, is not enforceable. That’s part of Section 524 of the Bankruptcy Code.

Let me say that again — a loan modification without a reaffirmation in the bankruptcy is unenforceable. That might work to a debtor’s advantage, but it also might work to a creditor’s advantage, so know and calculate the risks. As a debtor, you might rely on a lower interest rate in the new agreement with the creditor, but if the creditor didn’t comply, didn’t do as the agreement said, raises the interest rate, taking that as the example, the debtor would have to try to enforce an unenforceable agreement. There might be other legal theories to use, indeed, hopefully there would be, but the underlying contract is unenforceable.

That’s part of the trap. Local practice can vary, but in New Mexico, effective with reaffirmation agreements filed with the court on and after August 1, 2010, a reaffirmation without the debtor’s attorney’s certification is unenforceable. (I briefly posted about this new policy here; this continues the discussion of the new policy.) Thus, if the debtor wants any loan modification to be enforceable, the debtor must have his attorney’s involvement, or have his attorney withdraw from the case and represent himself. We used to be able to, as attorneys, take no position and the client took the issue to the judge herself. Now, the attorney is subject to contempt of court if the attorney is not sufficiently involved in the reaffirmation process. The bankruptcy judges in my District acknowledge this might require debtor’s counsel to raise the fees they charge their clients for a basic bankruptcy.

What’s an attorney to do? Here’s part of the trap for the debtor’s attorney: the debtor doesn’t want to pay the attorney for unnecessary work, a reaffirmation may not ever become an option or reality, and funds are usually pretty tight (that’s why the debtor is doing a bankruptcy!). So, one option is for the attorney to charge more for that client’s bankruptcy without knowing whether there will be a need for involvement in a reaffirmation, holding that money in a trust account to save to use in the event there is a reaffirmation, subject to refund to the client if there is not — okay, it holds the money but also uses up the debtor’s exemptions to cover it (double loss for the client). Another option is for the attorney to get up front the client’s signed consent to the attorney’s withdrawal if a reaffirmation ends up being requested — that seems pretty “cold” but the attorney may have to consider that. These may be necessary because otherwise the attorney risks the client refusing to pay for the additional services, which then may require the attorney to incur the time/money/energy costs of having to file a motion to withdraw, possibly without the client’s consent.

One of the underlying issues, simply starting to come to the surface especially now, I believe, with middle class bankruptcies becoming more the norm, is “unbundling”. I’ve also started talking about unbundling here. The New Mexico bankruptcy court where I practice has taken a very strong position against unbundling, at least in the reaffirmation context. I’ll continue this discussion with another post in the unbundling series.

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Jay S. Fleischman is a bankruptcy lawyer with offices in Los Angeles and New York. He can often be found on Google+ and Twitter, where he shares information about consumer protection issues and personal finance.
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