NEW YORK, NY -- Section 524(c) and (d) of the Bankruptcy Code set forth the basis for reaffirmation agreements in chapter 7 bankruptcy cases. A reaffirmation is an agreement to pay a dischargeable debt that meets the requirements of these sections. Any other agreement to pay a discharged or dischargeable debt is without legal effect. These sections of the bankruptcy code are a result of coercive and deceptive tactics used by creditors to secure reaffirmation of discharged debts. These sections came into effect with the present bankruptcy code on October 1, 1979. Once a debt is reaffirmed, however, the debt survives discharge as if no bankruptcy petition had been filed.

Typically, in a chapter 7 case, a debtor that owns either a house or automobile would be obligated to reaffirm the debt to the secured creditor if the debtor wanted to retain the collateral. The debtor would also need to be current on its payment obligation. Thus, until recently, a debtor typically had three options when faced with a secured consumer debt situation. The options were as follows:

Option 1: Surrender the collateral;

Option 2: Reaffirm the debt and keep the collateral, and continue to make payments as they come due.

Option 3: Redeem the collateral in exchange for the agreed upon present value of same.

Over the past few years, several circuit courts have added a fourth option ("Fourth Option": retain the collateral and keep the debt current.) The Fourth Option allows debtors to avoid reobligating themselves on the debt. Provided they remain current, they are permitted to keep the collateral. In the event of a post-discharge default, they would lose the collateral but not be subject to any deficiency judgment liability which they would have had they reaffirmed the debt. The Fourth Option presently exists in the 2nd, 4th, 9th and 10th Circuits.

The 1st Circuit Court of Appeals has now added a new twist in the non-Fourth Option jurisdictions. The 1st Circuit, in the matter of In re Jamo, has recently held that "all or nothing" reaffirmation agreements do not violate the automatic stay. This is the first Circuit Court of Appeals to rule on this issue.

According to Michael L. Moskowitz, a New York bankruptcy attorney, this decision gives lenders some new negotiating leverage. If you are a creditor with a security interest in a mortgage or car, and the only way the debtor can keep it is by reaffirming it, and you are owed more than one obligation, you will have some leverage to make the debtor reaffirm all of its obligations to you.

The facts of Jamo are simple. Stephen & Lynn Jamo filed for relief under chapter 7 of the bankruptcy code. In their bankruptcy petition, they said that they wanted to reaffirm their mortgage debt. The creditor, a credit union, refused to allow the debtors to reaffirm their mortgage unless they also agreed to reaffirm five other unsecured debts, citing their all or nothing policy for reaffirmations.

When the debtors' lawyer failed to get the credit union to accept a single reaffirmation, he suggested the debtors might consider reaffirming all of their debts. The lawyer however, refused to sign the reaffirmation agreement, as required, believing that it was not in the debtors' best interest. The bankruptcy court ultimately rejected the agreement, and the debtors then sued the credit union for violating 11 U.S.C. section 362(a)(6).
While the lower courts agreed with the debtors, the 1st Circuit Court of Appeals reversed the lower court decisions holding that requiring an "all or nothing" reaffirmation was not a per se violation of the automatic stay.

In its opinion, the 1st Circuit said, "just as a debtor is not obliged to seek reaffirmation, so to a creditor retains the right to reject any and all reaffirmation proposals, for whatever reason. [A] debtor who persists in traveling the chapter 7 route knows that reaffirmation depends entirely on his ability to come to terms with the secured creditor. He also knows (or, at least, has every reason to expect) that the creditor may drive a hard bargain."

The bankruptcy code "does not outlaw linkage as an element of reaffirmation negotiations," the court said. "The absence of such a prohibition makes sense, for a secured creditor's insistence on linkage does not force a debtor to reaffirm unsecured obligations. As we have explained, reaffirmation agreements are consensual and a debtor always has the option of walking away from an unattractive proposal. Of course, a debtor whose home is at stake is in an unenviable position. But a chapter 7 discharge is not a walk in the park; it is a benefit that comes with certain costs." According to Moskowitz, the court went on to emphasize that the creditor's actions must not be coercive. If they are coercive, the court has left open the option for denial of an all or nothing reaffirmation agreement if the facts exist to prove the creditor crossed the line from negotiation to coercion or harassment. In the Jamo case, the court found that the credit union's actions did not amount to coercion. What to do you may ask. According to Moskowitz, if a debtor seeks legal advice before actually filing for bankruptcy, the debtor could avoid the issue from the get-go by transferring the balance of the unsecured loan to another credit card with a different bank and then filing for bankruptcy. This way, the debtor could discharge new credit card debt in full and reaffirm just the mortgage. This is only one of several options which may be available to a debtor in the non-Fourth Option jurisdictions. Consequently, it is important for all debtors with multiple consumer debts involving secured and unsecured positions, to discuss this concern prior to a bankruptcy filing. Similarly, credit unions, banks and other lenders should determine in advance their negotiating position based upon which jurisdiction the debtor files in.

Michael L. Moskowitz, is a member of the firm of Weltman & Moskowitz, LLP, having offices for the practice of law in New York and New Jersey, where it handles cases involving bankruptcy and creditors' rights, business litigation, organization, sale and transfer, intellectual property protection, real estate, and other transactional matters. He can be reached at 212.684.7800 or 201.794.7500 or by e-mail.