One of the questions that people frequently have who file bankruptcy in Kentucky or Indiana is whether they will have to return items that were purchased on credit. Will they have to return the refrigerator to Sears, or the camera to Best Buy?
In order to answer that question, it must first be determined whether the creditor from whom the credit was obtained is a secured creditor or an unsecured creditor. An unsecured creditor is a creditor that is owed money but does not have a lien on any of the debtor’s property. Examples of unsecured debts are medical bills and credit cards. With respect to those types of debts, the creditor may have a legally binding claim, but there is no specific property of the debtor that has been pledged to secure the debt and therefore, nothing that the creditor can repossess. For example, when someone charges a purchase on his or her Visa or Mastercard, there is generally no security interest created in the merchandise purchased. Rather, there is simply a contractual obligation on the part of the debtor to pay the bill, but no claim by the creditor against the merchandise itself.
In order for a creditor to become a secured creditor, there must be a written security agreement that specifically provides that the creditor has a security interest in some property of the debtor. In the absence of such a document signed by the debtor, there is no right to repossess anything by the creditor.
There are two different types of security interests that can be created. The first is what is called a “purchase money security interest”. This is where the creditor obtains a security interest in the property that is being purchased with the funds being loaned. A typical example of this type of security interest is the purchase of an automobile. An individual borrows money for the specific purpose of financing the purchase of an automobile. The second type of security interest is what is called a “non-purchase money security interest”. This is where one borrows money and pledges as collateral some property that he already owns. For example, suppose the debtor needs to borrow money to pay for a new transmission in a car that he owns. Because the creditor doesn’t feel secure enough about repayment based on the debtor’s signature alone, the creditor asks that the debtor’s car be used as collateral. Since the debtor is not using the loan to purchase the car, this type of security interest is called a non-purchase money security interest. This is an important distinction, because what type of security interest the creditor has may effect that creditor’s rights in the event of bankruptcy.
Once it has been established that a creditor has a secured claim, as opposed to an unsecured claim, it becomes more complicated to deal with that creditor in bankruptcy. If the debtor does not address the creditor’s security interest in some manner in the bankruptcy case, then that creditor will have the right to repossess the collateral after the bankruptcy is over. For the discharge that the debtor receives does not discharge the lien but only the underlying debt. So even though the secured creditor cannot take legal action against the debtor to collect the debt after discharge, its rights in the property pledged survive the bankruptcy discharge, and the creditor is entitled to take action to recover the property to satisfy its debt.
So how does one deal with his secured creditors when filing Chapter 7 Bankruptcy in Kentucky or Indiana?
The Bankruptcy Code offers several methods for dealing with secured creditors.
The first and simplest way to deal with a secured creditor in bankruptcy is to surrender the property, i.e. just hand over the keys to the car. If one elects to do so, he is completely off the hook. The creditor’s sole remedy to get paid back is to sell the collateral and apply the proceeds to the loan.
The second option is to reaffirm the debt. This means that one signs a legally binding document during the course of the bankruptcy that waives the debtor’s right to a discharge of that debt. So in other words, it becomes the same as if the debtor never filed bankruptcy with respect to that debt, because the creditor retains all of its rights against the debtor that it would have had in the absence of bankruptcy.
The third option is to redeem the property. This is accomplished by paying the secured creditor the value of the property in a lump sum. Suppose for example that the debtor owes the creditor $5,000.00 and the car that serves as collateral for the loan is worth only $500.00. The debtor can force the creditor to release its security interest in the car upon payment of the $500.00 rather than the full balance. To exercise this option, the debtor must file a motion with the Kentucky or Indiana Bankruptcy Court and obtain an Order. If the creditor disputes the value, it can object to the motion and the judge will then have to hold a hearing to determine the value. This option is only available for consumer debts that are secured by personal property.
The fourth option is to avoid the lien. This option may be available available where the security interest is a non-purchase money security interest that is secured by exempt household goods. This is also accomplished by the filing of a motion with the Bankruptcy Court. However, not all household goods are subject to this type of lien avoidance. The Bankruptcy Code provides a list of which household goods are subject to lien avoidance. So make sure you consult with your Kentucky or Indiana Bankruptcy lawyer.
The final option is to simply continue to pay the secured creditor without signing anything new. This is sometimes referred to as “ride through”. When Congress amended the Bankruptcy Code in 2005, it eliminated this option for debts secured by personal property, unless the creditor consents. However, the option is still available for debts secured by real estate.
Dealing with secured creditors in Bankruptcy is a complex undertaking so make sure that you employ a competent Kentucky or Indiana Bankruptcy attorney to assist you.