To keep possession of your property that is collateral on a secured debt, you need to give the creditor “adequate protection.”
The Balancing of the Interests of Creditors and Debtors
Bankruptcy law attempts to balance the interests of debtors and creditors. That’s true as to how the law deals with debtors’ and creditors’ opposing interests as to the collateral on secured debts.
For example, once you file bankruptcy what does the law require you to do in order to keep your vehicle if you are behind on its payments and the creditor wants to repossess it? Or if you are many months behind on your home mortgage, how long do you have to catch up?
The “Automatic Stay” and “Adequate Protection”
In the balancing of the interests of debtors and creditors in these situations, both get certain kinds of protections. One major type of protection debtors receive is the “automatic stay.” That’s the part of bankruptcy law which stops a creditor from repossessing or foreclosing any collateral. It kicks in the moment you file a bankruptcy case. (See Section 362(a) of the U.S. Bankruptcy Code.)
“Adequate protection” relates to what you must do to be able to keep your vehicle or other property long-term. It’s the creditor that’s entitled to “adequate protection.” The term refers to conditions you must meet to keep the automatic stay in effect. To keep protecting your property through the automatic stay, you must provide “adequate protection” to the creditor. (See Section 361 of the U.S. Bankruptcy Code.)
These two protections are designed to balance out each other.
Why the Creditor is Entitled to “Adequate Protection”
One of the main principles of bankruptcy law is that debtors and creditors deserve to have their property rights respected. When it comes to secured debts, the original contract gave you a conditional right to possession of the collateral. You could keep possession as long as you made payments when due and kept up the insurance.
But that contract gives the creditor the right to repossess or foreclose if you don’t make payments on time. If you prevent the creditor from taking possession of the collateral by filing bankruptcy, you still have to satisfy its property rights. You do so by providing the creditor “adequate protection.”
What “Adequate Protection” Requires
The Bankruptcy Code says that “adequate protection… of an interest of [a creditor] in property” is “provided by… mak[ing]… periodic cash payments to [the creditor] to the extent that the [automatic] stay… results in a decrease in the value of such [creditor’s] interest in such property.” Section 361(a).
What this means is that to maintain the automatic stay and keep collateral you just need to:
- pay the creditor periodic (usually monthly) payments
- in an amount large enough to at least offset any reduction of the creditor’s interest in the property while you keep the property
Payments to Offset the Decrease in the Value of Creditor’s Interest in the Property
This simply means that the payments need to be large enough to make up for depreciation of the collateral while you continue in possession of it.
For example, a vehicle loses value through the passage of time and you using the vehicle. Let’s assume that a $10,000 used vehicle is expected to depreciate by $1,200 to $8,800 in one year. That’s $100 per month. To provide adequate protection you would have to pay the creditor at least $100 per month.
Besides depreciation, owning and driving a vehicle creates a risk that it could be damaged or destroyed in an accident. There is also a risk it could be stolen. The creditor is entitled to protection from these potentially sudden decreases in the value of its collateral. So besides the $100 per month, adequate protection requires you to maintain insurance on the vehicle.
Adequate Protection Is Just One Requirement
Maintaining your adequate protection obligation to the creditor allows you to tread water. But most likely you don’t want to stay still but rather get ahead! You want to pay off your vehicle loan under a Chapter 7 “reaffirmation.” Or maybe you can get clean title to the vehicle for less in a Chapter 13 “cramdown.”
Meeting the adequate protection requirement enables you to keep the automatic stay protection intact. But there’s a lot more to dealing favorably with your secured debts in bankruptcy. Our next few blog posts will get into terms pertaining to secured debts, such as “reaffirmation” and “cramdown,” and lots more.