Crucial Question: In a Chapter 13 Case, How Do You Keep Collateral That’s Not a Home or Vehicle?
A Chapter 13 plan lets you propose what collateral you want to keep and what it is worth paying for, giving you a lot of leverage.
The Disadvantages under Chapter 7 in Keeping Personal and Business Collateral
Our last blog post focused on keeping collateral under Chapter 7 “straight bankruptcy. There are two main disadvantages there. First, sometimes it is not easy to determine if a creditor has a legal right to repossess something that may be collateral on its debt. And second, if it does have that right, for practical reasons the creditor often has a lot of leverage to make you pay top dollar for the right to keep the collateral.
First, Is the Creditor Secured—Does It Have the Right to Repossess?
In that last blog post we said that under Chapter 7 you and your attorney first need to determine whether a debt is or is not legally secured by the asset(s) at issue. For example, if you financed the purchase of a washer and dryer that you want to keep, did the financing document you signed give the creditor the right to repossess them if you didn’t pay?
If not, you could likely discharge (legally write off) the debt and keep the washer and dryer without paying anything. But if the creditor has a legal right to repossess, you would have to pay the debt, possibly in full, to keep the appliances.
It isn’t always easy to tell one way or the other. The financing document may be hard to locate. The creditor may not be responsive. There isn’t an efficient way to force the issue so that you know for sure.
And even if the creditor does have a right to repossess, it may not bother to make you pay if the collateral is not worth repossessing. However, even the creditor is silent during your bankruptcy, if it does have that right then as soon as your Chapter 7 case is over it could legally repossess the collateral.
So under Chapter 7 there can be a lot of ambiguity in this arena.
Second, Practical Leverage Against You
And if the debt IS secured by the assets—here, the washer and dryer—you usually have to pay for the right to keep them. You either pay the debt in full or maybe an amount closer to the value of the collateral.
Under Chapter 7 the creditor has a fair amount of leverage in making you pay more to keep the collateral. For a number of practical reasons, if want to keep the collateral—that washer and dryer—you are often willing to pay more than that collateral is worth in order to keep it. As in the case of this example, your family would probably be greatly inconvenienced to lose those appliances. There’s a good chance you can’t just come up with the money to buy replacement ones. Right in the middle of or right after a bankruptcy case, you likely can’t buy them on credit. And there are the hassle and reliability factors—it takes effort and some risk to replace what you already have and is working well for you.
The creditor thus can often effectively require you to pay the whole balance, and often at the full contract interest rate and monthly payments.
The Chapter 13 Solution
Under Chapter 13 “adjustment of debts,” you don’t have these disadvantages. First, there is a very efficient way to find out and quickly resolve whether a debt is or is not secured by collateral. And second, when a debt is secured, you have the leverage in valuing and paying for the right to keep that collateral.
First, Resolving Whether a Debt is Secured
Under Chapter 13, you get to propose whether a debt is secured or not. The creditor then has a relatively short time to object to how you are proposing to treat its debt. If it doesn’t object, for practical purposes it is stuck with whatever you proposed. If it does object, there is a convenient court and an efficient legal mechanism for resolving the objection.
In the example of the washer and dryer, if the financing document cannot be located or it is ambiguous, and your Chapter 13 plan proposes to treat the debt as unsecured, the creditor would usually have only about two months to object. If it failed to do so, it would usually be stuck with being treated as an unsecured creditor during the 3-to-5-year case. This means it would only get whatever percentage on its debt that the other unsecured creditors were receiving. That is often a low percentage, or sometimes even 0%. (It may or may not have rights against the collateral after your case is completed, but by that time that collateral would likely be worth very little.)
Second, Resolving How Much to Pay to Keep the Collateral
Under Chapter 13 the leverage shifts to your favor in a number of ways in determining how much to pay for collateral on debts that are legally secured.
When your Chapter 13 plan proposes to treat a debt as a secured debt, at the same time your plan proposes to value the collateral at a certain value. If the creditor does not object in time, the bankruptcy judge “confirms,” or approves, the plan, and the creditor is stuck with that value. You just have to make sure to successfully complete the case to get the remaining debt discharged. (This all assumes that the secured debt was entered into more than a year before your Chapter 13 case was filed; in the unlikely event that your debt is newer than that, you are stuck with paying the full contract amount, at the payment terms provided in the contract.)
If the creditor does object on time to the value of the collateral proposed in your Chapter 13 plan, a compromise value is usually quickly arrived upon between your attorney and the creditor. You have the leverage to keep the value low because you always have the threat of surrendering the collateral. That would saddle the creditor with the costs, hassles, and risks involved with taking possession of the collateral, storing and selling it, usually getting a very modest return for all its efforts.
And in contrast to Chapter 7, the creditor has much less of a threat of repossession against you, because the collateral is protected during the ongoing Chapter 13 case. You are not induced to pay a premium for the right to keep the collateral to prevent it from being suddenly taken from you. And if the creditor does get unreasonable about the value, your bankruptcy judge is on the scene to set it straight.
In the example of the washer and dryer, assume you bought them more than a year ago, still owed $900 on the debt, with monthly payments of $75 at 18% interest, but they could only be sold for $400. Under Chapter 13, most likely you would pay $400 for the secured portion of the debt, at a much reduced interest rate and at much lower monthly payments. Then the remaining $500 would be paid only as much as your other unsecured creditors, at often quite a small percentage of the total owed, and generally only as much as you could reasonably afford to pay.