When a Creditor Does Not Have an Enforceable Lien
For a debt to be secured, the creditor has to go through the right legal steps. Otherwise you don’t have to pay the debt.
Expressing Your Intentions with Your Secured Debts
When you file a Chapter 7 “straight bankruptcy” case you list all your debts on the bankruptcy court documents. You separately list secured and unsecured ones. A secured debts is one in which the creditor has a lien on an asset you own. For example, a vehicle loan is a secured debt in which the lender is a lienholder on your vehicle’s title.
As to each of your secured debts, you inform the creditor whether you intend to keep the asset or not. If you intend to keep it, you also state what you intend to do with the debt. For example, with a vehicle loan, if you state that you intend to keep the vehicle you would likely also state that you intend to “reaffirm” the debt—that is, pay the debt under its usual terms in order to be able to keep the vehicle.
These disclosures are done through the “Chapter 7 Individual Debtor’s Statement of Intention” form. Your lawyer will help you complete it; after you sign it copies are mailed to your creditors and it’s filed at the bankruptcy court.
What It Takes for a Debt to Be Legally Secured
Creditors must take certain legal steps to create a legally enforceable lien in something you purchase or in something you already owed. Those legal steps are determined by state laws, which tend to be similar from state to state. But they can differ a lot in the details.
Those legal steps vary a lot among different kinds of collateral. Let’s go back to our example of a lender’s lien on a vehicle. The paperwork and procedure to create a lien on a vehicle title is completely different from the paperwork and procedure that your home mortgage lender used to create a lien on your home. And those are completely different from how a furniture store creates a lien on what you buy there.
If a Creditor Doesn’t Go Through the Legal Steps
It’s usually the creditor’s job to do what is necessary to create a lien on what you are buying or on what you are providing as collateral. After all, the creditor is the one who wants the extra leverage against you. You’ll more likely pay a debt it it’s backed up by a lien on something you need or want. And if you don’t pay, the creditor will at least be able to repossess or foreclose on the collateral to get back some of the money it lent.
For countless reasons creditors don’t always go through the legally necessary steps. If not, what happens to that debt in a Chapter 7 case?
Debts Unexpectedly Not Secured
As mentioned above, there are different procedures for creating liens for different kinds of collateral. Those procedures differ in sometimes crucial details from state to state, and those state laws change over time. Notwithstanding these challenges, you’d think creditors would keep on top of this given how important it would be for them. But they don’t always know the laws as well as you’d think. Or even if their official procedures are appropriate, their employees don’t always follow those procedures perfectly. Creditors can mess up.
As a result when you file a bankruptcy case it’s smart to find out whether debts that you think are secured really are. The difference can be huge. Simply put, it can make the difference between having to pay a debt in full vs. paying nothing at all.
We’ll illustrate this with an example.
Assume that you bought your stove, refrigerator, clothes washer and drier at a local appliance store 18 months ago. You and your family had moved into a rental home which didn’t have these appliances. You bought them all on credit for $3,000, financed on a contract through the store. You thought you remember hearing or reading somewhere that the store had a right to repossess what you bought if you didn’t pay off the contract. That would’ve meant that the store had a legally enforceable lien on the appliances to secure the debt you owed.
You didn’t have to make payments on the contract for the first 3 months (“90 days same as cash”). Then a high interest rate kicked in, and you made most of the relatively small payments. But then you didn’t pay the last couple payments, and now still owe $2,600.
You and your spouse have now filed a Chapter 7 bankruptcy case to get a fresh financial start.
Your family really needs these appliances. You have no spare cash with which to replace them, and no credit with which to do so. So you figure you’ll have to keep paying on the high interest contract until it’s paid off. With the low payments and high interest you’d probably end up paying close to $4,000 more on appliances that currently likely have a fair market value of no more than a combined $1,500. But you figure you really don’t have a choice.
The Store Contract Didn’t Actually Create a Secured Debt
However, your bankruptcy lawyer looks through the purchase contract and finds out that the store did not create a lien in the appliances. To create a lien, the contract needed to clearly state that it was doing so. But it did not. As a result, the debt is not legally secured by those appliances or by anything else you own. It’s an unsecured debt, one that can almost certainly be discharged—legally written off—without paying for the appliances.
So, instead of having to pay anything more on the appliances, much less the $4,000 or so that you thought you would, you pay nothing. And the appliances are yours to keep free and clear.