Bankruptcy: Marital Obligation Discharged in Bankruptcy

     The United States Bankruptcy Court in Richmond, in the case of Nelson v. Nelson, ruled that a wife’s obligation to husband was discharged. The Court found that although a Virginia Circuit Court held that the wife had to pay a husband $5,6535 for a car debt under a “hold harmless” clause in their divorce agreement, the Bankruptcy Court ruled that the State Circuit Court order was void. 

     The parties’ separation agreement, incorporated into their final divorce decree, provided that an auto was the wife’s exclusive property, that she would be responsible for debt, taxes, insurance and licensing fees on the vehicle, and that she would “indemnify and hold the Husband harmless for the same.” The wife, who received a Chapter 7 discharge in bankruptcy, contends the obligation was discharged. The husband brought a show cause proceeding in a Virginia Circuit Court seeking an order that wife remained liable for the debt secured by the auto and that she was in contempt for violating the separation agreement. The State Circuit Court entered an order stating that the wife was liable to the husband for the debt secured by the auto, or $5,635 with interest. Although the State Circuit Court found that the debtor still had an obligation to indemnify the husband, it lacked the jurisdiction to determine whether this debt had been discharged because the Bankruptcy Court has exclusive jurisdiction in discharging a pre-petition debt included in Bankruptcy Code §523 (c). In any event, the Circuit Court order was silent as to its findings on the dischargeability of the debt. The parties therefore could not argue that the Circuit Court order prevented the relitigation of the dischargeability issue based on the principle of collateral estoppel; nor could the parties argue that this matter was barred by res judicata.

     The Bankruptcy Court ruled that the debtor’s obligation to discharge the husband for the indebtedness secured by the auto was discharged by operation of Bankruptcy Code §523 (c)(1). Accordingly, Bankruptcy Code § 524(a)(1) voided the judgment the husband obtained in State Circuit Court and the discharge injunction in Bankruptcy Code §524(a)(2) further enjoined the husband from taking any action to collect this debt as a personal liability of the debtor.

Bankruptcy: Bank's Security Interest - Stocks pledged as Security

     In the case of Winters v. George Mason Bank the United States District Court, reviewing a case from the United States Bankruptcy Court at Alexandria, Virginia, affirmed a ruling for the creditor bank which enforced the bank's security interest against stocks held jointly by a mother and daughter and pledged as collateral for the bank's loan (actually a series of loans) to the daughter and her husband (which were in default), even though the daughter and her husband had declared bankruptcy. 

     The District Court found that from over the course of three years the plaintiff signed a total of three commercial pledge agreements pledging as collateral her interest in the stocks. In the second of three years the daughter and her husband filed a bankruptcy petition. The plaintiff argued that because she and her daughter jointly owned the stocks, those stocks were part of the bankruptcy estate. The plaintiff also argued that the second pledge agreement was an act to create or perfect a lien against that property, and thus violated the automatic stay provision of the Bankruptcy Code. The District Court ruled, however, that the automatic stay did not apply to non-bankrupt codebtors, nor did the automatic stay prevent actions against guarantors of loans. The District Court further stated that even if the agreement violated the stay as to the debtors, the agreement did not violate the stay as to the plaintiff. The District Court found that the plaintiff's attempt to use the automatic stay to her own benefit contradicted the purpose behind the stay provision. The plaintiff sought to use the automatic stay to avoid an agreement that was beneficial to the bankruptcy estate, and an agreement that she and the debtors had voluntarily entered into. Accordingly, the District Court upheld the bank's lien.

Bankruptcy: Collateral Estoppel - Default Judgment in State Court

     Two cases illustrate how courts will handle default judgments being argued as collateral estoppel in bankruptcy court. 

     The United States District Court at Norfolk, Virginia, in the case of L&R Assoc. v. Curtis, reviewed the question as to whether a creditor's default judgment in state court collaterally estopped a debtor from relitigating in Bankruptcy Court whether his debt was nondischargeable because of the debtor's alleged fraud. 

     In Curtis the Bankruptcy Court found that the creditor advanced funds to the debtor for the purchase of automobiles at auction. The debtor was to be compensated in the form of half of the profits from the subsequent sale of the automobiles. The creditor apparently charged in state court that the debtor had fraudulently converted some of the purchase money to his own personal use. 

     The Bankruptcy Court found in Curtis that the issue of fraud, as alleged by the creditor, was not the subject of actual litigation in the state court action which resulted in the entry of the default judgment. The Bankruptcy Court held that because it had no evidence before it that the state court had decided this issue of fraud with "particular care", the doctrine of collateral estoppel did not apply to the judgment. Subsequently, the Bankruptcy Court dismissed the complaint upon a full trial on the merits. The United States District Court, upon appeal, agreed with the result of the Bankruptcy Court's decision, but stated that the emphasis for reaching the decision should have been on whether the state court had actually litigated the issue of fraud. The District Court recognized that counsel for the creditor represented to the Bankruptcy Court that it had presented witnesses and evidence before the state court. The judgment order indicated that the plaintiff/creditor and witnesses for the plaintiff appeared before the state trial court. Yet the creditor presented no other information to the Bankruptcy Court to indicate that the issue actually had been litigated and was necessary to the decision. 

     The Bankruptcy Court gave the creditor in Curtis more than one opportunity at the hearing on its motion for summary judgment and at trial to present evidence concerning prior litigation. The creditor presented no transcript of the proceeding before the state court or anything else to suggest that the state court entered more than a standard default judgment. 

     The District Court agreed with the Bankruptcy Court in Curtis that more had to be submitted than the state court default judgment by testimony at trial to establish that the issue was actually litigated and that the determination of the issue was necessary to the judgment of the state court. The District Court found that the Bankruptcy Court determined "with particular care" that the state court's default judgment should not collaterally estop debtor from relitigating the issue of fraud as it relates to the dischargeability of this debt.

     In Neese the creditor, a video store, had obtained a default judgment in state court against a husband and wife, who had contracted to use store material and services in a nightclub. The wife filed a bankruptcy petition. The Creditor filed a proof of claim in order to collect from the debtor's bankruptcy estate.

     The District Court in Neese found that the Bankruptcy Court evaluated the validity of the State Court judgment for reasons other than fraud. Accordingly, the District Court found that this was an error. The District Court ruled that under Bankruptcy Code §502, a creditor's proof of claim is deemed allowed unless a party in interest objects to that claim. The validity of a creditor's claim that is based on a State Court judgment may be attacked in Bankruptcy Court by an objection to a proof of claim only upon the grounds that there was a lack of jurisdiction over the parties or subject matter of the suit (which was not alleged in this case) or that the judgment was the product of fraud (which was initially raised but not pursued). The trial conducted in the Bankruptcy Court, however, focused upon whether judgment was proper against the debtor individually.

     In regard to the facts in Neese, the District Court found that the debtor had properly been served with the State Court suit, that she failed to respond to that claim, and that she failed to contest the claim on appeal even after judgment was entered. Nothing in the record indicated that the judgment was obtained fraudulently, and it was clear that the default judgment was fully enforceable in State Court.

     Accordingly, the District Court ruled that the Bankruptcy Court did not have the authority to look beyond the validity of the State Court judgment. The doctrine of res judicata applied. The creditor's claim should have been allowed.

Bankruptcy: Pre Default Waiver of Notice of Sale is Void

     In the case Woodward v. Resource Bank, from the Circuit Court, City of Virginia Beach, the Virginia Supreme Court reviewed provisions in a promissory note that provided for the debtors' waiver of notice of the default sale of the collateral securing the loan. In Woodward, a married couple operated a gas station and convenience store in Portsmouth and desired to expand. The couple obtained the financing necessary to purchase a store in Virginia Beach (the Pavilion Store) from a bank. In doing so the couple executed a note for $80,000.00 which was secured by a second deed of trust on their home, as well as with security interests in the inventory and equipment at the Pavilion Store. Later the couple decided to purchase a third store in Virginia Beach. They obtained financing from the same bank by executing a note in the amount of $90,900.00, and by signing a security agreement which granted the bank a security interest in the equipment and inventory of all three stores. The bank required the principal shareholders of the corporation to sign a guaranty for $45,000.00 of the $90,900.00 note. The guarantee agreement stated that the liability of the guarantors would not be affected by "any failure to ... give any required notices" by the bank. 

     The couple defaulted on the note and the bank demanded that the guarantors honor their respective guaranties. Thereafter, the bank sold the collateral securing the notes without formal notice. The collateral was sold at prices far below the stated value. The shareholders argued that they were entitled to notice of the sale, notwithstanding that they had signed pre-default waivers of notice, because they were "debtors" within the meaning of Virginia Code §8.9-105(1)(d) and §8.9-504(3). The Virginia Beach Circuit Court agreed with the bank that the waivers precluded the necessity of giving notice, but the Virginia Supreme Court ruled that since the shareholders were "debtors" within the meaning of the statutes, they were entitled to notice of the disposition of the collateral. Applying the plain language of Virginia Code §8.9-504(3), the Virginia Supreme Court held that the notice provision contained therein may not be waived before the occurrence of a default.

     The Virginia Supreme Court further ruled that a rebuttable presumption arose that the value of the collateral that the bank sold equaled the amount of the debt because the bank failed to give notice to the guarantors, and because the sale was thus "commercially-unreasonable". Virginia Code §8.9-504(3) requires that every aspect of the disposition of collateral, including "the method, manner, time, place and terms must be commercially reasonable". Because the bank failed to rebut this presumption by putting on evidence to the contrary, the Court ruled that the indebtedness was extinguished, and the creditor was precluded from further collection. 

     The lesson of Woodward is simple: always obtain a legal opinion regarding sales of reclaimed security, and always follow the requirements of the applicable statutes.

Bankruptcy: Debtors Retaining Collateral

     The Fourth Circuit Court of Appeals case of Home Owners Funding v. Belanger stands for the proposition that Chapter 7 bankruptcy debtors may retain their collateral after discharge if they are current in their consumer loan installment payments.

     In Belanger the debtors, who had remained current on their payments, filed for Chapter 7 relief and filed a statement of intent under Bankruptcy Code §521 (2) (a) indicating that they wanted to retain possession of their mobile home. The creditor moved the Bankruptcy Court to compel the debtors to reaffirm the debt, redeem the collateral, or surrender it. The creditor, relying on Bankruptcy Code §522 (2) (a), was obviously concerned that the collateral would depreciate to a value less than the balance due, and would be barred from recovering the deficiency. The Court noted that the creditor is presumed to have structured the risk of depreciation into its loan.
     The Court noted that it has held (in the case of Riggs National Bank v. Perry) that a "default-on-filing clause" in an installment loan contract was unenforceable as a matter of law. Therefore, the creditor could not ask for the collateral merely based on the filing. Note, however, that not all courts take this position; see Dominion Bank v. Koons.
     The Court in Belanger denied the creditor's motion and discharged the debtors, holding that the debtor's had complied with Bankruptcy Code §521 (2) (a) by giving notice of their intent to retain the property while continuing to make payments in accordance with their contract with the creditor.
     Attorneys representing debtors can use this opinion against creditors by urging them to remain current with their loans, but not to sign reaffirmation agreements. Many of you have already run into this problem with debtor's counsel.

Collections: Notice of Sale of Security Interest

     The case of The State Bank of the Alleghenies v. Hundall, decided by the United States District Court at Roanoke, Virginia, serves as a good example of what happens where a creditor sells items pledged as security for a loan without making proper notice to all parties.

     In Hundall, the defendant guaranteed the bank's loan to his brother for a dry-cleaning business, but the defendant guarantor never received notice of how, when and by what manner of sale the bank intended to sell motor vehicles belonging to the brother's business. The evidence taken clearly proved that the bank failed to send notice of the sale of the motor vehicles, which had a fair wholesale value of approximately $8,500.00 in the aggregate. The District Court ruled that this violated the provisions of Virginia Code §8.9-504(3); however, the Code does not provide a remedy for the failure to comply with the statutory provisions for resale, and the appropriate remedy had not been ruled upon by the Virginia Supreme Court. The District Court, in its ruling, cited that courts which have addressed this appropriate remedy for failure to provide notice have adopted one (1) of the following three (3) rules:
     1. The debtor must prove that he has suffered an injury in order to obtain any recovery against the secured party;
     2. The secured party is absolutely barred from recovering a deficiency, even if the debtor suffered no injury; and
     3. A rebuttable presumption is that the collateral was worth the amount of the debt which requires the secured party to prove that the debtor suffered no injury.
     Virginia Code §8.9-507(1) entitles the debtor, or any person entitled to notification, "to recover from the secured party any loss caused by the failure to comply with the provision of this part".
     The Court elected the third of the three remedies listed above, and forced the creditor to prove the fair value of the collateral.
     The lesson of Hundall: creditors should send notice to all parties to the transaction -- the principal debtors, guarantors and the owners of the collateral.

Bankruptcy: Objection to Discharge - Willful and Malicious Injury by Depriving Access to Secured Collateral

     A few years ago I tried a case in the United States Bankruptcy Court, Eastern District of Virginia, Richmond Division, Judge Huennekins, that will be of interest to many lenders who hold a security for their loan. My client was Dominion Credit Union. At the request of the debtor, and, as part of a settlement where the debtor agreed to pay on the judgment rendered, I agreed not to state the debtor’s name.

     The factual scenario is as follows: the Credit Union had made a $30,000.00 loan to the debtor in March, 2006 to purchase a pickup truck from Chambers Auto. The loan was secured by this pickup truck. There was no co-signer for the loan, nor was the debtor married. The debtor’s loan application made no reference for the purpose for which the loan was sought. The debtor listed no other owner or user. Within two months the debtor became delinquent. The Credit Union ordered repossession of the truck. The repossession company could not find the truck, and the debtor offered minimal cooperation, claiming only that another person had the vehicle and took it out of state. The debtor referenced the name of the person, Michael Chambers (this name became important years later, but note that the name of the company from which she purchased the vehicle was Chambers Auto). The debtor did provide a telephone number for Michael Chambers. The repossession company made several attempts to repossess the truck, checking at the debtor’s residence on various days and at various times, but to no avail. Calls were also made to Michael Chambers. On one occasion Mr. Chambers said that he was out of state, and, that he was also in the repossession business. With no luck at repossession, the Credit Union retained me to obtain judgment against the debtor and try collection. While judgment was obtained for over $29,000.00 plus costs, interest and attorney’s fees, collection was difficult, as the debtor was constantly in school and working only part-time. Finally in early 2010 I found the debtor working a sufficient number of hours to garnish, and issued the garnishment. As a result of the garnishment, the debtor filed a Chapter 7 bankruptcy case in March, 2010, seeking discharge of all of her financial obligations – at this point in her life the debtor had accumulated some other debt as well, and was finally about to complete her schooling and become a full time nurse. I advised the debtor’s attorney that I would be objecting to the discharge of this debt based upon the fact that we had been unable to obtain the truck since May, 2006, and that we had obviously lost money due to the debtor’s willful and malicious injury to the Credit Union by depriving it access to and repossession of the collateral securing its loan pursuant to Bankruptcy Code Section 523(a)(6). The debtor’s attorney responded by stating that the truck would be surrendered. Weeks passed without the debtor surrendering the truck, so I filed an objection to the dischargeability of the debt. Subsequently the truck was returned, but in horrible condition, having limited value, resulting in a substantial loss to the Credit Union.

     To prepare for the trial of the case I conducted written discovery and scheduled depositions of the debtor and Michael Chambers. Depositions were scheduled on several dates. On the first date both parties appeared (although almost an hour late), even though I had only subpoenaed the debtor. I excluded Mr. Chambers from the debtor’s deposition – important because Mr. Chambers tried to “control” the proceedings. At the debtor’s deposition she stated, for the first time, that the truck was purchased as a business deal with her brother (although not an actual blood brother, but someone just like a brother, named “John Jones”). She and Mr. Jones had a “falling out” and he left with the truck, never to have contact with him again, and not knowing where either he or the truck was. The debtor denied telling the Credit Union or the repossession company that Michael Chambers had it. The debtor admitted that she and Mr. Chambers were now boyfriend and girlfriend, although she was not sure when this relationship commenced, although probably within six months of the loan. The debtor admitted that Chambers Auto was a family business, but that Michael Chambers’ father ran it. The debtor stated that when it became apparent that she would not be able to get a bankruptcy discharge without surrendering the vehicle to the Credit Union, Mr. Chambers (who had a “questionable” past and had “questionable” connections) “put the word out on the street”, and magically the vehicle was returned to Mr. Chambers. The debtor also stated that they tried their best to put the vehicle back in decent shape, but ran out of time. Following the debtor’s deposition, I tried to immediately take Mr. Chambers’ deposition, but he and the debtor said that they had no time and had a child care problem. A new date was set for Mr. Chambers’ deposition. However, he failed to show on that date. I advised the Court of this lack of cooperation, asked for a continuance to obtain the necessary evidence to prove my case. The Court granted the continuance and set a new trial date. I then set a new deposition date for Mr. Chambers, who, this time did show up, although about an hour late again. Mr. Chambers’ testimony was similar, but somewhat inconsistent with that of the debtor in some key areas.

     On the trial date Mr. Chambers’ failed to appear in Court despite subpoena. His deposition was submitted into evidence, and the Court issued a Show Cause summons against him for his non-appearance. After hearing all of the evidence, the Court ruled that the debtor did willfully and maliciously injure the Credit Union by depriving it access to and repossession of the collateral securing its loan pursuant to Bankruptcy Code Section 523(a)(6), and awarded non-dischargeability to the extent of the Credit Union’s reasonable loss based upon the debtor’s conduct.

     The lesson of this case: be diligent about repossession efforts, document all events, and if the debtor deprives you of the security and attempts to discharge the debt in a Chapter 7 bankruptcy case, object!

Bankruptcy: Unperfected Purchase Money Lien

     In the case of In re Johnson the United States Bankruptcy Court, Eastern District of Virginia, at Richmond, ruled that a Chapter 7 debtor's claim of homestead and poor debtor's exemptions in her automobile should be denied because the debtor had not paid the purchase price of the car, and thus the car was subject to a debt to the credit union that made the loan for the purchase price. Had the car been non-purchase money security interest, the result would have been different.
     In determining the facts the Court found that the debtor purchased the car using credit union loan proceeds, that the debtor intended to grant a security interest in the vehicle to the credit union, and that the credit union's lien was not recorded on the vehicle's certificate of title.
     The debtor claimed a $5,500 homestead exemption under Virginia Code §34-4, and a $2,000 poor debtor's exemption under Virginia Code § 34-26. The credit union that loaned the debtor the money to buy the car had a purchase money security interest pursuant to Virginia Code §8.9-107(b).
     Although a purchase money security interest had attached to the vehicle, a second step of perfection is required for the interest to be enforceable as to third parties -- a notation must appear on the vehicle's certificate of title. Testimony was given that no notation of a security interest appeared upon the title to the car. The credit union, therefore, held an unperfected purchase money security interest in the vehicle.
     The Court ruled the credit union's unperfected interest was subordinate to the rights of a lien creditor, and that the statutory definition of "lien creditor" under the Virginia Code included a trustee in bankruptcy.
     The Court was left with the question whether the debtor could exempt property in which the credit union held an unperfected purchase money security interest, and in which the value of the property was exceeded by the debt owed on the property. Exemptions under both Virginia Code §§ 34-4 and 34-26 cannot be claimed against debts for the purchase price of the property, or for any part of the purchase price.
     The debt created in Johnson was for the purchase price of the car, as the loan application, note and security agreement clearly illustrated. Many of the cases in which Virginia Code §34-5 have been applied have involved a merchant creditor, or an actual seller of the goods for which the purchase price was not paid, rather than a third-party creditor.
     The Court held that the debtor's claimed exemptions were improper because they were for property, the purchase price of which had not been paid, and the property was subject to a debt for the purchase price. The Court further held that a third-party creditor could prevail under Virginia Code §34-5 if the creditor successfully showed that its loan proceeds were used to acquire the collateral, and that it had a valid purchase money security interest.
     As an alternative basis for its holding that the debtor's claimed exemption of $4,500 was improper, the Court looked to the language of Virginia Code §34-4, which allows an exemption of personal property up to $5,000 "in value", plus personal property of $500 "in value", for each dependent. Even if the exemption were properly claimed, the debtor in Johnson had no equity in the car. The credit union held a purchase money security interest, which was valid between it and the debtor. The value of the car was stated by the debtor to be $18,000 and the loan balance was approximately $19,000. The Court has held on prior occasions, as it did in this instance, that where the debtor has no equity in the exempted property, no exemption exists.
     Further, the Court held that because the debt on the car exceeded its claimed value, there was no amount to be claimed exempt under Virginia Code §34-26(8). Finally, the Court noted that if it were to allow the claimed exemptions, the debtor would retain the property exempted, subject to the security interest of the credit union. This would result in the improper outcome in which a creditor holding an unperfected security interest would be placed ahead of the trustee.
     The lesson in Johnson - perfect your liens. Remember that had this been a non-purchase money security interest case, the result would have been different there would have been no lien. Set up systems to ensure lien protection.

Bankruptcy: Cross Collateralization Prevails

     In In Re: Martin, an important precedent was set in regard to the enforceability of cross collateralization.
     In Martin the debtors filed a Chapter 13 bankruptcy case. At the time of the filing the debtors were obligated on three loans to the credit union:
     $1,200.00 open end credit agreement (initial loan);
     $3,401.01 open end credit agreement for a truck loan (truck loan); and,
     $1,386.94 Visa card credit account (Visa loan).
     The initial loan documents and the truck loan documents had cross collateralization language stating that collateral given as security for these loans, or for any other loan, would secure all amounts owed to the credit union now or in the future. The Visa application did not contain cross collateralization language. The debtor argued that because the Visa application did not have cross collateralization language and did not refer to the truck, that the truck should not stand as collateral for the Visa loan. The credit union argued that the truck should stand for all three loans.
     The Court found the cross collateralization language to be enforceable and effective as to all three loans. The Court held that confirmatory language was not required in the Visa application so long as the original agreement contained cross collateralization language.
     One would have to wonder, however, if the result would have been different if the Visa loan had been executed first.

Collection: Pre Default Waiver of Notice of Sale is Void

    In the case Woodward v. Resource Bank, from the Circuit Court, City of Virginia Beach, the Virginia Supreme Court reviewed provisions in a promissory note that provided for the debtors' waiver of notice of the default sale of the collateral securing the loan. In Woodward, a married couple operated a gas station and convenience store in Portsmouth and desired to expand. The couple obtained the financing necessary to purchase a store in Virginia Beach (the Pavilion Store) from a bank. In doing so the couple executed a note for $80,000.00 which was secured by a second deed of trust on their home, as well as with security interests in the inventory and equipment at the Pavilion Store. Later the couple decided to purchase a third store in Virginia Beach. They obtained financing from the same bank by executing a note in the amount of $90,900.00, and by signing a security agreement which granted the bank a security interest in the equipment and inventory of all three stores. The bank required the principal shareholders of the corporation to sign a guaranty for $45,000.00 of the $90,900.00 note. The guarantee agreement stated that the liability of the guarantors would not be affected by "any failure to ... give any required notices" by the bank.
     The couple defaulted on the note and the bank demanded that the guarantors honor their respective guaranties. Thereafter, the bank sold the collateral securing the notes without formal notice. The collateral was sold at prices far below the stated value. The shareholders argued that they were entitled to notice of the sale, notwithstanding that they had signed pre-default waivers of notice, because they were "debtors" within the meaning of Virginia Code §8.9-105(1)(d) and §8.9-504(3). The Virginia Beach Circuit Court agreed with the bank that the waivers precluded the necessity of giving notice, but the Virginia Supreme Court ruled that since the shareholders were "debtors" within the meaning of the statutes, they were entitled to notice of the disposition of the collateral. Applying the plain language of Virginia Code §8.9-504(3), the Virginia Supreme Court held that the notice provision contained therein may not be waived before the occurrence of a default.
     The Virginia Supreme Court further ruled that a rebuttable presumption arose that the value of the collateral that the bank sold equaled the amount of the debt because the bank failed to give notice to the guarantors, and because the sale was thus "commercially-unreasonable". Virginia Code §8.9-504(3) requires that every aspect of the disposition of collateral, including "the method, manner, time, place and terms must be commercially reasonable". Because the bank failed to rebut this presumption by putting on evidence to the contrary, the Court ruled that the indebtedness was extinguished, and the creditor was precluded from further collection.
     The lesson of Woodward is simple: always obtain a legal opinion regarding sales of reclaimed security, and always follow the requirements of the applicable statutes.

Bankruptcy: Redemption - An Introduction

     In this and future blogs I will explore Redemption.
     In general. Bankruptcy Code §722 provides debtors with the right to redeem property. The redemption option is being exercised more often (as opposed to reaffirmation) because collateral loan balances are frequently much greater than the value of the underlying collateral, and, because redemption financing options are growing. The code states:
     [a]n individual debtor may, whether or not the debtor has waived the right to redeem under this section, redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempt under section 522 of this title or had been abandoned under section 554 of this title, by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption.
     Financing options. In the past redemption has been rare, as what debtor in bankruptcy has the ability to raise money for a lump sum purchase price, and what lender would make such a loan? There is, however, an option available for debtors, and debtor attorneys are aware of it. The option is to borrow the redemption price from “specialized” lenders, such as the company called “722 Redemption Funding, Inc.” This company is based in Cincinnati, Ohio. The company has been in business for a number of years and has expanded into other states - Virginia is one of them. Once the loan is made, this company takes a non-purchase money security interest in the vehicle and has first priority since the debtor has redeemed from (and therefore extinguished) the lien if the prior lender. To add insult to injury, this company uses another Cincinnati company (Collateral Valuation Services, L.L.C.) to prepare a vehicle condition report in an effort to determine the lowest possible value for the vehicle. If you have yet to see redemption by this method, I am sure that you will see one soon.
     How do you value the collateral? This is a good question that does not always have a clear answer. To make it complicated, the method for determining redemption value differs in Chapters 7 and 13.
     To determine collateral value in Chapter 7 cases, the case law is clear that the retail value should be used. The law is not so clear, however, in Chapter 13 cases. In 2004 I tried two cases before Judge Tice in the United States Bankruptcy Court, Eastern District of Virginia, Richmond Virginia, involving this very issue. The debtors’ attorneys filed motions for redemption proposing to pay the trade-in value rather than the retail value. I objected to the motions, arguing that they were not proposed in good faith based upon these proposed values, and, that the creditors would be irreparably harmed. In doing the legal research it became clear that there was no preexisting Virginia decision controlling the decision, and that different states were taking different positions – some states use the wholesale value, some use the retail value, and, some use something other value determined by either an average of the two or utilizing other factors, such as the expected return to the creditor from a disposal of the collateral in a commercially reasonable manner. Of course I argued that it is unfair to place the entire burden and the risk of loss on the creditor, especially since it was the debtor who was in default! Ultimately, Judge Tice, having reviewed all of the tests applied across the country, wrote a detailed opinion. Judge Tice ruled that debtors should not be forced to redeem at retail valuation because the purpose of Bankruptcy Code §722 is to allow debtors to avoid having to pay the cost for replacing a vehicle. He ruled that a close approximation to the wholesale or liquidation value would be fair to creditors given the fact that creditors will save the cost of repossession and resale – that the redemption value should resemble an amount which the secured creditor would expect to recover upon the repossession and reasonable commercial disposition of the property.
      Since these decisions, the law has not become clearer. Judge Tice was presented with a similar issue in In re Hutchinson, where the court found that the fair redemption value was to be determined after considering the varying appraisals submitted. The court did not choose the trade in appraisal or the retail appraisal, but stated that debtors should not have been forced to redeem their car at a retail valuation (replacement value) of the property. Further, a close approximation to the wholesale or liquidation value was fair to the creditor in light of the fact that the repossession and resale costs would not have been incurred in light of the redemption. The court held that the redemption value should resemble an amount which the secured creditor would expect to recover upon repossession and reasonable commercial disposition of the property. The fair redemption value ultimately was determined to be a value between the trade in appraisal and the retail appraisal.

Collections: Fraudulent Conversion or Removal of Property Subject to Lien or Title

     If a creditor is a lien holder, that creditor should be aware of a lesser known remedy available if a debtor fraudulently sells, removes, or hides the property subject to the lien. Virginia Code §18.2-115 states that a debtor is guilty of larceny if he/she fraudulently sells, pledges, pawns, removes from the premises agreed upon, removes from Virginia, disposes of, or hides the property subject to a lien without the written consent of the owner or lienor or the person in whom the title is, or, if the writing is a deed of trust, without the written consent of the trustee or beneficiary in such deed of trust. Unlike civil fraud, this statute’s fraud contemplates an act by a debtor intended to deprive a secured creditor of his collateral by appropriating it to the debtor’s own use.
     There must be proof that the debtor’s fraudulent intent was directed against the lienor or person in whom the title is. The statute also states that failure or refusal to disclose the location of the property or surrender the property shall be prima facie evidence of a violation of this statute. In Lewis v. First National Bank, the Fourth Circuit clarified that even the existence of written permission to remove the collateral is immaterial under this section, as the creditor need not show the lack of such permission to make out a prima facie case.
     The final provision of the statute provides that the venue of prosecution against persons fraudulently removing any such property, including motor vehicles, from the Commonwealth shall be the county or city in which such property or motor vehicle was purchased or in which the accused last had a legal residence.
     Debtors may argue that the debtor did not actually receive the demand for return of the collateral; however, in Lewis, failure to leave a functional forwarding address or contact with the creditor constituted a waiver of the debtor’s right to deny that the demand was made.
     Debtors have also argued that criminal charges such as these cause emotional distress or are extreme and outrageous. In Lewis¸ the Fourth Circuit stated that creditors should not be fearful of a debtor’s claim that these charges cause emotional distress. To hold such would render the statute useless, which was not intended by the legislature. The court held that the initiation of criminal proceedings against someone under this section with probable cause is not extreme or outrageous as a matter of law.

 

Bankruptcy: Bankruptcy Filings: Chapter 7 and 13

     Although there are other Chapters under which debtors may seek relief, Chapters 7 and 13 are the most frequently encountered.
Chapter 7

     Chapter 7 involves a discharge of debt by court order. While secured debts may be routinely "reaffirmed", unsecured debts normally are not. Traditionally, debts have been reaffirmed through a Reaffirmation Agreement. The Courts of the Eastern District of Virginia have held, however, that creditors cannot force debtors to execute reaffirmation agreements if they were not in default at the time of the bankruptcy filing.
     Why would a debtor want to pay a debt when he has filed for Chapter 7 relief? The answer is future credit. The possibility of future credit can be sufficient incentive to encourage voluntary repayment for at least two (2) reasons:
     1. Debtors want and need future credit after bankruptcy discharge, and

     2. Reasonable credit after bankruptcy is very difficult to obtain as bankruptcy carries a stigma. Absent special circumstances, the only credit card a debtor may obtain after bankruptcy is a "secured" credit card. These cards are tantamount to a line of credit drawn upon account deposits pledged as security. There are also user fees and high interest rates.
     How do you encourage debtors to voluntarily pay their pre-bankruptcy petition debts? Consider adopting the following written policies:
     1. Post-bankruptcy credit may be extended to debtors who voluntarily pay their dischargeable debts ("the carrot").
     2. No future credit or services, other than those required by law, will be extended to debtors who have caused you a loss by bankruptcy or otherwise, unless the debt is voluntarily repaid (“the stick").
     How do creditors inform their debtors of this policy once a petition of bankruptcy is filed? Consider sending a letter directly to the debtors’ counsel asking that counsel advise their client of the policy.

Chapter 13
     Chapter 13 involves a "reorganization" of the debtor's finances. The debtor is required to devise a plan for repayment: 100% for secured debts and a court-approved percentage for unsecured debts. Creditors are paid in the order of priority - preferred (taxes), secured, and finally, unsecured. Creditors are required to file proofs of claim with the Bankruptcy Court to protect their place in the plan. Plans can take up to five (5) years to complete.

Co-Makers
     When can you proceed against co-makers? In Chapter 7 you can proceed immediately. In Chapter 13, you have to either wait until the plan pays out, or petition the Bankruptcy Court to lift the automatic stay against the co-maker. Once this is granted you can proceed against the co-maker for the percentage not paid by the plan. Although you are required to file the motion to lift the stay, the court is required to grant your relief.

Planning Summary
     Regardless of the Chapter, the best way to minimize your bankruptcy loss is to be secured. In Chapter 13 cases, security can mean the difference between payment at 100% rather than at a nominal percentage. In Chapter 7 cases, security can mean the difference between reaffirmation or no payment at all. In either Chapter, collateral is the key.
     The second best protection from bankruptcy loss is having a solvent co-signer. The old saying "two heads are better than one" can mean much in bankruptcy, especially when your co-signer is not a spouse. Generally, spouses do not make good co-signers because they can file a joint petition for bankruptcy and, in fact, often do because family finances are inter-related. It should be noted, however, that in a case of jointly owned real estate, a spouse's signature is necessary in order to perfect a lien against any real property.

 

Bankruptcy: Security Interest Protected in Future Advances

     Virginia Code §8.9A-232 provides that a security agreement may provide for collateral securing future advances. Subsection (a) clarifies the result when the initial advance is paid and a future advance is subsequently made. Specifically, subsection (a) of this section replaced and clarified former §8.9-312(7) discussed in In re Enfolinc, Inc. The former section provided that the priority of a new advance turned on whether it was made “while a security interest is perfected.” The code as it is written today resolved the ambiguity by omitting that requirement.
     In the bankruptcy case In re Enfolinc, Inc., the United State Bankruptcy Court for the Eastern District of Virginia, Alexandria Division, was requested to make a determination of the priority of three competing claims of creditors in a debtor’s bankruptcy case. The debtor filed under Chapter 11, and the court ordered the sale of assets, but the proceeds did not satisfy all of the liens. Three creditors then asserted a senior claim in the proceeds of the sale.
     One of the creditors had a security agreement with the debtor to secure a promissory note. The creditor renewed and refinanced the original loan with some modification in the terms and with additional collateral to secure the increased amount owned several times after the original promissory note was made. The creditor contended that the original security agreement contained a future advance clause that included all debts owed to the creditor under the original security agreement. A future advance clause was codified in Virginia Code §8.9-312(7), and is now codified in Virginia Code §8.9A-323. The former section provided that “if future advances are made by a secured creditor to the debtor while a security interest is perfect, the security interest has the same priority with respect to future advances as it does with respect to the original advance.” The creditor’s original security agreement was found to have had sufficient language to constitute a future advance clause as defined in the case of In re Brice, so the court held that the later renewals and refinancing done by the creditor was not another loan, but an advance of the original transaction. The court granted the creditor a first priority security interest in the remaining funds generated from the sale of the debtor’s assets.

Bankruptcy: Objection to Discharge - Willful and Malicious Injury by Depriving Access to Secured Collateral

       A couple of years ago I tried a case that will be of interest to many lenders who hold a security for their loan. The case was Dominion Credit Union v. Kristle Hembrick, tried in the United States Bankruptcy Court, Eastern District of Virginia Richmond Division, Judge Huennekins.
      The factual scenario is as follows: the Credit Union had made a $30,000.00 loan to the debtor in March, 2006 to purchase a pickup truck from Chambers Auto. The loan was secured by this pickup truck. There was no co-signer for the loan, nor was the debtor married. The debtor’s loan application made no reference for the purpose for which the loan was sought. The debtor listed no other owner or user. Within two months the debtor became delinquent. The Credit Union ordered repossession of the truck. The repossession company could not find the truck, and the debtor offered minimal cooperation, claiming only that another person had the vehicle and took it out of state. The debtor referenced the name of the person, Michael Chambers (this name became important years later, but note that the name of the company from which she purchased the vehicle was Chambers Auto). The debtor did provide a telephone number for Michael Chambers. The repossession company made several attempts to repossess the truck, checking at the debtor’s residence on various days and at various times, but to no avail. Calls were also made to Michael Chambers. On one occasion Mr. Chambers said that he was out of state, and, that he was also in the repossession business. With no luck at repossession, the Credit Union retained me to obtain judgment against the debtor and try collection. While judgment was obtained for over $29,000.00 plus costs, interest and attorney’s fees, collection was difficult, as the debtor was constantly in school and working only part-time. Finally in early 2010 I found the debtor working a sufficient number of hours to garnish, and issued the garnishment. As a result of the garnishment, the debtor filed a Chapter 7 bankruptcy case in March, 2010, seeking discharge of all of her financial obligations – at this point in her life the debtor had accumulated some other debt as well, and was finally about to complete her schooling to become a full time nurse. I advised the debtor’s attorney that I would be objecting to the discharge of this debt based upon the fact that we had been unable to obtain the truck since May, 2006, and that we had obviously lost money due to the debtor’s willful and malicious injury to the Credit Union by depriving it access to and repossession of the collateral securing its loan pursuant to Bankruptcy Code Section 523(a)(6). The debtor’s attorney responded by stating that the truck would be surrendered. Weeks passed without the debtor surrendering the truck, so I filed an objection to the dischargeability of the debt. Subsequently the truck was returned, but in horrible condition, having limited value, resulting in a substantial loss to the Credit Union.
      To prepare for the trial of the case I conducted written discovery and scheduled depositions of the debtor and Michael Chambers. Depositions were scheduled on several dates. On the first date both parties appeared (although almost an hour late), even though I had only subpoenaed the debtor. I excluded Mr. Chambers from the debtor’s deposition – important because Mr. Chambers tried to “control” the proceedings. At the debtor’s deposition she stated, for the first time, that the truck was purchased as a business deal with her brother (although not an actual blood brother, but someone just like a brother, named “John Jones”). She and Mr. Jones had a “falling out” and he left with the truck, never to have contact with him again, and not knowing where either he or the truck was. The debtor denied telling the Credit Union or the repossession company that Michael Chambers had it. The debtor admitted that she and Mr. Chambers were now boyfriend and girlfriend, although she was not sure when this relationship commenced, although probably within six months of the loan. The debtor admitted that Chambers Auto was a family business, but that Michael Chambers’ father ran it. The debtor stated that when it became apparent that she would not be able to get a bankruptcy discharge without surrendering the vehicle to the Credit Union, Mr. Chambers (who had a “questionable” past and had “questionable” connections) “put the word out on the street”, and magically the vehicle was returned to Mr. Chambers. The debtor also stated that they tried their best to put the vehicle back in decent shape, but ran out of time. Following the debtor’s deposition, I tried to immediately take Mr. Chambers’ deposition, but he and the debtor said that they had no time and had a child care problem. A new date was set for Mr. Chambers’ deposition. However, he failed to show on that date. I advised the Court of this lack of cooperation, asked for a continuance to obtain the necessary evidence to prove my case. The Court granted the continuance and set a new trial date. I then set a new deposition date for Mr. Chambers, who, this time did show up, although about an hour late again. Mr. Chambers’ testimony was similar, but somewhat inconsistent with that of the debtor in some key areas.
     On the trial date Mr. Chambers’ failed to appear in Court despite subpoena. His deposition was submitted into evidence, and the Court issued a Show Cause summons against him for his non-appearance. After hearing all of the evidence, the Court ruled that the debtor did willfully and maliciously injure the Credit Union by depriving it access to and repossession of the collateral securing its loan pursuant to Bankruptcy Code Section 523(a)(6), and awarded non-dischargeability to the extent of the Credit Union’s reasonable loss based upon the debtor’s conduct.
     The lesson of Hembrick: be diligent about repossession efforts, document all events, and if the debtor deprives you of the security and attempts to discharge the debt in a Chapter 7 bankruptcy case, object!