Redemption in Chapter 7 Bankruptcy

What exactly is Redemption?

11 U.S.C §722 authorizes an individual debtor to redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing dischargeable consumer debt. A debtor in a Chapter 7 bankruptcy may have the ability, or more accurately, the opportunity to redeem personal property. Redemption is the process in which a debtor in bankruptcy elects to pay the secured portion of a loan, allowing the debtor to keep the property, while, discharging the unsecured portion of the debt. The debtor pays an amount equal to the fair market value of the loan collateral. Basically, the debtor pays the secured creditor the fair market value of the property or an amount equivalent to the secured portion of the debt, discharges the unsecured portion of the debt, and gets to keep the property. Redemption does not apply to non-consumer debts such as business debts or tax debt. Redemption does not apply to property not intended for personal or family use. In addition, redemption only applies to a debtor’s interest in the property is exempt or has been abandoned.

Because the debtor retains ownership and possession of exempt property, a secured creditor’s lien on the property remains unsatisfied. Although a bankruptcy discharge disposes of all personal liability of the debtor, see 11 U.S.C. § 524(a) (2), a discharge does not dissolve a creditor’s lien on exempt property, see Dewsnup v. Timm, 502 U.S. 410, 418, 112 S. Ct. 773, 116 L. Ed. 2d 903 (1992); Farrey v. Sanderfoot, 500 U.S. 291, 297, 111 S. Ct. 1825, 114 L. Ed. 2d 337 (1991). Instead, the lien survives the bankruptcy proceedings and remains a vehicle for actions against the debtor in rem. See Johnson v. Home State Bank, 501 U.S. 78, 84, 111 S. Ct. 2150, 115 L. Ed. 2d 66 (1991). Thus, although bankruptcy staves off actions against the debtor personally, it does not prevent in rem actions, such as repossession or foreclosure, to recover exempted secured collateral.

Redemption is not the same as reaffirming a debt which is governed by Section 524. Of the Bankruptcy Code. When a debtor reaffirms a debt, the debtor is asking the Court to allow the debtor to keep responsibility for the debt so that the debtor can continue to make payments after the debtor receives a discharge. When reaffirming a debt, the underlying debt is not discharged. When a debtor redeems property, the Debtor is paying off the secured portion of the debt and discharging the unsecured portion of the debt. After the redemption process is completed, the debtor has no more ties to the secured creditor.

If a debtor owns a car with a fair market value of $15,000 and had an automobile loan with a balance of $28,000, the debtor could redeem the vehicle by paying the secured creditor $15,000 which is the secured portion of the loan. The unsecured portion of the automobile loan or $13,000 will then be treated as an “unsecured debt” and will likely be discharged in the Chapter 7 bankruptcy. Accordingly, the debtor can keep the vehicle.

Property eligible for Redemption.

As mentioned earlier, a debtor can only redeem property of a personal nature such as vehicles, boats or watercraft, household furniture or appliances, or other items used by a debtor or the debtor’s family. Real property such as the debtor’s home is not eligible for redemption, neither are items used by the debtor in a business. For example, a debtor can redeem a personal vehicle which is used for grocery shopping or to take the children to and from school, but a debtor may not redeem a tow truck used in the debtor’s auto-body business.  The property must also be exempt under Section 522 of the Bankruptcy Code or the applicable state exemptions or the property must have been abandoned by the bankruptcy estate. Property which is not exempt is not eligible for redemption.

A motion to the Bankruptcy Court is required to redeem property.

In order to redeem property, a debtor must file a motion with the Bankruptcy Court. A debtor must demonstrate to the Court the fair market value of the property, the amount owed to the secured creditor, that the property is indeed exempt or abandoned, and that the debtor has secured the funding to pay off the secured portion of the loan. The Bankruptcy Court held that neither the Bankruptcy Code nor the Federal Rules of Bankruptcy Procedure authorizes the performance of redemption agreements absent judicial approval. In re Spivey, 230 B.R. 484 (Bankr.E.D.N.Y.1999).

For example, let us assume that a debtor is seeking to redeem the family’s 2019 Dodge Grand Caravan Minivan. The fair market value of the vehicle is $18,000 but because the debtor purchased the vehicle off lease with a very high interest rate, the balance due on the loan is $28,000. The Debtor must first demonstrate to the Court that the balance owed on the automobile loan is $28,000. This can be done by attaching the most recent auto-loan statement to the motion as an exhibit. The debtor must then demonstrate to the Court that the fair market value of the vehicle is $18,000 to establish that the secured portion of the loan is $18,000 (or the fair market value of the vehicle) and that the unsecured portion of the loan is $10,000 or the difference between the loan balance of $28,000 and the fair market value which is $18,000. It Is in the Debtor’s best interest if the vehicle valuation to be as low as possible to allow some wiggle room should the creditor file an objection to debtor’s motion. A debtor may be tempted to use a Kelly Blue Book printout to establish the fair market value of the vehicle. The accuracy of a Kelly Blue Book valuation can often vary wildly, leaving the creditor and the Court open to question the valuation’s voracity. The website Edmunds.com may be a little more accurate in that this site bases the value of a vehicle on the license plate number or vehicle identification number. This method can take into account if there have been any previous insurance claims or accidents regarding the vehicle which may lower the car’s value. This is often the creditor’s preferred method for obtaining the value of a vehicle as the creditor rarely has personal access in which to obtain an actual physical appraisal. This method however may also be flawed, as it cannot account for outer and inner body damage unknown to the website at the time. The preferred method for a debtor to obtain a valuation is always a physical appraisal. A physical appraisal will allow for dings and dents or interior damage. Remember, the debtor wants a valuation to be as low as possible to help counter the creditor’s assertion that the secured portion of the car loan higher than it actually is. The debtor will have to take the vehicle to a company which specializes in vehicle appraisals. This could cost the debtor anywhere from $100 to $200 which is money wells spent. In addition, the Court will often give greater credence to a physical appraisal over that of an online valuation as they tend to be more accurate. The physical appraisal should be attached to debtor’s motion as an exhibit.

The “value of the collateral” is subject to some debate. Some creditors argue that the value is represented by the replacement valuation developed by Associates Commercial Corp. v. Rash, 520 U.S. 953, 117 S. Ct. 1879, 138 L. Ed. 2d 148 (1997). However, most courts hold that the redemption price is the liquidation value: what the creditor would recover if it repossessed and resold the collateral. See, e.g., In re Weathington, 254 B.R. 895, 899 (6th Cir.BAP2000); In re Tripplett, 256 B.R. 594 (Bankr.N.D.Ill.2000).

Next, the debtor will have to demonstrate to the Court that the vehicle is exempt or abandoned. Assuming that the debtor is using the federal bankruptcy exemptions, the debtor should apply the motor vehicle exemption (11 U.S.C. §522(d)(2) on Schedule C of the debtor’s Chapter 7 bankruptcy petition and attach this as an exhibit redemption motion. If the property has been abandoned, the debtor will have to provide proof of such in the form of an exhibit attached to the motion.

The debtor will then have to demonstrate proof of funds in which to redeem the property. If the funds in question are not excessive, a family member may help the debtor to pay the secured creditor and can demonstrate proof of funds by providing a bank statement or other equivalent financial statement which debtor can then attach to the motion. There are also lenders that specialize in providing loans to debtor’s in Chapter 7 bankruptcy who are seeking to redeem property. Often a debtor can fill out an application online and find out relatively quickly whether they qualify for a new car loan which can be used to redeem the vehicle. There are often several restrictions attached to the loan such as the age of and mileage on the vehicle. In addition, these types of loans often come with high interest rates. A debtor must determine if it is his or her best interest to borrow these funds if the interest rate will be increased. This is done with a simple analysis. The debtor must first calculate what will be paid back on the balance of the loan if the debtor keeps the existing loan. For example, let’s assume the debtor will pay back $28,000 at 7.50% over sixty months which is the balance of the current loan. The debtor’s monthly payment will be $561.06 and the debtor will pay the lender a total of $47,653.75. If the debtor obtains a new loan to redeem the vehicle and pays back $18,000 over seventy-two months at 15.00% interest, the debtor’s monthly payment will be $380.61 and the debtor will end up paying back a total of $40,343.94. Assuming the debtor pays a bankruptcy attorney $1,000 for the motion and $200 for a physical appraisal, the debtor will have a new savings of $6,109.81 as well as a significantly lower monthly loan payment.

What if the secured creditor objects to debtor’s motion?

Most secured creditors will not lie down and allow debtors to keep property using the redemption process without a fight. The majority of secured creditors will file opposition to the debtor’s redemption motion. Opposition usually consists of attacking the debtor’s valuation. As explained previously, the secured creditor will seek to demonstrate the highest possible fair market value of the underlying property. This is done for two reasons, firstly, if the secured creditor can lower the amount of the unsecured portion of the debt by increasing the value of the property, it may make not financially feasible to redeem the property, or in the alternative, if the redemption motion is ultimately granted, the secured creditor is seeking to maximize its payout.            

The secured creditor will use best efforts to cast doubt on the debtor’s valuation while convincing the Court of the voracity of the valuation proffered by the creditor. The Court will often give more weight to a physical appraisal and if need be, the debtor can also have the professional who prepared the appraisal appear as an expert witness. Keep in mind that an expert witness will want to be paid for his or her time. Assuming that the debtor stands to save thousands of dollars by redeeming the property, there should be room in the number to pay an expert to testify before the Court. It is often helpful to use the same appraisers often used by bankruptcy trustees as they are already familiar with the process and the Court is often familiar with their work.

Many of the attorneys who represent secured creditors may not be located in the actual district in which debtor’s bankruptcy or motion have been filed. This means that the creditor’s attorney would have to hire local counsel to appear per diem at the hearing on the motion. Local counsel may not be as familiar with counsel’s papers as would be the attorney who drafted and filed the opposition. As many of the bankruptcy judges have returned to in person hearings, this may be an incentive for creditor’s counsel to seek a settlement in the matter instead of appearing on the motion. If the debtor’s appraisal and the secured creditor’s valuation are not worlds apart, it may be possible to settle the matter if the parties can find some middle ground regarding the value of the property. Assuming the debtor’s appraisal states that the property is worth $18,000 and the secured creditor’s valuation states that the property is worth $23,000, the difference between the two valuations is $5,000. If the parties meet in the middle and agree that the property is worth $20,500, the debtor will still save a significant amount of money in the long run and the creditor will be satisfied in knowing that it maximized its return. Both parties will also avoid the uncertainty of having the Court make a determination regarding the motion. The parties can then submit a stipulation to the Court which can be so ordered. Other portions of the motion may still have to be determined by the Court, such as attorney’s fees and the unsecured portion of the debt being deemed unsecured and discharged. Before finalizing such an agreement, debtor must make certain that the newly agreed upon valuation will not negatively affect the terms of the proposed financing. The Court may still have to approve the financing portion of the motion. If the source of the funds is coming from a family member or friend, the parties are free to stipulate as to the value of the property unhindered.

Is Redemption worth the cost and effort?  

As with all motions, there is no guarantee of success. If the motion is not successful, the debtor may be out the cost of an appraisal and maybe the fees and expenses.  A debtor must determine if these costs are worth the risk should the motion not be granted or if an agreement cannot be reached with the secured creditor. A debtor can best determine if Redemption is a viable option by having all the pertinent information available, such as cost, value of the property, cost associated with a new loan and the motion, and determining, after having a frank discussion with debtor’s attorney, what the potential savings are.  Redemption can be a very useful tool at the debtor’s disposal that may make it worth retaining property that has negative equity. If the debtor determines that Redemption is not a viable option, a debtor can then consider whether reaffirming the debt is a viable option or whether it may make more sense to simply surrender the property. Besides redemption, or reaffirmation, a debtor also has the options of challenging the creditor’s secured standing or simply surrender the collateral. See In re Bushey, 204 B.R. 661, 663 (Bankr.N.D.N.Y.1997). In addition, a debtor who has not defaulted on the security obligations may have the right to retain the property and remain current on payments. See In Re Brian K Boodrow, 126 F.3d 43.