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New Challenges for Attorneys Signing Reaffirmation
Meeting a Heightened Standard of Judicial Review
by J. Christopher Marshall
United States Trustee, Region 1
and Eric K. Bradford
Attorney Advisor, Boston
Duties of Debtor's Counsel
The attorney's declaration under Bankruptcy Code Section 524 that a
reaffirmation agreement imposes no "undue hardship" upon the debtor client has
always carried the potential for conflict unique to bankruptcy law. Potentially,
it pits the lawyer's duty to advocate for clients who wish to reaffirm
pre-petition debt, usually to retain goods that secure the debt, against the
totally independent duty under Section 524(c) to certify that a reaffirmation
imposes "no undue hardship" on the client. Reaffirmation abuses described in
In re Latanowich and in the National Bankruptcy Review Commission Final
Report have spawned heightened judicial scrutiny of the attorney's duties before
signing the Section 524 declaration. In cases such as In re Hovestadt
and In re Bruzzese, and especially the recent case of In re
Melendez, judges have examined in detail the lawyers' diligence, or lack
thereof, in investigating whether their clients should sign a reaffirmation
However, a new form of disclosure statement and reaffirmation
agreement recently promulgated by the Administrative Office of the United States
Courts (AOUSC) has provided attorneys with a useful tool for meeting their
obligations. New Form B240 not only facilitates judicial review of reaffirmation
agreements, but also informs the debtor of the consequences of the reaffirmation
and acts as a checklist for counsel to consider before signing the Section
524(c) declaration. Form B240 has already been adopted in at least two
jurisdictions, the Northern District of California and the District of
Massachusetts. We suggest that debtor's counsel use the form even if it is not
required by local rule.
Evolution of Section 524: Contradictory Roles
As initially enacted in 1978, Section 524 prescribed a formal
reaffirmation process in order to preserve the paramountcy of a debtor's
discharge. It required a bankruptcy court to determine, upon hearing and notice,
whether a proposed reaffirmation agreement was in a debtor's best interest and
did not impose an "undue hardship" on a debtor or her dependents. A hearing was
required in every case.
Congress partially streamlined the reaffirmation procedure in 1984 by
making reaffirmation agreements negotiated with the assistance of counsel
effective upon filing, subject to an attorney's certifying that the agreement
imposed no "undue hardship" on the debtor or a dependent. Amendments enacted in
1994 further required the attorney to certify that she had fully advised her
client of the legal consequences of reaffirmation and default and that the
agreement represented a fully informed and voluntary decision.
While not vitiating the bankruptcy court's oversight of the
reaffirmation process, amended Section 524(c) shifted the onus of reviewing a
reaffirmation agreement to the debtor's attorney. It thus placed a debtor's
attorney in a contradictory role--serving as the advocate for her client's
interests, but being required to "veto" the debtor's decision to reaffirm by not
executing a supporting affidavit if she believed, in the exercise of her
independent judgment, that doing so would impose an undue hardship.
For a time, bankruptcy courts were content to take attorney
declarations at face value, opting not to question their reasonableness under
the circumstances. But some judges noticed that attorneys were submitting
statements supporting reaffirmation agreements where a debtor's Schedule "J"
monthly expenses exceeded her Schedule "I" monthly income, suggesting that the
attorneys' scrutiny was, at best, perfunctory. While some debtors might have
deliberately understated income and overstated expenses to avoid dismissal for
substantial abuse under Section 707(b), this was hardly an issue for the poorest
debtors, some of whom were on welfare or showed no income at all.
Circuit Split on "Ride Through"
If the debtor seeks to reaffirm in order to retain collateral, as
opposed to obtaining new credit, the dilemma may be exacerbated in those
judicial circuits that do not allow a "ride through"--the so-called "fourth
option." Section 521(2)(A) requires a debtor, within 30 days of the petition
date, to file a statement as to whether he intends to surrender, to reaffirm, or
to redeem estate property securing pre-petition consumer debt. Section 521(2)(B)
requires the debtor, within 45 days, to perform his stated intention. Four
Circuit Courts of Appeal--the Second, Fourth, Ninth, and Tenth-have held that a
debtor who is current on payments has a fourth option under Section 521 of
continuing to make payments without either reaffirming the debt or redeeming or
surrendering the property, thereby "riding through" the bankruptcy and
converting the original obligation to a non-recourse loan.
The First, Fifth, Seventh, and Eleventh Circuits, however, have held
that a debtor must elect and then perform only one of the three options listed
in Section 521--surrender, reaffirmation, or redemption. If a debtor wishes to
keep the collateral and cannot afford to redeem for fair market value or
persuade the creditor to "ride along," his sole option is to reaffirm. Some
cases have held that a debtor and his attorney bear the burden of diligently
performing his stated intention; the court in In re Donnell recently
indicated that the Chapter 7 trustee, consistent with duties imposed under
Section 704(3), must monitor the debtor's progress in doing so. In In re
Harris, the court even held that a debtor's failure to effectuate
intentions stated under Section 521 was a ground for dismissal of the case "for
cause" under Section 707(a). Thus, in those circuits that do not provide a ride
through, the options available to the debtor are fewer and the pressure on
debtor's counsel to sign a declaration supporting reaffirmation may be greater.
Hovestadt, Bruzzese, and Melendez
In Hovestadt, Bruzzese, and Melendez, the
debtors sought to reaffirm pre-petition debts, which they could not repay with
their post-discharge net income, as indicated by Schedules "I" and "J." In
Hovestadt and Melendez, the debtors sought to reaffirm in order to
keep consumer goods; in Bruzzese, they sought to reaffirm as a
prerequisite to obtaining additional post-discharge store credit. Counsel in
each case certified that reaffirmation imposed no "undue hardship" and that the
agreements were voluntary and informed.
The courts, after reviewing the agreements, issued orders requiring
the debtors and their attorneys to show cause why they should not be sanctioned
for seeking to reaffirm, given the debtors' inability to pay their living
expenses, let alone the additional reaffirmed debts. In Melendez, the
court directed the show cause orders to eight different debtors and their
counsel. Each court determined that, despite the 1984 amendments to the
Bankruptcy Code, it had an independent duty to review the debtors' reaffirmation
agreements under Section 524(c).
The courts ultimately struck the attorneys' supporting statements
under Bankruptcy Rule 9011, nullifying the reaffirmation agreements, because the
attorneys appeared to have ignored the debtors' financial circumstances and
failed to advise the debtors of alternatives to reaffirmation, such as
redemption under Section 722. The Melendez court held that Rule 9011
required attorneys to make a reasonable inquiry based upon "the totality of the
circumstances" before signing a Section 524(c) declaration. The Bruzzese
court required the debtors' counsel to refund $200 as "excessive compensation"
for the services performed for the debtors in connection with the case. Monetary
sanctions were not levied against the attorneys in Hovestadt or
Melendez, but in both cases the court indicated it would consider doing so
in the future.
The Melendez court held that, for a Section 524(c)
declaration to pass muster under Rule 9011, a debtor's attorney must: establish
whether the debtor can pay the reaffirmed debt; review the security agreement
and sales receipt, verify the creditor's claim and determine the extent,
validity and perfection of the creditor's purported security interest;
independently estimate the value of the collateral; evaluate the risk of replevy
by the creditor; discuss the relevant financial disclosures with the debtor;
ensure that the agreement was entered into voluntarily and without creditor
misrepresentations or coercion; ensure that the debtor understands the effect of
the agreement and the consequences of default; ensure that the debtor is
informed as to his options as to the collateral; and advise the debtor regarding
alternative sources of credit.
Although daunting at first blush, the list of "to do's" can best be
addressed by using a new form reaffirmation agreement offered by the AOUSC.
The AOUSC's Form B240
On June 17, 1999, the AOUSC issued a proposed reaffirmation
agreement, Form B240, which addresses at least some of the concerns raised by
Bruzzese and Melendez. An attorney who follows the form will
go a long way toward meeting her obligations of reasonable inquiry under the
circumstances and informing the client of the consequences of reaffirmation.
The form was developed as the result of a recommendation by the
National Bankruptcy Review Commission. In its final report issued Oct. 20, 1997,
the commission recommended that the United States Judicial Conference's Advisory
Committee on Bankruptcy Rules "prescribe a form motion for approval of
reaffirmation agreements that contains information enabling the court and the
parties to determine the propriety of the agreement." Approval of the motion
would not entail a separate court order, the commission stated.
The commission reported that the use of reaffirmation agreements was
far more prevalent than previously estimated and that Section 524 did not always
work as intended. The commission's report cited a National Survey of Bankruptcy
Debtors commissioned by Visa, which stated that 52 percent of the debtors
reported reaffirming one or more debts and that 50 percent of the reaffirmations
filed were for unsecured, nominally secured, or undersecured debt. As to the
role of debtor's counsel, the report stated:
Some debtors' attorneys refuse all requests for reaffirmations, while
others believe that debtors can benefit from carefully chosen reaffirmation
agreements. However, other attorneys apparently believe that they should not
interfere in the reaffirmation decision. In the absence of zealous,
well-informed counsel, many debtors commit to significant post-discharge
obligations. The burden of economically unwise reaffirmations falls especially
hard on the debtors with the fewest resources to hire careful counsel.
Using the Form to Discharge Counsel's Duties
Given the history of abuses and the trends in case law, debtors'
counsel should negotiate reaffirmation agreements more carefully. Clients and
counsel both need to make informed and defensible decisions where the monetary
stakes may be small but the client's stake in her property is critically
important. The following is a brief discussion of how counsel can meet her
obligations and how the new form can be helpful.
Does Reaffirmation Impose An "Undue Hardship?"
In evaluating whether a proposed reaffirmation agreement imposes an
"undue hardship," an attorney should first understand her client's financial
situation, as expressed most basically in household income and expenses listed
on Schedules "I" and "J," which she should be prepared to update as needed.
While acknowledging that the Bankruptcy Code does not define "undue hardship,"
the Melendez court generally offered that it "would deem reaffirmation
to cause a debtor 'undue hardship' where it would result in a significant, but
otherwise avoidable, obstacle to the attainment or retention of necessaries by
the debtor or the debtor's dependents."
If the debtor will realize positive, post-discharge net income,
neither the agreement nor the certification should pose a problem, because
"payment of a reaffirmed debt cannot constitute an undue hardship where the
funds come from disposable income." However, if the debtor's post-discharge
expenses will exceed his income and/or the debt exceeds the likely value of any
collateral securing it, the attorney should consider other factors, which
implicate whether the debtor's decision to reaffirm is both fully informed and
Counsel should consider the type of collateral involved. If the
collateral is the debtor's residence or automobile, reaffirmation may be more
justifiable, "because those [are] items of indisputable necessity and
substantial value regardless of the terms offered by the creditor and because
failure of the debtor would likely result in foreclosure and replevy..." But for
collateral such as household items, the attorney must evaluate necessity in
light of the replacement cost, "taking into consideration age, obsolescence or
other factors that might render it valueless...
Critically important is an evaluation of whether the creditor will
seek to replevy or foreclose on the collateral, and if it does, whether the
client has an alternative. Ultimately, evaluating the likelihood of repossession
is a crucial, and perhaps the most difficult, element of the attorney's advice.
Is The Agreement Informed And Voluntary?
The cover page alone of Form B240 helps an attorney meet her
obligation to assure that a reaffirmation agreement is informed and voluntary.
The form's first page is a plainly worded "Notice to Debtor." It advises that:
the agreement gives up the protection of the bankruptcy discharge, the creditor
can act to collect the debts, there is a right of recession, the debtor is not
obligated to enter into the agreement, the debtor can pay the debt without
signing the agreement, and there is a right of redemption.
The attorney should explain the financial terms of the reaffirmation
agreement, including interest on the debt and other associated costs. Form B240
encourages such an explanation by requiring disclosure of the amount of the debt
reaffirmed and the composition of that debt, such as whether it includes accrued
interest, attorney's fees, or late fees. It also requires disclosure of the
interest rate, the monthly payment amount, the date upon which payments start,
and the number and amount of payments if paid according to schedule. Further,
the form requires attachment of all court judgments, security agreements, and
evidence of perfection.
Bruzzese and Melendez require the attorney to check
the valuation of the collateral rather than accepting the creditor's statement
of value. The form, however, merely requires a creditor's statement describing
the collateral, with assertions regarding value and lien validity. Counsel would
be well advised to go beyond the requirements of the form with respect to
collateral valuation, to ensure that the requirements of case law are met.
Did the Attorney Advise on Legal Consequences?
Finally, the attorney should explain the legal consequences of
reaffirmation default, discuss alternatives to reaffirmation such as redemption,
and ensure that the debtor is voluntarily entering the agreement without
coercion. The form's "Notice to Debtor" explains that the agreement gives up the
protection of the bankruptcy discharge and that the creditor may be able to take
the debtor's property or wages if payment is not made. The form requires the
debtor to state why she chose not to redeem and whether she was represented by
counsel in the negotiations.
If the attorney performs this entire analysis, which would be aided
by completion of Form B240, both the interests of the client in deciding whether
to reaffirm and the duty of the lawyer to determine whether the reaffirmation
imposes an undue hardship will be served. However, if after completing the form
and doing a due diligence analysis the attorney cannot, in the exercise of
independent judgment, execute a declaration supporting reaffirmation, she might
consider refusing to affix her signature and filing the reaffirmation agreement
without the declaration, thereby letting the court decide the matter.
In summary, reaffirmation agreements and attorneys' declarations are
under increased judicial scrutiny. The emerging standard of care for a consumer
debtor's attorney counsels a more cautious and informed approach to
reaffirmation. Use of the new Form B240 should aid attorneys in discharging
their duties to both the client and the court, while allowing Section 524(c) to
operate as intended.
Bankruptcy Basics - For Cases Filed on or after October 17, 2005 (pdf)
Basics - For Cases Filed before October 17, 2005 (pdf)
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