First State Bank is a secured party on a $5,000 loan to Geoff, who owns Happy Hours, a nightclub. When Geoff experiences financial difficulty, creditors other than First State Bank petition him into involuntary bankruptcy. The value of the secured collateral has substantially decreased in value. On its sale, the debt to First State Bank is reduced to $2,500. Geoff's estate consists of $100,000 in exempt assets and $2,000 in nonexempt assets. After the bankruptcy costs and back wages to Geoff's employees are paid, nothing is left for unsecured creditors. Geoff receives a discharge in bankruptcy. Later he decides to go back into business. By selling a few exempt assets and getting a small loan, he is able to buy the Idle Inn, a small, but profitable, restaurant. Geoff goes to First State

Question

Bank for the loan. The bank claims that the balance of its secured debt was not discharged in Geoff's bankruptcy. He signs an agreement to pay First State Bank the $2,500, and the bank makes a new unsecured loan to him. Is First State Bank correct that the balance of its secured debt was not discharged in bankruptcy? What is the legal effect of Geoff's agreement to pay the bank $2,500 after the discharge in bankruptcy?

What will be an ideal response?

Answer 1

A secured creditor is entitled to priority to the proceeds from the disposal of the secured collateral of the bankrupt debtor up to the amount of the debt owed. Should the proceeds not cover the secured debt, the secured party becomes an unsecured creditor for the balance. Unless the debtor is denied a discharge in bankruptcy, all debts of the debtor are rendered void upon the granting of the discharge. In this case, First State Bank is incorrect. First State Bank became an unsecured creditor to the balance of $2,500 owed. Geoff's discharge in bankruptcy discharged his obligation to pay the debt.

The Bankruptcy Code restricts the legality of reaffirmations-agreements to pay debts discharged in bankruptcy. For these agreements to be binding, they must be executed before the discharge in bankruptcy is granted. All reaffirmation agreements must be filed with the court. Unless the debtor (Geoff) is represented by an attorney, court approval is required. The court will only approve the reaffirmation if the agreement will not cause her a hardship and is in the best interests of Geoff. If Geoff is represented by an attorney, the attorney must file a declaration or affidavit stating that Geoff was fully informed of the consequences, the agreement was voluntarily made, and the agreement does not impose a hardship on Geoff or her dependents. Geoff has a right to rescind this agreement. Because the reaffirmation agreement in this case was made after Geoff's discharge in bankruptcy, she is not legally obligated to pay the $2,500 debt previously discharged in bankruptcy.