Federal Bank is a secured party on a $50,000 loan to Gigi, who owns Home HealthCare, an assisted living facility. When Gigi experiences financial difficulty, creditors other than Federal Bank petition her into involuntary bankruptcy. The value of the

Question

secured collateral has substantially decreased in value. On its sale, the debt to Federal Bank is reduced to $25,000 . Gigi's estate consists of $100,000 in exempt assets and $20,000 in nonexempt assets. After the bankruptcy costs and back wages to Gigi's employees are paid, nothing is left for unsecured creditors. Gigi receives a discharge in bankruptcy. Later she decides to go back into business. By selling a few exempt assets and getting a small loan, she is able to buy Indulgence, a small, profitable nightclub. Gigi goes to Federal Bank for the loan. The bank claims that the balance of its secured debt was not discharged in Gigi's bankruptcy. She signs an agreement to pay Federal Bank the $25,000, and the bank makes a new unsecured loan to her. IsFederalBank correct that the balance of its secured debt was not discharged in bankruptcy? What is the legal effect of Gigi's agreement to pay the bank $25,000 after the discharge in bankruptcy?

Answer 1

A secured creditor is entitled to priority to the proceeds from the dis-posal 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 be-comes an unsecured creditor for the balance. Unless the debtor is denied a dis-charge in bankruptcy, all debts of the debtor are rendered void on the grant-ing of the discharge. In this case, Federal Bank is incor-rect. Federal Bank became an unsecured creditor to the balance of $25,000 owed. Gigi's discharge in bankruptcy discharged her obligation to pay the debt.
The Bankruptcy Code restricts the legality of reaffirma-tions—agreements to pay debts discharged in bankruptcy. For these agree-ments to be binding, they must be executed before the discharge in bankruptcy is granted. All reaf-firmation agreements must be filed with the court. Unless the debtor (Gigi) is repre-sented by an attorney, court approval is required. The court will only approve the reaf-firmation if the agreement will not cause the debtor a hardship and is in her best interests. If Gigi is represented by an attor-ney, the attorney must file a declaration or affidavit stat-ing that Gigi was fully informed of the consequences, the agreement was voluntarily made, and the agreement does not impose a hardship on Gigi or her de-pendents. Gigi has a right to rescind this agreement. Because the reaffirma-tion agreement in this case was made after Gigi's discharge in bankruptcy, she is not le-gally obligated to pay the $25,000 debt previously discharged in bankruptcy.