Paying Back the Loss: No Loss Policies and Member Bankruptcy

By: Robert Rutkowski, Partner and Bryan Kostura, Associate

Many credit unions have no loss policies. When a member causes the credit union a loss, the member either loses services (down to a share account and the right to vote at meetings) or, in the case of some state credit unions, the member is expelled. At times, a member will come to grips with financial reality and seek rehabilitation. In most cases, all that is necessary to get back in the good graces of the credit union is to pay back the loss the member caused in the first instance. Unfortunately this simple concept becomes exponentially more difficult when the member is in the midst of a bankruptcy. During those instances a credit union needs to walk a fine line between educating the member on how restore member benefits and active debt collection. When a member asks the credit union, “How can I become a member again?” or “How can I get my services back?,” the response is easy: “Eliminate the loss.” However, if not handled carefully, this could result in the well meaning credit union violating the Federal Bankruptcy Court Stay.

The purpose of the automatic stay is to give a debtor a brief reprieve from creditors and prevent one creditor from rushing to enforce a lien to the detriment of other creditors. The stay protects the debtor and his creditors by allowing the debtor to organize his affairs, and ensures that the bankruptcy procedures operate to provide an orderly resolution of all claims.

Notwithstanding this prohibition against the collection of discharged debts, a debtor may repay debts that would otherwise be dischargeable, either by entering into a formal reaffirmation agreement or by making voluntary payments in the absence of such an agreement.

After bankruptcy debtors may repay debts as they choose without being legally obligated in the event they later become unable to fulfill their intention.

While repayment induced by harassment or duress by a creditor is clearly prohibited, it is unclear to what extent a debtor’s repayment must be free from external influences. One meaning of “voluntary” would require that the repayment be spontaneous, that is, induced by nothing other than the debtor’s own conscience. On the other hand, “voluntary” is often used to refer to actions resulting from one’s interest in experiencing gain or avoiding loss. Under this interpretation, figuring out whether or not a repayment is “voluntary” would be determined from the totality of circumstances surrounding the repayment.

With respect to credit unions specifically, courts have held that the mere cancellation of the debtor’s membership privileges, such as maintaining an interest-bearing share account for the debtor, or maintaining a checking account for the debtor, is not a withdrawal of privileges unique to union membership and therefore not so valuable as to be found coercive. However, where the creditor combines the cancellation with certain acts that result in the repayment of a discharged debt, those acts may violate the Bankruptcy Code.

Courts have discussed acts that go beyond mere cancellation. For example, a credit union violates the stay by terminating a debtor’s membership, refusing to accept his mortgage payments, and subsequently declaring the mortgage in default. Although terminating the debtor’s membership is not a coercive act, refusing mortgage payments and foreclosing on the mortgage is coercive.

Courts have consistently held that the mere cancellation of a debtor’s credit union membership, although perhaps against public policy to some extent, does not violate the automatic stay or the discharge injunction as an act to collect a dischargeable or discharged debt. When credit unions have a policy of terminating membership privileges to any member who caused it a loss, courts have held that this does not violate the automatic stay.

Courts have discussed whether notification of the credit union’s policy amounts to coercion. The consensus among the courts that have examined this issue is that it is not a violation. The rational is that nothing in the Bankruptcy Code requires a creditor to do business with a debtor; therefore, simply notifying a debtor of its policy is not a violation.

In summary, actions taken by a creditor in the process of seeking voluntary repayment of a post-petition indebtedness violates the Bankruptcy Code only if the action (1) could reasonably be expected to have a significant impact on the debtor’s determination as to whether to repay, and (2) is contrary to what a reasonable person would consider to be fair under the circumstances. Further, mere notice of a stop loss policy by a credit union does not violate Bankruptcy law, so long as the notice is not coupled with coercive acts.

If you have further questions or require additional explanation related to this topic Robert Rutkowski, Partner of WWR’s Credit Union Department or Bryan Kostura, Associate with WWR’s Bankruptcy Department would be happy to talk with you.

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